##### **UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D. C.  20549**

 

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

 

**x        QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.**

** **

**For thequarterly period ended January 26, 2008**

 

**o        TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition periodfrom                 to**

 

 

**Commission file number 000-24990**

 

**WESTAFF,INC.**(Exact name of registrant as specified in its charter)

 
| **Delaware**                       | ** ** | **94-1266151**         |
|------------------------------------|------------|------------------------|
| (State or other  jurisdiction      |       | (I.R.S.employer        |
| of incorporation or  organization) |       | identification number) |

 

##### **298 North Wiget Lane**

##### **Walnut Creek, California 94598-2453**

##### (Addressof registrant’s principal executive offices, including zip code)

** **

** **

**(925) 930-5300**

(Registrant’stelephone number, including area code)

 

Securitiesregistered pursuant to Section 12(b) of the Act:

 

 

 

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.    Yes x    No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reportingcompany.  See the definitions of  “large accelerated filer”, “accelerated filer”,“non-accelerated filer”and “smaller reporting company” in Rule 12b-2 of theExchange Act.  (Check One):

 

| Large accelerated file o |   | Accelerated filer o |   | Non-accelerated filer x                         |   | Smaller reporting company  o |
|-------------------------------|--------|--------------------------|--------|------------------------------------------------------|--------|-----------------------------------|
|                          |   |                     |   | (Do not check if a  smaller reporting  company) |   |                              |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).    Yes o    No x

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date:

 

 

| **Class**                      | ** ** | **Outstanding  at March 6, 2008** |
|--------------------------------|------------|----------------------------------------|
| Common Stock,  $0.01 par value |       | 16,697,010  shares                     |

##### ** **

##### ** **

----

 

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

#####  

**INDEX**

 
|              |                                                                                                              |   | **Page** |   |
|-------------------|-------------------------------------------------------------------------------------------------------------------|--------|----------|--------|
|              |                                                                                                              |   |     |   |
| **Part I.**  | **Financial  Information**                                                                                        |   |     |   |
|              |                                                                                                              |   |     |   |
| Item 1.           | Financial  Statements (Unaudited)                                                                                 |   |     |   |
|              |                                                                                                              |   |     |   |
|              | Condensed  Consolidated Balance Sheets - January 26, 2008 and November 3, 2007                          |   | 3        |   |
|              |                                                                                                              |   |     |   |
|              | Condensed Consolidated Statements of Operations - 12  weeks ended January 26, 2008 and January 20, 2007 |   | 4        |   |
|              |                                                                                                              |   |     |   |
|              | Condensed Consolidated Statements of Cash Flows - 12  weeks ended January 26, 2008 and January 20, 2007 |   | 5        |   |
|              |                                                                                                              |   |     |   |
|              | Notes to Condensed Consolidated Financial Statements                                                              |   | 6        |   |
|              |                                                                                                              |   |     |   |
| Item 2.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                       |   | 17       |   |
|              |                                                                                                              |   |     |   |
| Item 3.           | Quantitative and  Qualitative Disclosures About Market Risk                                                       |   | 24       |   |
|              |                                                                                                              |   |     |   |
| Item 4T.          | Controls and  Procedures                                                                                          |   | 24       |   |
|              |                                                                                                              |   |     |   |
| **Part II.** | **Other Information**                                                                                             |   | 25       |   |
|              |                                                                                                              |   |     |   |
| Item  1.          | Legal  Proceedings                                                                                                |   | 25       |   |
|              |                                                                                                              |   |     |   |
| Item  1A.         | Risk  Factors                                                                                                     |   | 25       |   |
|              |                                                                                                              |   |     |   |
| Item 2.           | Unregistered  Sales of Equity Securities and Use of Proceeds                                                      |   | 31       |   |
|              |                                                                                                              |   |     |   |
| Item 3.           | Defaults Upon  Senior Securities                                                                                  |   | 31       |   |
|              |                                                                                                              |   |     |   |
| Item 4.           | Submission of  Matters to a Vote of Security Holders                                                              |   | 31       |   |
|              |                                                                                                              |   |     |   |
| Item  5.          | Other  Information                                                                                                |   | 31       |   |
|              |                                                                                                              |   |     |   |
| Item  6.          | Exhibits                                                                                                          |   | 31       |   |
|              |                                                                                                              |   |     |   |
|              | Signatures                                                                                                        |   | 32       |   |

 

2

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**Part l.  FinancialInformation**

**Item 1.  Financial Statements**

**Westaff, Inc.**

 

**Condensed Consolidated BalanceSheets (Unaudited)**

 
| ** **                                                                                                                                           | ** ** | **January 26,**      | ** ** | **November 3,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|----------------------|------------|
| ** **                                                                                                                                           | ** ** | **2008**                  | ** ** | **2007**             | ** ** |
| ** **                                                                                                                                           | ** ** | **(In thousands, except** | ** ** |
| ** **                                                                                                                                           | ** ** | **per share amounts)**    | ** ** |
| **ASSETS**                                                                                                                                           | ** ** | ** **                | ** ** | ** **           | ** ** |
| Current assets:                                                                                                                                      |       |                      |       |                 |       |
| Cash and cash equivalents                                                                                                                            |       | $                         | 2,446      |                 | $          | 3,277 |   |
| Trade accounts receivable, less allowance for doubtful accounts of  $1,324 and $1,019                                                                |       | 70,849                    |       | 76,098               |       |
| Deferred income taxes                                                                                                                                |       | 9,685                     |       | 9,688                |       |
| Prepaid expenses                                                                                                                                     |       | 3,700                     |       | 4,059                |       |
| Other current assets                                                                                                                                 |       | 1,267                     |       | 1,833                |       |
| Total current assets                                                                                                                                 |       | 87,947                    |       | 94,955               |       |
|                                                                                                                                                 |       |                      |       |                 |       |
| Property and equipment,  net                                                                                                                         |       | 15,285                    |       | 16,186               |       |
| Deferred income taxes                                                                                                                                |       | 12,720                    |       | 12,076               |       |
| Goodwill                                                                                                                                             |       | 12,567                    |       | 12,628               |       |
| Intangible assets                                                                                                                                    |       | 3,690                     |       | 3,695                |       |
| Other long-term assets                                                                                                                               |       | 1,633                     |       | 1,752                |       |
| Total Assets                                                                                                                                         |       | $                         | 133,842    |                 | $          | 141,292 |   |
|                                                                                                                                                 |       |                      |       |                 |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                       | ** ** | ** **                | ** ** | ** **           | ** ** |
| Current liabilities:                                                                                                                                 |       |                      |       |                 |       |
| Borrowing under revolving credit facilities                                                                                                          |       | $                         | 9,906      |                 | $          | 6,837 |   |
| Current portion of capital lease obligations                                                                                                         |       | 562                       |       | 544                  |       |
| Note payable to related party                                                                                                                        |       | 2,000                     |       | 2,000                |       |
| Accounts payable                                                                                                                                     |       | 4,083                     |       | 2,226                |       |
| Accrued expenses                                                                                                                                     |       | 25,585                    |       | 34,147               |       |
| Short-term portion of workers compensation                                                                                                           |       | 9,311                     |       | 9,897                |       |
| Income taxes payable                                                                                                                                 |       | 125                       |       | 113                  |       |
| Total current liabilities                                                                                                                            |       | 51,572                    |       | 55,764               |       |
|                                                                                                                                                 |       |                      |       |                 |       |
| Long-term capital lease  obligations                                                                                                                 |       | 616                       |       | 752                  |       |
| Long-term portion of  workers compensation                                                                                                           |       | 16,000                    |       | 16,000               |       |
| Other long-term  liabilities                                                                                                                         |       | 2,151                     |       | 2,881                |       |
| Total liabilities                                                                                                                                    |       | 70,339                    |       | 75,397               |       |
|                                                                                                                                                 |       |                      |       |                 |       |
| Commitments and  contingencies (Note 13)                                                                                                             |       |                      |       |                 |       |
|                                                                                                                                                 |       |                      |       |                 |       |
| Stockholders’ equity:                                                                                                                           |       |                      |       |                 |       |
| Preferred stock, $0.01 par value; authorized and unissued: 1,000,000  shares                                                                         |       |                      |       |                 |       |
| Common stock, $0.01 par value; authorized: 25,000,000 shares; issued  and outstanding: 16,697,010 at January 26, 2008 and November 3, 2007 |       | 167                       |       | 167                  |       |
| Additional paid-in capital                                                                                                                           |       | 39,635                    |       | 39,561               |       |
| Retained earnings                                                                                                                                    |       | 22,460                    |       | 24,355               |       |
| Accumulated other comprehensive income                                                                                                               |       | 1,241                     |       | 1,812                |       |
| Total stockholders’ equity                                                                                                                      |       | 63,503                    |       | 65,895               |       |
| Total Liabilities and Stockholders’ Equity                                                                                                      |       | $                         | 133,842    |                 | $          | 141,292 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

3

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** **

**Westaff, Inc.**

 

**Condensed Consolidated Statementsof Operations (Unaudited)**

** **
| ** **                                     | ** ** | **12 Weeks Ended**                           | ** ** |
|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                     | ** ** | **January 26,**                         | ** ** | **January 20,** | ** ** |
| ** **                                     | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| ** **                                     | ** ** | **(In thousands, except per share amounts)** | ** ** |
|                                           |       |                                         |       |   |   |
| Revenue                                        |       | $                                            | 116,834    |   | $ | 129,949 |   |
|                                           |       |                                         |       |   |   |
| Costs of services                              |       | 96,587                                       |       | 107,032 |   |
|                                           |       |                                         |       |   |   |
| Gross profit                                   |       | 20,247                                       |       | 22,917 |   |
|                                           |       |                                         |       |   |   |
| Franchise agents’ share of  gross profit  |       | 3,397                                        |       | 3,539 |   |
| Selling and administrative  expenses           |       | 17,419                                       |       | 17,558 |   |
| Restructuring benefit                          |       | (150                                         | )          | — |   |
| Depreciation and  amortization                 |       | 1,375                                        |       | 915 |   |
|                                           |       |                                         |       |   |   |
| Operating (loss) income                        |       | (1,794                                       | )          | 905 |   |
|                                           |       |                                         |       |   |   |
| Interest expense                               |       | 762                                          |       | 571 |   |
| Interest income                                |       | (38                                          | )          | (35 | ) |
|                                           |       |                                         |       |   |   |
| (Loss) income before  income taxes             |       | (2,518                                       | )          | 369 |   |
| Income tax (benefit)  expense                  |       | (623                                         | )          | (35 | ) |
|                                           |       |                                         |       |   |   |
| Net (loss) income                              |       | $                                            | (1,895     | ) | $ | 404 |   |
|                                           |       |                                         |       |   |   |
| (Loss) earnings per share:                     |       |                                         |       |   |   |
| Basic and diluted                              |       | $                                            | (0.11      | ) | $ | 0.02 |   |
|                                           |       |                                         |       |   |   |
| Weighted average shares  outstanding - basic   |       | 16,697                                       |       | 16,590 |   |
| Weighted average shares  outstanding - diluted |       | 16,697                                       |       | 16,658 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

4

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**Westaff, Inc.**

 

**Condensed Consolidated Statements of Cash Flows (Unaudited)**

 
| ** **                                                                                | ** ** | **12 Weeks Ended**   | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                | ** ** | **January 26,** | ** ** | **January 20,** | ** ** |
| ** **                                                                                | ** ** | **2008**             | ** ** | **2007** | ** ** |
| ** **                                                                                | ** ** | **(In thousands)**   | ** ** |
| **Cash flows from operating  activities**                                                 | ** ** | ** **           | ** ** | ** ** | ** ** |
| Net income (loss)                                                                         |       | $                    | (1,895     | ) | $ | 404 |   |
| Adjustments to reconcile net income (loss) to net cash provided by  operating activities: |       |                 |       |   |   |
| Depreciation and amortization                                                             |       | 1,375                |       | 915 |   |
| Stock-based compensation                                                                  |       | 74                   |       | 41 |   |
| Provision for losses on doubtful accounts                                                 |       | 389                  |       | (28 | ) |
| Amortization of deferred gain on sale-leaseback                                           |       | (177                 | )          | (172 | ) |
| Amortization of debt issuance costs                                                       |       | 68                   |       | 75 |   |
| Deferred income taxes                                                                     |       | (656                 | )          | (244 | ) |
| Amortization of deferred gain from sales of affiliate operations                          |       | (618                 | )          | (42 | ) |
| Loss on sale or disposal of assets                                                        |       | 159                  |       | 2 |   |
| Changes in assets and liabilities:                                                        |       |                 |       |   |   |
| Trade accounts receivable                                                                 |       | 3,968                |       | 3,978 |   |
| Other assets                                                                              |       | 820                  |       | 1,630 |   |
| Accounts payable and accrued expenses                                                     |       | (5,456               | )          | (4,624 | ) |
| Income taxes payable                                                                      |       | 13                   |       | 69 |   |
| Other liabilities                                                                         |       | (1,441               | )          | 258 |   |
|                                                                                      |       |                 |       |   |   |
| Net cash (used) provided  by operating activities                                         |       | (3,377               | )          | 2,262 |   |
|                                                                                      |       |                 |       |   |   |
| **Cash flows from investing  activities**                                                 | ** ** | ** **           | ** ** | ** ** | ** ** |
| Capital expenditures                                                                      |       | (710                 | )          | (906 | ) |
| Payments for the purchase of affiliate operations                                         |       | 31                   |       | (140 | ) |
| Proceeds from sales of affiliate operations                                               |       | —               |       | 10 |   |
| Other, net                                                                                |       | 44                   |       | 17 |   |
|                                                                                      |       |                 |       |   |   |
| Net cash used in investing  activities                                                    |       | (635                 | )          | (1,019 | ) |
|                                                                                      |       |                 |       |   |   |
| **Cash flows from financing  activities**                                                 | ** ** | ** **           | ** ** | ** ** | ** ** |
| Net borrowings (repayments) under line of credit agreements                               |       | 3,363                |       | (45 | ) |
| Principal payments on capital lease obligations                                           |       | (118                 | )          | (75 | ) |
| Payment of debt issuance costs                                                            |       | (2                   | )          | (61 | ) |
| Proceeds from the issuance of common stock                                                |       | —               |       | 117 |   |
|                                                                                      |       |                 |       |   |   |
| Net cash provided from  (used in) financing activities                                    |       | 3,243                |       | (64 | ) |
|                                                                                      |       |                 |       |   |   |
| Effect of exchange rate  changes on cash                                                  |       | (62                  | )          | 119 |   |
|                                                                                      |       |                 |       |   |   |
| Net change in cash and  cash equivalents                                                  |       | (831                 | )          | 1,298 |   |
| Cash and cash equivalents  at beginning of period                                         |       | 3,277                |       | 3,545 |   |
| Cash and cash equivalents  at end of period                                               |       | $                    | 2,446      |   | $ | 4,843 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

5

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**Westaff, Inc.**

 

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

 

**1.     Basis of Presentation**

 

The accompanying condensed consolidated financial statements of Westaff, Inc.and its domestic and foreign subsidiaries (together, the Company), as of January 26,2008 and for the 12-week periods ended January 26, 2008 and January 20,2007 are unaudited.

 

The condensed consolidated financial statements, in the opinion ofmanagement, reflect all adjustments, which are of a normal recurring nature,necessary for a fair presentation of the financial position, results ofoperations and cash flows for the periods presented.  The condensed consolidated balance sheet as November 3,2007 presented herein, has been derived from the audited balance sheet includedin the Company’s Annual Report on Form 10-K for the fiscal year ended November 3,2007.

 

The Company’s critical accounting policies are described in Item 7 “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andin the notes to the consolidated financial statements in the Company’spreviously filed Annual Report on Form 10-K for the fiscal year ended November 3,2007.  Except as disclosed in Note 2,there were no changes to these policies during the 12-week period ended January 26,2008. Certain financial information normally included in annual financialstatements prepared in accordance with accounting principles generally acceptedin the United States that is not required for interim reporting purposes hasbeen condensed or omitted. The accompanying condensed consolidated financialstatements should be read in conjunction with the financial statements andnotes thereto included in the Company’s Annual Report on Form 10-K for thefiscal year ended November 3, 2007.

 

The Company’s fiscal year is a 52 or 53-week period ending the Saturdaynearest the end of October. For interim reporting purposes, the first threefiscal quarters comprise 12 weeks each, while the fourth fiscal quarterconsists of 16 or 17 weeks. The results of operations for the 12-week periodended January 26, 2008 are not necessarily indicative of the results to beexpected for the full fiscal year or for any future period.

 

Accounts receivable as originally reported on the November 3, 2007balance sheet have been increased by $961,766 to reflect unbilled amounts tocustomers related to services performed in the United Kingdom previouslyincluded in other current assets.  TheCompany’s policy is to record as trade accounts receivables, the amounts earnedfor the final week of the period but not billed to customers.

 

The Company has included as part of interest expense certain amountspaid to GE Capital for letters of credit issued to the Company’s insurancecarrier to secure liabilities reflected on the balance sheet. These costs arecharged based on a percentage of the outstanding letters of credit. These costsduring the fiscal year 2007 that were originally classified as selling andadministrative expenses have been reclassified to interest expense to conformto the fiscal year 2007 presentation. The reclassifications had no change tonet income or earnings per share and are shown below:

 

| ** **                                   | ** ** | **12 weeks ended**         | ** ** |
|----------------------------------------------|------------|----------------------------|------------|
| ** **                                   | ** ** | **January 20, 2007**  | ** ** |
| ** **                                   | ** ** | **As originally reported** | ** ** | **As reclassified** | ** ** | **Change** | ** ** |
| Selling and administrative  expenses         |       | $                          | 17,810     |   | $ | 17,558 |   | $ | (252 | ) |
|                                         |       |                       |       |   |   |   |   |
| Operating income from  continuing operations |       | 653                        |       | 905 |   | 252 |   |
|                                         |       |                       |       |   |   |   |   |
| Interest expense                             |       | 319                        |       | 571 |   | 252 |   |
| Net income                                   |       | $                          | 404        |   | $ | 404 |   | $ | — |   |

 

6

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**2.     Adoption of recentpronouncement**

 

The Company adopted the provisions of Financial Accounting StandardsBoard (“FASB”) Interpretation No. (“FIN”) 48, Accounting for Uncertaintyin Income Taxes, an interpretation of FASB Statement No. 109 (“FIN 48”),on November 4, 2007. FIN 48 clarifies the accounting for uncertainty in incometaxes recognized in an enterprise’s financial statements in accordance withFASB Statement No. 109, Accounting for Income Taxes, and prescribes arecognition threshold and measurement process for financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. FIN 48 also provides guidance on derecognition, classification,interest and penalties, accounting in interim periods, disclosure andtransition.

 

As a result of the implementation of FIN 48, the Company made acomprehensive review of its portfolio of uncertain tax positions in accordancewith recognition standards established by FIN 48. Based on our evaluation, wehave concluded that there are no material uncertain tax positions requiringrecognition in our financial statements. Our evaluation was performed for thetax years ended  2007, 2006, 2005 and2004, the tax years which remain subject to examination by major taxjurisdictions as of November 4, 2007. Effective upon adoption of FIN 48,the Company adopted the method to recognize interest and penalties accruedrelated to unrecognized tax benefits and penalties within its provision forincome taxes. The Company had no such interest and penalties accrued at November 4,2007.

 

**3.     Stock-Based Compensation**

 

### **Stock options and restricted stock**.  In April 2006,the Company’s stockholders approved the 2006 Stock Incentive Plan to replacethe 1996 Stock Option/Stock Issuance Plan, which terminated in April 2006.The 2006 Stock Incentive Plan provides for the granting of incentive andnonqualified stock options, restricted stock awards and stock appreciationrights. The 2006 Stock Incentive Plan also provides for the automatic grant ofstock options to each non-employee director at pre-established times and at apredetermined value. Incentive stock options and non-qualified stock optionsmay be granted at a price not less than 100% (110% for employees what at thetime of the grant own stock representing more than 10% of the voting power ofall classes of stock) of the fair market value of the Company’s common stock atthe date of grant.

###  

The options’ vesting schedules vary subject to the participant’s periodof future service or to the Company’s or the option holder’s attainment ofdesignated performance goals, or otherwise at the discretion of the Board ofDirectors. Standard vesting is over four years with  either 25% of the options vesting uponcompletion of one year of service from the vesting commencement date, and theremaining options vesting in 36 equal monthly installments or 25% vesting overfour years on the anniversary date of the grant beginning one year after theinitial grant date.  No option may have aterm in excess of 10 years. As of January 26, 2008, 318,999 options wereoutstanding under the 2006 Stock Incentive Plan and 83,500 options were stilloutstanding under the 1996 Plan. The Company may grant restricted shares toofficers and employees. The fair value of these shares at the date of grant isexpensed on a straight-line basis over the vesting period. No restricted shareshave been granted under the 2006 Stock Incentive Plan.

 

**Employee Stock Purchase Plan**.  In July 2006, the Board of Directorsadopted and approved an amendment and restatement of the Company’s 1996Employee Stock Purchase Plan. The Purchase Plan was bifurcated into the Company’sEmployee Stock Purchase Plan and the Company’s International Employee StockPurchase Plan, (together the “Purchase Plans”). Under the Purchase Plans,eligible employees may authorize payroll deductions of up to 10% of eligiblecompensation for the purchase of the Company’s common stock during eachsemiannual purchase period. The purchase price for shares purchased under thePurchase Plans is equal to 90% of the lower of the fair market value at thebeginning of the purchase period or the fair market value on the last day ofthe purchase period. The Purchase Plans provide for the issuance of up to750,000 shares of the Company’s common stock. As of January 26, 2008,shares issued under the Purchase Plans totaled 663,457.

 

**Stock-based compensation**.  Effective with the beginning of the firstquarter of fiscal 2006, the Company adopted Statement of Financial AccountingStandards (“SFAS”) No. 123 (revised 2004) “Share-Based Payment” (SFAS123(R)) using the modified prospective method of adoption, which does notrequire restatement of prior periods. SFAS 123(R) requires the Company torecognize compensation expense for its stock options, restricted stock awardsand employee stock purchase shares outstanding, but not yet vested, as of thedate of adoption and for future stock option and award grants and employeestock purchase shares.

 

The determination of the fair value of stock options and Employee StockPurchase Plan (“ESPP”) shares, using the Black-Scholes model, is affected bythe Company’s stock price as well as assumptions as to the Company’s expectedstock price volatility over the term of the awards, actual and projectedemployee stock option exercise behavior, the risk-free interest rate, andexpected dividends.

 

In a private transaction in February 2007, W. Robert Stover,Westaff’s founder and former Chairman of the Board of Directors, sold all ofhis common stock in Westaff, representing approximately 49.6% of the

 

7

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outstanding common stock to DelStaff, LLC, a Delaware limited liabilitycompany (‘‘DelStaff’’). Prior to the sale the Company used historical data toestimate the options’ expected term, which represented the period of time thatoptions granted were expected to be outstanding. Subsequent to the sale, theCompany accelerated the options of the former President and Chief ExecutiveOfficer who held 225,000 of the outstanding options at the beginning of theyear. These options were exercised late in fiscal year 2007. An additional93,000 options of the 417,000 outstanding at the beginning of the year werealso exercised or cancelled. 337,500 of the 366,000 options granted in fiscalyear 2007 were issued following the sale to DelStaff. These new options toselected employees typically have a seven year life while the options issuedprior to the sale typically had a 10 year life. The Company has applied theprovisions of SEC Staff Accounting Bulletin (“SAB”) No. 107 “Share-Based Payment” and SAB 110 “Share-BasedPayment” in electing the simplified method for determining the expected life ofoptions granted subsequent to the date of the shareholder transaction.

 

The Company estimates the volatility of the common stock by usinghistorical volatility over a period equal to the award’s expected term. Therisk-free interest rates that are used in the valuation models are based uponyields of the U.S. Treasury constant maturities at the time of grant having aterm that approximates the expected life of the options. Dividend yield is zeroas we did not declare or pay dividends during fiscal 2008 or fiscal 2007, andour current credit facilities prohibit payment of dividends.  We do not currently have plans to declaredividends in future years.

 

SFAS No. 123(R) requires companies to estimate futureexpected forfeitures at the date of grant and revise those estimates insubsequent periods if actual forfeitures differ from those estimates. Prior tothe adoption of SFAS 123(R), the Company had recognized the impact offorfeitures as they occurred. Now, the Company uses historical data to estimatepre-vesting forfeiture rates in determining the amount of stock-basedcompensation expense to recognize. All stock-based compensation awards areamortized on a straight-line basis over the requisite service periods of theawards.

 

8

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TheCompany did not grant any stock options for the 12-week period ending January 26,2008, and had no stock issuances from the employee stock purchase plan for the12-week periods ended January 26, 2008 and January 20, 2007.

 

TheCompany recorded stock-based compensation of $74,000 ($30,000 net of relatedincome tax benefit) for the quarter ended January 26, 2008 and $41,000($30,000 net of related income tax benefit) for the quarter ended January 20,2007, which is included in selling and administrative expenses.

 

The following table summarizes stock option activity forthe 12-weeks ended January 26, 2008:

 

| ** **                                    | ** ** | ** **          | ** ** | **Weighted average** | ** ** |
|-----------------------------------------------|------------|---------------------|------------|----------------------|------------|
| ** **                                    | ** ** | **Shares**          | ** ** | **exercise price**   | ** ** |
| ** **                                    | ** ** | **(In 000’s)** | ** ** | ** **           | ** ** |
| Options outstanding at  November 3, 2007 |       | 445                 |       | $                    | 4.23       |   |
| Granted                                       |       | —              |       | —               |       |
| Exercised                                     |       | —              |       | —               |       |
| Cancelled                                     |       | (49                 | )          | 4.30                 |       |
| Options outstanding at  January 26, 2008 |       | 396                 |       | $                    | 4.22       |   |

 

The following table summarizes information about the weighted averageremaining contractual life (in years) and the weighted average exercise pricesfor stock options both outstanding and exercisable as of January 26, 2008:

 

| ** **          | ** **          | **Options outstanding**                                  | ** ** | **Options exercisable** | ** ** |
|---------------------|---------------------|----------------------------------------------------------|------------|-------------------------|------------|
| ** **          | ** **          | ** **                                               | ** ** | **Weighted average**    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Range of**        | ** **          | ** **                                               | ** ** | **remaining**           | ** ** | **Weighted average** | ** ** | ** ** | ** ** | **Weighted average** | ** ** |
| **exercise prices** | ** **          | **Shares**                                               | ** ** | **contractual life**    | ** ** | **exercise price** | ** ** | **Shares** | ** ** | **exercise price** | ** ** |
| ** **          | ** **          | **(In thousands, except for years and exercise prices)** | ** ** | ** **              | ** ** |
|                |                |                                                     |       |                    |       |   |   |   |   |   |   |
| $                   |  2.20 - 4.02   |                                                     | 118        |                    | $          | 5.77 |   | $ | 3.38 |   | 68 |   | $ | 2.91 |   |
| $                   |  4.05 - 4.14   |                                                     | 14         |                    | 7.64       |   | 4.08 |   | 9 |   | 4.05 |   |
| $                   |  4.34 - 4.34   |                                                     | 230        |                    | 7.85       |   | 4.34 |   | — |   | — |   |
| $                   |  4.35 - 6.00   |                                                     | 31         |                    | 8.36       |   | 5.17 |   | 6 |   | 5.22 |   |
| $                   |  16.17 - 16.17 |                                                     | 3          |                    | 0.17       |   | 16.17 |   | 3 |   | 16.17 |   |
| $                   |  2.20 - 16.17  |                                                     | 396        |                    | $          | 7.20 |   | $ | 4.20 |   | 86 |   | $ | 3.64 |   |

 

The total intrinsic value of stock options outstanding and exercisableas of January 26, 2008 and January 20, 2007 was $0.1 million and $0.4million, respectively.  The intrinsicvalue is calculated as the difference between the market value as of the fiscalperiod end and the exercise price of the shares.  The market value as of January 26, 2008and January 20, 2007 as reported by the NASDAQ Global Market System was$3.76 and $4.96, respectively.  As of January 26,2008, total deferred compensation cost related to nonvested stock options andawards not yet recognized is $0.7 million, which is expected to be recognizedover a weighted-average remaining term of 3.3 years.  The total number of in-the-money optionsexercisable as of January 26, 2008 is 65,500.

 

**4.****             ****Goodwill and Intangibles**

 

The Company follows the provisions of SFAS No. 142 “Goodwill andOther Intangible Assets.” SFAS No. 142 provides that goodwill and otherintangible assets with indefinite lives are evaluated for impairment at areporting unit level by applying a fair-value based test. The primary otheridentifiable intangible assets of the Company with indefinite lives arereacquired franchise rights. The Company determined its reporting units as itsoperating segments under SFAS No. 131 “Disclosures about Segments of anEnterprise and Related Information”.

 

9

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The first step in the impairment test compares the fair value of areporting unit with its carrying value, including goodwill. If the carryingvalue of a reporting unit exceeds its fair value, the second step of thegoodwill impairment is performed to determine the amount of any impairment lossby comparing the implied fair value of the reporting unit’s goodwill with therespective carrying value.  This test isperformed in the fourth quarter of each fiscal year or more frequently when webelieve impairment indicators are present. The Company is currently monitoring its revenue and operating resultsagainst its planned results.  Managementbelieves that the decline in revenue during the first quarter of fiscal year2008 is not indicative of expected future results, but will continue to monitorresults during the next few quarters.  Acontinued decline in revenues and operating results may be impairmentindicators that necessitate a valuation in a period earlier than the annualtesting date in the fourth quarter.

 

The Company most recently performed its annual impairment evaluation inthe fourth quarter of the 2007 fiscal year. No impairment charges were made as a result of the evaluation. Thefollowing table show the change to goodwill during the first quarter of fiscal2008.

 

| ** **                              | ** ** | **Domestic**          | ** ** | ** **    | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|---------------|------------|------------|------------|
| ** **                              | ** ** | **Business Services** | ** ** | **Australia** | ** ** | **Total**  | ** ** |
| ** **                              | ** ** | **(In thousands)**    | ** ** |
| Balance at November 3,  2007            |       | $                     | 11,369     |          | $          | 1,259      |       | $ | 12,628 |   |
| Effect of foreign currency  translation |       | —                |       | (61           | )          | (61        | )          |
|                                    |       |                  |       |          |       |       |       |
| Balance at January 26,  2008            |       | $                     | 11,369     |          | $          | 1,198      |       | $ | 12,567 |   |

 

The following table shows the change to acquired intangible assetsduring the first quarter ended January 26, 2008:

 

| ** **                                                                           | ** ** | **Domestic Business Services** | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                           | ** ** | **Gross Carrying**             | ** ** | **Accumulated** | ** ** | **Net** | ** ** |
| ** **                                                                           | ** ** | **Amount**                     | ** ** | **Amortization** | ** ** | **Amount** | ** ** |
|                                                                                 | ** ** | **(In  thousands)**            | ** ** |
| Amortized intangible  assets - Non-compete Agreements                                |       |                           |       |   |   |   |   |
| Balance at  November 3, 2007                                                    |       | $                              | 177        |   | $ | (140 | ) | $ | 37 |   |
| Fiscal 2008 acquisitions                                                             |       | —                         |       | — |   | — |   |
| Amortization                                                                         |       | —                         |       | (5 | ) | (5 | ) |
| Balance at  January 26, 2008                                                    |       | $                              | 177        |   | $ | (145 | ) | $ | 32 |   |
|                                                                                 |       |                           |       |   |   |   |   |
| Unamortized intangible assets as of January 26, 2008 and  November 3, 2007 |       |                           |       |   |   |   |   |
| Franchise rights                                                                     |       | $                              | 3,658      |   |   |   |   |   |
|                                                                                 |       |                           |       |   |   |   |   |
| Estimated amortization  expense                                                      | ** ** | **(In  thousands)**            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fiscal 2008                                                                          |       | $                              | 20         |   |   |   |   |   |
| Fiscal 2009                                                                          |       | 17                             |       |   |   |   |   |

 

**5.****             ****Company Restructuring**

 

In the third quarter of fiscal 2007, the Company approved certainrestructuring plans to, among other things, reduce its workforce andconsolidate facilities. Restructuring charges have been recorded to align theCompany’s cost structure with changing market conditions and to create a moreefficient organization. The Company’s restructuring charges have been comprisedprimarily of: (i) severance and termination benefit costs related to thereduction of our workforce; and (ii) lease termination costs and costsassociated with permanently vacating certain facilities.

 

10

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The Company accounted for each of these costs in accordance with FASB No. 146,“Accounting for Costs Associated with Exit or Disposal Activities.” In thethird quarter of fiscal 2007, we began to make changes to our operations thatmanagement believes will significantly reduce our costs. We terminated 86positions in our field and corporate offices and we closed 26 branch offices.The customers served by our closed offices have been transferred to otheroffices within the proximity of the closed offices. The detail is as follows:

 

| ** **                                                                      | ** ** | **12 weeks ended**        | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                                      | ** ** | **January 26, 2008** | ** ** |
| ** **                                                                      | ** ** | **(In thousands)**        | ** ** |
| ** **                                                                      | ** ** | **Facilities**            | ** ** |
| Restructuring accrual -  November 3, 2007                                  |       |                      |       |
| Rent expense under non-cancellable leases reduced by estimated  sublease income |       | $                         | 1,146      |   |
| Rents paid reduced by  sublease income                                          |       | (300                      | )          |
| Restructuring benefit                                                           |       | (150                      | )          |
| Restructuring accrual -  January 26, 2008                                  |       | $                         | 696        |   |

 

Duringthe first quarter of fiscal 2008 we successfully negotiated early terminationagreements for six locations and entered into a sublease for one location, theeffects of which resulted in a $150,000 reduction of our accrual.  We are still responsible for lease paymentson 16 locations and are actively negotiating early terminations, wherepossible, and sublease opportunites to mitigate our obligation.

 

**6.****             ****Workers’Compensation**

 

Domestically, the Company is responsible for and pays workers’compensation costs for its temporary and regular employees and is self-insuredfor the deductible amount related to workers’ compensation claims. The Companyaccrues the estimated costs of workers’ compensation claims based upon theexpected loss rates within the various temporary employment categories providedby the Company.  At least annually, theCompany obtains an independent actuarial valuation of the estimated costs ofclaims reported but not settled, and claims incurred but not reported, andadjusts the accruals based on the results of the valuations.  The following summarizes the workers’compensation liability as of January 26, 2008 and November 3, 2007:

 

| ** **                             | ** ** | **January 26, 2008** | ** ** | **November 3, 2007** | ** ** |
|----------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                             | ** ** | **(In Millions)**         | ** ** |
| Current portion                        |       | $                         | 9.3        |                      | $          | 9.9 |   |
| Long-term portion                      |       | 16.0                      |       | 16.0                      |       |
| Total Liabilities                      |       | $                         | 25.3       |                      | $          | 25.9 |   |
|                                   |       |                      |       |                      |       |
| Self-insurance Deductible  (per claim) |       | $                         | 0.75       |                      | $          | 0.50 |   |
| Letters of Credit (1)                  |       | $                         | 27.3       |                      | $          | 28.4 |   |

 

The amount included incurrent liabilities includes $0.3 and $0.5 million in workers compensationexpense related to Australia.

 

----

(1)  Theinsurance carrier requires the Company to collateralize its recordedobligations through the use of irrevocable letters of credit, surety bonds or cash.

 

 

11

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**7.****             ****(Loss)earnings per share**

 

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

** **

| ** **                                                                                             | ** ** | **12 Weeks Ended**                           | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                             | ** ** | **January 26,**                         | ** ** | **January 20,** | ** ** |
| ** **                                                                                             | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| ** **                                                                                             | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Net (loss) income                                                                                      |       | $                                            | (1,895     | ) | $ | 404 |   |
|                                                                                                   |       |                                         |       |   |   |
| Denominator for basic  earnings per share - weighted average shares                                    |       | 16,697                                       |       | 16,590 |   |
|                                                                                                   |       |                                         |       |   |   |
| Effect of dilutive  securities: stock options and awards                                               |       | —                                       |       | 68 |   |
| Denominator for diluted earnings per share - adjusted weighted average  shares and assumed conversions |       | 16,697                                       |       | 16,658 |   |
|                                                                                                   |       |                                         |       |   |   |
| (Loss) earnings per share                                                                              |       |                                         |       |   |   |
| Basic                                                                                                  |       | $                                            | (0.11      | ) | $ | 0.02 |   |
| Diluted                                                                                                |       | $                                            | (0.11      | ) | $ | 0.02 |   |
|                                                                                                   |       |                                         |       |   |   |
| Anti-dilutive weighted  shares excluded from diluted earnings per share                                |       | 396                                          |       | 182 |   |

 

Optionsto purchase 396,000 shares of common stock were outstanding at January 26,2008 and were excluded from the computation of diluted earning per sharebecause they were anti-dilutive due to the Company’s net loss in the firstquarter of fiscal 2008.  Options topurchase 182,000 shares of common stock were outstanding at January 20,2007 and were excluded from the computation of dilutive earnings per sharebecause they were anti-dilutive.

 

12

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**8.****             ****Comprehensive(Loss) income**

 

Comprehensive incomeconsists of the following:

 

| ** **                        | ** ** | **12 Weeks Ended**   | ** ** |
|-----------------------------------|------------|----------------------|------------|
| ** **                        | ** ** | **January 26,** | ** ** | **January 20,** | ** ** |
| ** **                        | ** ** | **2008**             | ** ** | **2007** | ** ** |
| ** **                        | ** ** | **(In thousands)**   | ** ** |
| Net (loss) income                 |       | $                    | (1,895     | ) | $ | 404 |   |
| Currency translation  adjustments |       | (571                 | )          | 446 |   |
| Comprehensive  (loss) income      |       | $                    | (2,466     | ) | $ | 850 |   |

 

**9.****              CreditAgreement**

 

Since May 2002 the Company has credit facilitieswith GE Capital, as primary agent, expiring in May 2009. The facilitiescomprise a five-year syndicated Multicurrency Credit Agreement consisting of a$55 million U.S. Revolving Loan Commitment and a £2.74 million U.K. RevolvingLoan Commitment.  In addition, theCompany’s Australian subsidiary maintains a A$12 million Australian dollarfacility agreement (the “A$ Facility Agreement”) that expires in May 2009.Each agreement includes a letter of credit sub-facility. Letters of creditunder the agreements expire one year from date of issuance, but areautomatically renewed for one additional year unless written notice is given toor from the holder.Our credit facilities with GE Capital as amended, required aminimum adjusted EBITDA of $9.5 million for the trailing 13 periods and aminimum fixed charge ratio of 1.25. We failed to meet the EBITDA requirement atthe end of our Fiscal Quarter ended July 7, 2007 and failed the MinimumFixed Charge Coverage Ratio for the trailing 13 fiscal periods ended August 4,2007 and September 1, 2007.

 

On January 25, 2007, the Company and its lenderexecuted an amendment to the A$ Facility Agreement, which extended theAgreement for two additional years to May 2009.

 

We entered into a 120 day Forbearance Agreement,Limited Waiver and Consent of Guarantors (“Forbearance Agreement”) with GECapital, on October 18, 2007, which required us to maintain a minimumBorrowing Availability no less than $1.0 million for more than two consecutivebusiness days for the first 60 days from the date of the Forbearance Agreement.Following the initial 60 day period and expiring  February 15, 2008 (“Forbearance Period”),the Company was  required to maintain aten business day rolling average borrowing availability of at least $8.0million, which was measured every seven days. The Forbearance Agreement alsowaived both the Minimum Fixed Charge Coverage Ratio covenant during theForbearance Period and the EBITDA requirement, however, the Company wasrequired to meet a minimum EBITDA of $1.0 million for fiscal 2007 as defined inthe GE Capital Credit Agreement.

 

We met the EBITDA test but failed the rolling averageavailability tests for several of the seven day testing periods.

 

On February 14, 2008 we entered into a new creditfacility described in Note 15.  The newfacility funded on February 28, 2008.

 

13

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**10.****       AccruedExpenses**

 

                        Accrued expenses consist of thefollowing:

 

| ** **                                          | ** ** | **January 26,** | ** ** | **November 3,** | ** ** |
|-----------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                          | ** ** | **2008**             | ** ** | **2007**             | ** ** |
| ** **                                          | ** ** | **(In thousands)**   | ** ** |
| Accrued payroll and  payroll taxes                  |       | $                    | 11,553     |                 | $          | 16,356 |   |
| Taxes other than income  taxes                      |       | 3,020                |       | 4,120                |       |
| Checks outstanding in  excess of book cash balances |       | 2,221                |       | 4,753                |       |
| Accrued insurance                                   |       | 2,091                |       | 3,151                |       |
| Franchise commisions  payable                       |       | 834                  |       | 1,599                |       |
| Restructuring accrual  (Note 5)                     |       | 696                  |       | 1,146                |       |
| Other                                               |       | 5,170                |       | 3,022                |       |
|                                                |       |                 |       |                 |       |
|                                                |       | $                    | 25,585     |                 | $          | 34,147 |   |

 

**11.****       RelatedParty Transactions**

 

The Company has anunsecured subordinated promissory note payable to the former  Chairman of the Board of Directors dated May 17,2002 in the amount of $2.0 million. The note, which has a maturity date of August 18,2007, is now past due and has an interest rate equal to an indexed rate as calculatedunder the Company’s credit facilities plus seven percent, compounded monthlyand payable 60 calendar days after the end of each of the Company’s fiscalquarters. The interest rate in effect on January 26, 2008 was 13.5%. TheCompany recorded $70,000 of interest expense for the 12 weeks ended January 26,2008. Payment of interest is contingent on the Company meeting minimumavailability requirements under its credit facilities. Additionally, paymentsof principal or interest are prohibited in the event of any default under thecredit facilities.  Following our defaultat the end of third quarter fiscal 2007, GE Capital exercised their right toprohibit repayment of the note at its maturity and has denied our request topay quarterly interest.  Accrued andunpaid interest at January 26, 2008 was $171,000.

 

 

**12.  OperatingSegments**

 

The following tablesummarizes reporting segment data:

 

|                                  |   | **Domestic**        | ** ** | **United**  | ** ** | ** **    | ** ** | **New**     | ** ** | ** ** |   |
|---------------------------------------|--------|---------------------|------------|-------------|------------|---------------|------------|-------------|------------|------------|--------|
|                                  |   | **Business  Svcs.** | ** ** | **Kingdom** | ** ** | **Australia** | ** ** | **Zealand** | ** ** | **Total**  |   |
|                                  |   | **(In  thousands)** |       |
| 12 Weeks Ended  January 26, 2008 |   |                |       |        |       |          |       |        |       |       |   |
|                                  |   |                |       |        |       |          |       |        |       |       |   |
| Revenue                               |   | $                   | 81,048     |        | $          | 8,757         |       | $           | 25,504     |       | $      | 1,525 |   | $ | 116,834 |   |
| Operating income (loss)               |   | $                   | (1,606     | )           | $          | (471          | )          | $           | 261        |       | $      | 22 |   | $ | (1,794 | ) |
|                                  |   |                |       |        |       |          |       |        |       |       |   |
| 12 Weeks Ended  January 20, 2007 |   |                |       |        |       |          |       |        |       |       |   |
|                                  |   |                |       |        |       |          |       |        |       |       |   |
| Revenue                               |   | $                   | 97,202     |        | $          | 9,262         |       | $           | 21,712     |       | $      | 1,773 |   | $ | 129,949 |   |
| Operating income (loss)               |   | $                   | 850        |        | $          | (166          | )          | $           | 147        |       | $      | 74 |   | $ | 905 |   |

 

**13.****      ****Commitments and Contingencies**

 

In the ordinary course of its business, theCompany is periodically threatened with or named as a defendant in variouslawsuits. The principal risks that the Company insures against are workers’compensation, general liability, automobile liability, property damage,alternative staffing errors and omissions, fiduciary liability and fidelitylosses.

 

14

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During the fourth quarter of fiscal 2005, wewere notified by the California Employment Development Department (“EDD”) thatour domestic operating subsidiaries unemployment tax rates would be increasedretroactively for both calendar years 2005 and 2004, which would result inadditional unemployment taxes of approximately $0.9 million together withinterest at applicable statutory rates. Management believes that it hasproperly calculated its unemployment insurance tax and is in compliance withall applicable laws and regulations. We have timely appealed the ruling by theEDD and are working with our outside counsel to resolve this matter.  A hearing officer has been assigned to the matter.  We are awaiting confirmation of a hearingdate from the EDD.

 

Other than the action listed above, theCompany is not a party to any material litigation. However, from time to timethe Company has been threatened with, or named as a defendant in, litigationbrought by former franchisees or licensees, and administrative claims andlawsuits brought by employees or former employees. Management believes theresolution of these matters will not have a material adverse effect on theCompany’s financial statements.

 

**14.****      ****Recent Accounting Pronouncements**

 

InJuly 2006, the Financial Accounting Standards Board (“FASB”) issued FASBInterpretation No. 48, “Accounting for Uncertainty in Income Taxes — aninterpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes arecognition threshold and measurement process for recording in the financialstatements uncertain tax positions taken or expected to be taken in a taxreturn in accordance with FASB No. 109, “Accounting for Income Taxes.”  Tax positions must meet amore-likely-than-not recognition threshold at the effective date to berecognized upon the adoption of FIN 48 and in subsequent periods.  The accounting provisions of FIN 48 will beeffective for the Company beginning in the first quarter of fiscal year2008.  As discussed in Note 2, the Companyadopted FIN 48 during the first quarter of fiscal 2008.

 

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements.”  SFAS No. 157defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles and expands disclosures about fairvalue measurements. SFAS No. 157 applies under other accountingpronouncements that require or permit fair value measurements, the FASB havingpreviously concluded in those accounting pronouncements that fair value is therelevant measurement attribute. Accordingly, SFAS No. 157 does not requireany new fair value measurements. SFAS No. 157 is effective for fiscalyears beginning after November 15, 2007. On November 14, 2007 the FASB agreed to partially defer theeffective date of the standard for certain nonfinancial assets andliabilities.  We are evaluating theimpact, if any, the adoption of SFAS No. 157 will have on our operatingincome or net earnings.

 

In February 2007, the FASB issued SFAS No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities.”  SFAS No. 159 permits companies to chooseto measure many financial instruments and certain other items at fair value.The objective is to improve financial reporting by providing companies with theopportunity to mitigate volatility in reported earnings caused by measuringrelated assets and liabilities differently without having to apply complexhedge accounting provisions. SFAS No. 159 is effective for fiscal yearsbeginning after November 15, 2007. Companies are not allowed to adopt SFASNo. 159 on a retrospective basis unless they choose early adoption.  We are evaluating the impact, if any, theadoption of SFAS No. 159 will have on our operating income or netearnings.

 

In December 2007, the FASB issued SFAS No. 141(R),“Business Combinations.”   SFAS 141(R) requiresall business combinations completed after the effective date to be accountedfor by applying the acquisition method (previously referred to as the purchasemethod). Companies applying this method will have to identify the acquirer,determine the acquisition date and purchase price and recognize at theiracquisition-date fair values the identifiable assets acquired, liabilitiesassumed, and any noncontrolling interests in the acquiree. In the case of abargain purchase the acquirer is required to reevaluate the measurements of therecognized assets and liabilities at the acquisition date and recognize a gainon that date if an excess remains. SFAS 141(R) becomes effective for fiscalperiods beginning after December 15, 2008. The Company is currentlyevaluating the impact of SFAS 141(R).

 

In December 2007, the FASB issued SFAS No. 160,“Noncontrolling Interests in Consolidated Financial Statements” (an Amendmentof ARB 51).  SFAS 160 amends ARB 51 toestablish accounting and reporting standards for the noncontrolling interest ina subsidiary and for the deconsolidation of a subsidiary. The statementrequires consolidated net income to be reported at amounts that include the amountsattributable to both the parent and the noncontrolling interest. It alsorequires disclosure on the face of the consolidated statement of income, of theamounts of consolidated net income attributable to the parent and to thenoncontrolling interest. In addition this statement establishes a single methodof accounting for changes in a

 

15

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parent’s ownership interest in a subsidiarythat do not result in deconsolidation and requires that a parent recognize again or loss in net income when a subsidiary is deconsolidated. SFAS 160becomes effective for fiscal periods beginning after December 15, 2008.The Company is currently evaluating the impact of SFAS 160.

 

**15.  Subsequent Events**

 

On February 28, 2008,  theCompany through its’ wholly owned subsidiary Westaff (USA), Inc. (the “Borrower”)was advanced credit in the form of letters of credit issued and loans advancedin an aggregate amount of approximately $29.6 million under a FinancingAgreement, dated as of February 14, 2008 (the “Financing Agreement”), withU.S. Bank NationalAssociation (U.S. Bank) and Wells Fargo Bank.

 

The Financing Agreement provides for a newfive-year US$50 million revolving credit facility, which includes a letter ofcredit sub-limit of US$35 million.   TheCompany and the following subsidiaries of the Borrower are guarantors under thenew credit facility: Westaff Support, Inc., MediaWorld International andWestaff (U.K.) Limited (together with the Company, collectively, the “Guarantors”).The maximum borrowing availability under the Financing Agreement is based upona percentage of certain eligible billed and unbilled accounts receivable of theBorrower and Westaff (U.K.) Limited. Borrowings under the Financing Agreementbear interest, at the Borrower’s election, at either U.S. Bank’s prime rateplus 0% or at LIBOR plus an applicable LIBOR rate margin ranging from 1.25% to2.00%. A default rate would apply on all loan obligations in the event ofdefault under the Credit Documents, at a rate per annum of 2% above theapplicable interest rate. Interest is payable on a monthly basis. The creditobligations under the Financing Agreement are secured by a first prioritysecurity interest in the assets of the Borrower, the Company and the otherGuarantors, with certain exceptions set forth in the Financing Agreement andthe other Credit Documents. The proceeds of the extensions of credit under theFinancing Agreement may be used by the Borrower for any lawful purpose.

 

The Credit Documents contain customaryaffirmative covenants and negative covenants restricting or limiting theability of the Borrower and the Guarantors to, among other things:

 

·                  incur debt;

 

·                  create liens;

 

·                  pay dividends, distributions or make otherspecified restricted payments;

 

·                  make certain investments and acquisitions;

 

·                  enter into certain transactions withaffiliates;

 

·                  merge or consolidate with any other entity orsell, assign, transfer, lease, convey or otherwise dispose of assets; and

 

·                  permit certain changes of control.

 

Such restrictions are subject to usual andcustomary exceptions contained in financing agreements of this nature.

 

The financial covenants under the FinancingAgreement include a Fixed Charge Coverage Ratio (as defined in the FinancingAgreement) requirement, measured as of the end of each fiscal quarter, and aminimum liquidity (as defined in the Financing Agreement) measured until theBorrower’s financial statements for the second fiscal quarter are delivered toU.S. Bank.

 

The Financing Agreement also contains usualand customary events of default (subject to certain threshold amounts and graceperiods).

 

Upon the occurrence and during thecontinuance of an event of default under the Financing Agreement, U.S. Bankmay, among other things: (i) accelerate the amounts outstanding under theFinancing Agreement to become immediately due and payable, and require theBorrower to cash collateralize outstanding letters of credit, (ii) terminatethe credit commitments under the Financing Agreement, (iii) terminate theFinancing Agreement and (iv) realize upon the loan collateral under theFinancing Agreement and related Credit Documents.

 

The Company will recognize a charge to earnings for the previously capitalized costsassociated with the former facility of approximately $0.4 million in the secondquarter of fiscal 2008.

 

16

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

 

### **Cautionary Statement**

###  

This Form 10-Q contains forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of 1995.Except for the historical information contained herein, the matters discussedshould be considered forward-looking statements and readers are cautioned notto place undue reliance on those statements. These statements are onlypredictions, and actual events or results may differ materially. Theforward-looking statements give our current expectations or forecasts of futureevents. You can identify these statements by the fact that they do not relatestrictly to current facts. They use words such as “will,” “anticipate,” “estimate,”“expect,” “project,” “intend,” “plan,” “believe,” “target,” “forecast,” andother words and terms of similar meaning in connection with any discussion offuture operating or financial performance. These forward-looking statements aremade based on information available as of the date of this report and aresubject to a number of risks and uncertainties that could cause the Company’sactual results and financial position to differ materially from those expressedor implied in the forward-looking statements and to be below the expectationsof public market analysts and investors. Investors should bear this in mind asthey consider forward-looking statements.

 

These risks and uncertainties include, but are notlimited to, those discussed in Part II Item 1A “Risk Factors” andelsewhere in this Form 10-Q. You should understand that it is not possibleto predict or identify all such factors. Consequently, you should not considerany such list to be a complete set of all potential risks or uncertaintiesfaced by us.

 

The Company undertakes no obligation to publicly releasethe results of any revisions to these forward-looking statements to reflectevents or circumstances after the date hereof or to reflect the occurrence ofunanticipated events, except as required by applicable laws and regulations.

 

The following discussion is intended to assist in theunderstanding and assessment of significant changes and trends related to theresults of operations and financial condition of Westaff, Inc., togetherwith its consolidated subsidiaries. This discussion and analysis should be readin conjunction with the Company’s Consolidated Financial Statements and Notesincluded elsewhere in this Form 10-Q and in the Company’s Annual Report onForm 10-K for the fiscal year ended November 3, 2007.

 

**CompanyOverview**

 

We provide staffing services primarily in suburban andrural markets (“secondary markets”), as well as in the downtown areas ofcertain major urban centers (“primary markets”) in the United States (“US”),the United Kingdom, Australia and New Zealand. Through our network ofCompany-owned, franchise agent and licensed offices, we offer a wide range ofstaffing solutions, including permanent placement, replacement, supplementaland on-site temporary programs to businesses and government agencies. Ourprimary focus is on recruiting and placing clerical/administrative and lightindustrial personnel. We have almost 60 years of experience in the staffingindustry and, as of January 26, 2008, operated through 204 offices in 45states and three foreign countries. As of January 26, 2008, 68% of theseoffices were Company-owned and operated and 32% were operated by franchiseagents. Our corporate headquarters provides support services to the fieldoffices in areas such as marketing, human resources, risk management, legal,strategic sales, accounting, and information technology.

 

To complement our service offerings, which includetemporary staffing, permanent placement, temp-to-hire services, payrollservices and on-location programs; we utilize a number of tools focused onincreasing our pool of qualified candidates. Additionally, we employ a robust,targeted marketing program as well as a consultative sales process, and both ofthese tools assist in our sales efforts to new and existing customers.  Management believes all of these toolsenhance our competitive edge and position us to effectively pursue high growthmarket niches.

 

The staffing industry is highly competitive withgenerally few barriers to entry, which contributes to significant pricecompetition as competitors attempt to maintain or gain market share. While theprice competition continues in 2008, we have noted consolidated marginimprovements as compared to the prior year. On a prospective basis, we believe

 

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our focus on increasing clerical/administrativesales, improving results from underperforming field offices and prudentlymanaging costs will permit us to improve our operating margins.

 

Itis important to note that our business tends to be seasonal with sales for thefirst fiscal quarter typically lower than other fiscal quarters due to itcontaining traditional holidays as well as varying degrees of customer closuresfor  the holiday season. Theseclosures  and post-holiday seasondeclines in business activity negatively impact orders received from customers,particularly in the light industrial sector. Demand for staffing services hashistorically tended to grow during the second and third fiscal quarters and hasbeen greatest during the fourth fiscal quarter due largely to customers’planning and business cycles. Furthermore, our fourth fiscal quarter consistsof 16 or 17 weeks, while the first, second and third fiscal quarters consist of12 weeks each.

 

Domestically,payroll taxes and related benefits fluctuate with the level of payroll costs,but tend to represent a smaller percentage of revenue and payroll costs laterin our fiscal year as federal and state statutory wage limits for unemploymentare exceeded on a per employee basis. Workers’ compensation expense, which is incurred domestically and inAustralia, generally varies with both the frequency and severity of workplaceinjury claims reported during a quarter. Adverse and positive loss developmentof prior period claims during a subsequent quarter may also contribute to thevolatility in our estimated workers’ compensation expense.

 

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

 

·                  seasonality, especially inour light industrial business,

 

·                  wage limits on statutorypayroll taxes,

 

·                  claims experience forworkers’ compensation,

 

·                  demand and competition forour services, and

 

·                  the effects of acquisitions.

 

Inaddition, our operating results have also historically tended to followseasonal sales trends with the bulk of annual operating profits falling withinthe third and fourth fiscal quarters.   TheCompany will recognize a charge to earnings for the previously capitalizedcosts associated with the former facility of approximately $0.4 million in thesecond quarter of fiscal 2008.

 

### **Critical Accounting Policies**

###  

Thepreparation of our financial statements in conformity with generally acceptedaccounting principles in the United States of America requires management tomake estimates and assumptions affecting the amounts and disclosures reportedwithin those financial statements. These estimates are evaluated on an ongoingbasis by management and generally affect revenue recognition, workers’compensation costs, collectibility of accounts receivable, impairment ofgoodwill and intangible assets, contingencies, litigation and income taxes.Management’s estimates and assumptions are based on historical experiences andother factors believed to be reasonable under the circumstances. Actual resultsunder circumstances and conditions different than those assumed could result indifferences from the estimated amounts in the financial statements.

 

Our critical accounting policies aredescribed in Item 7 “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and in the notes to the consolidatedfinancial statements in the Company’s previously filed Annual Report on Form 10-Kfor the fiscal year ended November 3, 2007.  We adopted the provisions of FIN 48 effectiveNovember 4, 2007, the opening day in the current 12-week period ended January 26,2008.  There were no other changes to ourpolicies during the 12-week period ended January 26, 2008.

 

**Executive Overview**

** **

Ourconsolidated net loss for the quarter was $1.9 million compared with net income of $0.4 million for the sameperiod last year.  The impact of asoftening economy, the disruption caused by our implementation of a newPay/Bill system during the first quarter, and extended holiday closures at anumber of our customers negatively impacted our performance.  The closure of a number of branch offices in2007 and the termination of unprofitable customer accounts also impacted theyear over year comparison for revenue results.  We are not satisfied with our performance and have made changes in ourDomestic operational structure to address both people and process inefficiencies.Our development of new metrics reporting has enhanced our ability to morequickly gain insight into performance deficiencies.  We remain committed to enhancing theprofitability of our accounts and are pleased that we saw continued improvementin  gross margin percentage on temporaryplacements in the United States.  Most of

 

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theshortfall in revenue was isolated to the United States. Beyond the softeningeconomy, much of the remaining shortfall can be attributable to the impact ofcustomer closures  having a larger effectthan planned as many of our manufacturing clients  closed down for two weeks over the Christmasto New Years holiday season.  A softeconomy will continue to impact the company’s performance, however, we do notanticipate the declines attributable to the holiday season to be an impact infuture quarters.  We  have implemented other initiatives designedto increase domestic sales prospectively, which should assist in growingdomestic revenue over the first quarter’s results.  In addition to this, we are not satisfiedwith the operating results of our United Kingdom operations, which generated anoperating loss in the first quarter. As compared to the prior year, our grossmargins in the United Kingdom have deteriorated, partially due to a shift inrevenue volume away from commercial accounts, coupled with growth in two large,national accounts, which generate lower margins for us.

 

Wehave had some success  in reducing ourselling and administrative costs in total, however, as a percent of total revenue we believe that there areadditional opportunities for savings.

 

OnFebruary 28, 2008 we finalized a new five-year $50 million credit facilitysyndicated through U.S. Bank and Wells Fargo Bank.  The facility is availablefor general corporate purposes, working capital needs and acquisitions. Theagreement consists of a $50 million credit facility with a $35 millionsub-limit for stand-by letters of credit. The borrowings are secured based upon a percentage of certain eligiblebilled and unbilled accounts receivables.

 

Thetotal $50 million five-year facility is replacing Westaff’s existing revolvingcredit facility with GE Capital and Bank of America, N.A which we believecontains favorable terms in the aggregate. We believe the new facility provides Westaff with thefinancing structure that will meet both short-term and long-term financialobjectives.

 

Asa result of our new credit facility which became effective on February 28,2008, we will recognize a charge to earnings for the previously capitalizedcosts associated with the former facility of approximately $0.4 million in thesecond quarter of fiscal 2008.

 

**Results of Operations - Fiscal Quarter ended January 26, 2008 andFiscal Quarter ended January 20, 2007**

 

***Revenue***

 

Gross revenue declined by $13.1 million or 10.1% to$116.8 million for the first fiscal quarter of 2008 as compared to the firstfiscal quarter of 2007. Domestic revenue declined by $16.2 million or 16.6% to$81.0 million driven largely by an 18.5% decrease in billed hours. Thisdecrease was experienced predominately in our South and West regions of ourDomestic business as a result of lower billings for several of our largercustomers as well as including a significant project for a single customer thatgenerated $0.6 million in the first quarter of fiscal 2007.  Total billings for the top 20 customers inthe first fiscal quarter of 2008 declined by $1.2 million or 5.2% to $21.6million compared to the same period for fiscal 2007.  Our average bill rate on a per hour basis fortemporary services increased 2.1% in the first quarter of fiscal 2008 comparedwith the first quarter of fiscal 2007.

 

Internationally, gross revenue increased by $3.0 millionor 9.3% to $35.8 million for the first fiscal quarter of 2008 as compared tothe first quarter of 2007.  $3.8 millionof this increase was attributed to Australia, with the United Kingdom and NewZealand experiencing a decrease of $0.5 million and $0.2 million,respectively.  The increase in Australiagross revenue in local currency was A$0.8 million, which translated to anincrease of $3.7 million as a result of a significant decline in the US dollarto the Australian dollar from the first quarter of fiscal 2008 to the first quarterof fiscal 2007.  The increase in localcurrency was  caused primarily by newcustomers in the first quarter of fiscal 2008.

 

The decline in revenue in the United Kingdom was notimpacted by currency translation.  Thedecline was a result of fewer branches in the first fiscal quarter of 2008compared with the same period last year.  The decline in revenue in New Zealand was approximately NZ$0.6 millionwhich was offset by favorable currency translation of $0.4 million.  NZ$0.4 million of the decline was a result ofa significant loss of business in a single branch.  61.6% of the revenue from that branch wasfrom a single customer who reduced their orders as a result of a decline indemand for their products.

 

***Costs of services and grossmargin***

 

Costs of services include hourly wages of temporaryemployees, employer payroll taxes, state unemployment and workers’ compensationcosts and other temporary employee-related costs. Costs of services decreased$10.5 million or 9.8% to $96.6 million for the fiscal 2008 quarter as comparedto the fiscal 2007 quarter.  The largerpercentage decrease in gross revenue than in direct costs caused consolidatedgross margin percentage to decrease slightly to

 

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17.3% in fiscal 2008 from 17.6% in fiscal 2007.  Domestic gross margin increased slightly from17.7% in the fiscal 2007 quarter to 17.9% in fiscal 2008.  This increase was achieved in spite ofdecline in permanent placement revenue, which typically has higher margins, from$1.0 million in fiscal 2007 to $0.5 million in fiscal 2008.  The increase in gross profit was achieved asa result of a focus on the elimination of unprofitable business, following thefield restructuring in the third quarter of fiscal 2007.

 

The gross margin in Australia, in local currency,decreased from 13.8% in the first quarter of fiscal 2007 to 12.9% in the firstquarter of fiscal 2008, primarily as a result of a decrease in human resourceconsulting revenue which stopped in the fourth quarter of fiscal 2007.  The gross margin for temporary labor inAustralia, in local currency, declined slightly from 11.3% in the first quarterof fiscal 2007 to 11.2% in the first quarter of fiscal 2008.

 

The average bill rate in the United Kingdom increasedmainly as a result of legislative increases in minimum wage and holidayentitlements.  Overall gross margin inlocal currency declined from 25.6% to 24.0%. This was a result of business mix as the rate for two on-site locationscomprised a larger portion of total revenue as a result of branch closures.

 

The gross margin in New Zealand, in local currency,increased significantly from 26.5% in the first fiscal quarter of 2007 to 30.5%in the first fiscal quarter of 2008.  Theincrease was largely driven from an increase in permanent placement fees whichconstituted 7.3% of gross revenue in fiscal 2008 as compared to 3.0% of totalrevenue in fiscal 2007.  The margin ontemporary labor also increased from 22.5% in fiscal 2007 to 23.0% in fiscal2008.

 

***Franchise agents’ share of grossprofit***

 

Franchise agents’ share of gross profit represents thenet distribution paid to franchise agents based either on a percentage of thesales or gross profit generated by the franchise agents’ operations. Franchiseagents’ share of gross profit decreased $0.1 million or 4.0% to $3.4 millionwhich was slightly greater than the decline in overall franchise owned grossrevenue.  Franchisees generally receive agreater share of permanent placement revenue which declined in line with the overalldecline in permanent placement revenue in the first quarter of fiscal2008.  As a percentage of consolidatedrevenue, franchise agents’ share of gross profit increased slightly from 2.7%for the fiscal 2007 quarter to 2.9% for the fiscal 2008 quarter.  The increase was a result of franchiseerevenue not dropping as significantly as the total decline in Domestic revenue.

 

***Selling and administrativeexpenses***

 

Selling and administrative expenses decreased $0.1million, or 0.8% to $17.4 million, for the first quarter of 2008as compared to the first quarter of 2007. This decrease is primarilyattributable to decreased salary and related costs of $0.6 million, as a resultof decreased headcount following the restructuring in the third quarter offiscal 2007. We experienced a decrease of $0.7 million of salary and relatedcosts in our Domestic operations which were offset by an increaseinternationally of approximately $0.1 million.

 

Weachieved cost savings in Domestic operations in the areas of facilities,advertising and promotion and supplies totaling $0.6 million as we consciouslylooked at opportunities to reduce spending in light of the significant declinein gross revenue.  In addition, weincurred lower communications and services costs, largely due to improvementsmade in our information systems infrastructure.   These reductions were offset by asignificant increase in bad debt expense from less than $0.1 million in thefirst quarter of fiscal 2007 to $0.4 million in the first quarter of fiscal 2008.  Management is also closely monitoring slowpaying customers in light of the slow down in the Domestic economy and is moreproactive in reserving for those amounts in the early stages of identifyingconcerns.

 

Ourprofessional fees increased by $0.9 million in the first quarter of fiscal 2008over the first quarter of fiscal 2007. Several factors caused the increase including additional unanticipatedaccounting fees for our fiscal 2007 audit together with continued costsincurred towards our required compliance with the provisions ofSarbanes-Oxley.  We also incurredsignificant post system implementation costs associated with the conversion ofour Pay-Bill system which went live during the first quarter of 2008.

 

Wealso benefited from the recognition of $0.6 million of previously deferred gainin the first quarter of fiscal 2008 related as a result of the termination ofour guarantee on a bank note payable related to sale of one of our franchiselocations during fiscal 2005.

 

Theremaining increase of approximately $0.2 was in a number of differentcategories, the most significant being an increase in maintenance related costsof $0.2 million and travel related costs caused primarily by the elimination of

 

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branchmanagers domestically following the 2007 restructuring  which resulted in increased travel by areamanagers.  We also increased ourreimbursement rate for vehicles in line with Internal Revenue Service rates.

 

Asa percentage of revenue, selling and administrative expenses were 14.9% for thefiscal 2008 quarter, compared to 13.5% for the fiscal 2007 quarter. Theincrease as a percent of sales is primarily due to the decreased level of salesas total selling and administrative costs declined in the first quarter of 2008quarter as compared to the first quarter of 2007.

 

***Restructuring benefit***

 

We  recorded restructuring charges in the thirdand fourth quarter of fiscal 2007 related to a reduction in force and closureof several branch offices.  In connectionwith the closure we recorded an expense in the third and fourth quarter forseverance payments and an estimate for lease termination costs calculated forthe remainder of the lease term reduced by an estimate for sublease income.  During the first quarter of fiscal 2008 wesuccessfully negotiated early termination agreements for six locations andentered into a sublease for one location. The results of this activity caused us to reduce our estimated remainingobligation by $0.2 million in the first quarter of fiscal 2008.  We are still responsible for lease paymentson 16 locations and are actively negotiating early terminations, wherepossible, and sublease opportunites to mitigate our obligation.

 

***Depreciation and amortization***

 

Depreciationand amortization increased $0.5 million or 50.3% to $1.4 million for the firstquarter of 2008 , as compared to the first quarter of 2007.  The increase was caused primarily as a resultof  the new Pay-Bill systemimplementation costs, which were previously capitalized during pre-launchstages and now are amortized to income concurrent with the launch of the systemin the the first quarter of fiscal 2008.

 

***Net interest expense***

 

Netinterest expense increased by $0.2 million, or 35.1% to $0.7 million for the 2008quarter, as compared to the 2007 quarter. In addition to a higher effective rate of interest caused by our defaultunder the terms of our agreement with GE during the third quarter of 2007, theincrease was caused principally by increased borrowings under our credit lineduring fiscal 2008.  The impact of alower sales volume and  and increases inour days sales outstanding for accounts receivable required us to drawadditional funds to support our working capital needs.

 

***Income taxes***

 

Forthe fiscal quarter ended January 26, 2008, we recorded a consolidatedincome tax benefit of $0.6 million on pre-tax loss of $2.5 million. The prioryear quarter’s tax benefit was $0.6 million lower than this year’s, primarilybecause of the pre-tax income generated in the first quarter of the prior yearand domestic workers’ opportunity tax benefits of $0.4 million related to 2006,largely offset by income taxes from various domestic and internationaljurisdictions. Under Generally Accepted Accounting Principles, we are requiredto evaluate the realizability of the deferred tax assets based on our abilityto generate future taxable income.  Wehave not provided for a valuation reserve as we believe that we will generatesufficient taxable income to fully utilize net operating loss and tax creditcarryforwards, however, if we are unable to return to our historical levels ofprofitability, we may need to establish a reserve against our deferred taxasset which would result in a reduction of our assets, stockholders’ equity andadversely affect our operating results.

 

***Net (loss) income***

 

Theresult of the aforementioned items was a net loss for the first quarter offiscal 2008 of $1.9 million, or $0.11 per share, as compared with net income of$0.4 million, or $0.02 per share for the first quarter of fiscal 2007.

 

**Liquidityand Capital Resources**

 

We require significantamounts of working capital to operate our business and to pay expenses relatingto employment of temporary employees. Our traditional use of cash is forfinancing of accounts receivable, particularly during periods of economicupswings and growth, when sales are seasonally high. Temporary personnel aretypically paid on a weekly basis while payments from customers are generallyreceived 30 to 60 days after billing.

 

We finance our operationsprimarily through cash generated by our operating activities and borrowingsunder our revolving credit facilities. Net cash used by operating activitieswas $3.4 million for the first quarter of 2008, compared to cash provided byoperating activities of $2.3 million for the first quarter of fiscal 2007. This$5.7

 

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million decrease isprimarily a result of a net loss of $1.9 million compared with net income of$0.4 million for the first quarter of 2007. Collections of accounts receivable was the largest significant source ofcash providing $4.0 million during both the first quarter of fiscal 2008 andthe first quarter of fiscal 2007.  Thechange in accounts receivable domestically was $5.6 million during the firstquarter of fiscal 2008 which was a combination of collections and a decrease inaccounts receivable from decreased sales during the quarter.  We also experienced a reduction in accountsreceivable in the United Kingdom during the first quarter of fiscal 2008 of$1.6 million as a result of increased collections combined with a decrease insales.  We saw an increase in accountsreceivable in Australia of $3.1 million during the first quarter of fiscal 2008caused partially by our first quarter falling prior to the first of the monthwhile our most recent fiscal year included a 53rd week and fell after the firstof the month.

 

Our number of days salesoutstanding, measured by dividing our ending net accounts receivable balance bytotal sales multiplied by the number of days in the fiscal quarter, (DSO)increased to 51.4 days at January 26, 2008 compared to from 47.0 days at January 20,2007.   We saw an increase in ourDomestic services DSO as well as in all of our international locations.

 

We reported a decline in ourDomestic DSO at year end, however, as a result of billing issues following ourconversion to a new Pay-Bill system, together with economic slowing we haveseen an increase in our Domestic DSO from 43.8 days at fiscal year end to 49.2days at January 26, 2008.  This alsorepresents an increase from the 47.4 days at January 20, 2007.  We believe that we have resolved asignificant portion of customer billing questions and have focused our effortson reducing our DSO.  We have brought oncontract labor with collection experience to assist in collection of past dueaccounts and are hopeful that this will assist us in driving our DSO back toacceptable levels.

 

Our Australian DSO increasedsignificantly to 55.4 days at January 26, 2008.  This was up significantly from the 47.7 daylevel November 3, 2007 and 47.5 days at January 20, 2007.  The increase was principally attributed toseveral accounts, one account with a balance in excess of A$1million who haveslowed their repayment from approximately 60 days to an excess of 65 days.  Additionally, Australia provides Santa’s toretail locations during the holiday season. These accounts tend to be slower paying and there was an increase in theSanta business at year end.  This work isperformed and billed at the same time each year and the first quarter forfiscal year 2008 ended one week later then the first quarter of fiscal2007.  There has not been a significantincrease in amounts over 60 days as a percentage of total accounts receivableand we feel our reserves for bad debt are adequate.

 

Our DSO in the UnitedKingdom,after taking into account the reclassification discussed in Note 1 ofthe financial statements,  has dropped to58.3 days at Janaury 26, 2008 compared with 59.0 days at November 3,2007.  This amount however is upsignificantly from the 41.7 day level at January 20, 2007.  This increase was caused by a shift inbusiness to more managed accounts which typically are slower pay.  The increase last year was a result of a keyemployee involved in the collection process being on leave during fiscal2007.  We are hopeful that we willcontinue to drive DSO lower, however, our efforts will be affected by the mixof managed accounts.

 

New Zealand accountsreceivable represent just over 1% of total accounts receivable and are not asignificant driver of our consolidated DSO.  New Zealand DSO levels were 42.5 days, 33.8 days and 43.1 days at January 26,2008; November 3, 2007 and January 20, 2007, respectively.  The decrease at November 3, 2007 wasprimarily a result of payments from customers made at the end of themonth.  Our fiscal year ended November 3,2007 had 53 weeks causing the period to end after the first of the month.  The increase in DSO has not been accompaniedby an increase in past due amounts and we believe that the increase, likeAustralia, is a result of the timing of period ends.  The variances are more exaggerated because ofthe impact of slight increases in accounts receivable balances against a relativelylow revenue base amount.

 

Cash used for investingactivities was $0.6 million in the first quarter of fiscal 2008, as comparedto  $1.0 million in the first quarter offiscal 2007. Capital expenditures, which are primarily for information systeminitiatives both domestically and internationally, represented the majority ofthis decrease in both quarters.  Cashprovided from financing activities was $3.2 million in the first quarter offiscal 2008 compared with cash used for financing activities  of $64,000 in the first quarter of fiscal2007.  We increased our short-termborrowing in Australia by $3.5 million in order to provide cash as our accountsreceivable increased during the period and we saw a reduction of our accountspayable.  We paid down our Domestic lineof credit by $0.2 million as we reduced our accounts receivable in an amountgreater than our paydown of accounts payable and accrued expenses.   The cash provided from financing activitieswas reduced by the reduction of principal on capital lease obligations of $0.1million.  This compared with less than$0.1 million of borrowings for the first quarter of fiscal 2007 and $0.1million received from the issuance of common stock offset by repayment of principalon capital leases of $0.1 million and debt issuance costs of  $0.1 million.

 

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In February 2004, wecompleted the sale of our former corporate headquarters’ building for cashproceeds of $1.9 million. The proceeds were used to pay down outstandingborrowings under our revolving credit facilities. We have an outstanding $0.7million irrevocable standby letter of credit as a security deposit for the December 2002sale leaseback of the land and buildings housing our administrative offices.

 

In May 2002, we enteredinto agreements with GE Capital, as primary agent, to provide senior securedmulticurrency credit facilities that originally expired in May 2007. Thecredit facility comprised a five-year syndicated Credit Agreement (the ‘‘MulticurrencyCredit Agreement’’) consisting of a $50.0 million U.S. Revolving LoanCommitment, a £2.74 million U.K. Revolving Loan Commitment (U.S. dollarequivalent of approximately $4.0 million at the date of the agreement), and a$5.0 million term loan, which was repaid during fiscal 2003. In addition, afive-year Australian dollar facility agreement (the ‘‘A$Facility Agreement’’)was executed on May 16, 2002, consisting of an A$12.0 million revolvingcredit facility (U.S. dollar equivalent of approximately $6.0 million at thedate of the A$Facility Agreement).

 

On January 25, 2007, weand our lenders, executed an amendment to the A$ Facility Agreement, whichextended the agreement for two additional years to May 2009.

 

As of January 26, 2008,our total borrowing capacity was $11.4 million consisting of $5.9 million forthe domestic operations, $1.6 million for Australia and $3.9 million for theUnited Kingdom.

 

On February 28,2008,  we were advanced credit in theform of letters of credit issued and loans advanced in an aggregate amount ofapproximately $29.6 million under a Financing Agreement, dated as of February 14,2008 (the “Financing Agreement”), with U.S. Bank National Association (U.S.Bank) and Wells Fargo  Bank.

 

The Financing Agreementprovides for a new five-year US$50 million revolving credit facility, whichincludes a letter of credit sub-limit of US$35 million. This new FinancingAgreement replaces our U.S. Revolving Loan Commitment and the £2.74 millionU.K. Revolving Loan Commitment  Themaximum borrowing availability under the Financing Agreement is based upon apercentage of certain eligible billed and unbilled Domestic and U.K. accountsreceivable.  Borrowings under theFinancing Agreement bear interest, at our election, of either U.S. Bank’s primerate plus 0% or at LIBOR plus an applicable LIBOR rate margin ranging from1.25% to 2.00%. A default rate would apply on all loan obligations in the eventof default under the Credit Documents, at a rate per annum of 2% above theapplicable interest rate. Interest is payable on a monthly basis. The creditobligations under the Financing Agreement are secured by a first prioritysecurity interest in our assets, with certain exceptions set forth in theFinancing Agreement and the other Credit Documents.

 

We have an unsecuredsubordinated promissory note payable to the former Chairman of the Board ofDirectors in the amount of $2.0 million with a maturity date of August 18,2007, and an interest rate equal to an indexed rate as calculated under theCompany’s credit facilities plus seven percent (13.5% at January 26,2008), compounded monthly and payable 60 calendar days after the end of each ofour fiscal quarters. Payment of interest is contingent on the Company meetingminimum availability requirements under its credit facilities. Additionally,payments of principal or interest are prohibited in the event of any defaultunder the credit facilities.  Followingour default at the end of third quarter fiscal 2007, GE Capital exercised theirright to prohibit the repayment of the note at its maturity and has denied ourrequest to pay quarterly interest. Unpaid interest at January 26, 2008 was $171,000.

 

We work to balance ourworldwide cash needs through dividends from and loans to our internationalsubsidiaries. These loans and dividends are limited by the cash availabilityand needs of each respective subsidiary, restrictions imposed by our seniorsecured debt facilities and, in some cases, statutory regulations of thesubsidiary. The U.S. operations cannot directly draw on the excess borrowingavailability of the U.K. or Australian operations; however, we may requestdividends from the U.K. The U.S. can also request repayments on itsintercompany loan to Australia, along with intercompany interest and royalties,although remittances from Australia may be limited by certain covenants underthe terms of the Australia credit facility. Outstanding principal on theintercompany loan to Australia was approximately $4.8 million as of January 26,2008.  An additional $1.7 million wasoutstanding from New Zealand to the U.S.

 

We are responsible for andpay workers’ compensation costs for our domestic temporary and regularemployees and are self-insured for the $750,000 deductible amount related toworkers’ compensation claims. Typically, each policy year the terms of theagreement with the insurance carrier are renegotiated. The insurance carrierrequires us to collateralize our obligations through the use of irrevocablestandby letters of credit, surety bonds or cash.

 

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For our 2008 policy yearinsurance program, we anticipate total cash premium payments of $4.2 millionwill be paid during fiscal 2008 in equal monthly installments, which commencedon November 1, 2007. Cash payments for 2008 policy year claims will bepaid directly by us up to our deductible which was increased from $500,000 perclaim to $750,000 per claim for fiscal 2008. As of January 26, 2008, wehad outstanding $27.3 million of letters of credit to secure all estimatedoutstanding obligations under our workers’ compensation program for all yearsexcept 2003, which is fully funded although subject to annual retroactivepremium adjustments based on actual claims activity. We will also make ongoingcash payments for claims for all other open policy years (except for 2003 asnoted above).

 

We calculate the estimatedliabilities associated with these programs based on our estimate of theultimate costs to settle known claims as well as claims incurred but not yetreported to us (“IBNR claims”) as of the balance sheet date. Our estimatedliabilities are not discounted and are based on information provided by ourinsurance brokers, insurers and actuary, combined with our judgment regarding anumber of assumptions and factors, including the frequency and severity ofclaims, claims development history, case jurisdiction, applicable legislationand our claims settlement practices. We maintain stop-loss coverage with thirdparty insurers to limit our total exposure for each of these programs.Significant judgment is required to estimate IBNR amounts as parties have yetto assert such claims. If actual claims trends, including the severity orfrequency of claims, differ from our estimates, our financial results could beimpacted.  We continue to evaluate otheropportunities to further strengthen our financial position. However, we believethat if our proposed financing will provide us with sufficient borrowingcapacity, together with cash generated through our operating performance, tomeet our working capital needs for the foreseeable future.

 

**Item 3.  Quantitative andQualitative Disclosures About Market Risk**

 

We are exposed to certainmarket risks from transactions that are entered into during the normal courseof business. Our primary market risk exposure relates to interest rate risk. AtJanuary 26, 2008, our outstanding debt under variable-rate interestborrowings was approximately $9.9 million. A change of two percentage points inthe interest rates would cause a change in interest expense of approximately$0.2 million on an annual basis. Our exposure to market risk for changes ininterest rates is not significant with respect to interest income, as ourinvestment portfolio is not material to our consolidated balance sheet. Wecurrently have no plans to hold an investment portfolio that includesderivative financial instruments.

 

For the 12 weeks ended January 26, 2008, our internationaloperations comprised 30.7% of our gross revenue and, as of the end of thatperiod, 23.2% of our total assets. We are exposed to foreign currency riskprimarily due to our investments in foreign subsidiaries. Our multicurrencycredit facility, which allows our Australian and United Kingdom subsidiaries toborrow in local currencies, partially mitigates the exchange rate riskresulting from fluctuations in foreign currency denominated net investments inthese subsidiaries in relation to the U.S. dollar. Our new credit agreementwith U.S. Bank does not contain a borrowing facility for our United Kingdomsubsidiary, however, their accounts receivable are included in the computationof our borrowing base.  The amount ofshort term borrowings in the United Kingdom over the past year were minimal andwe do not believe this limitation will severely impact our foreign currencyrisk.  We do not currently hold anymarket risk sensitive instruments entered into for hedging risks related toforeign currencies. In addition, we have not entered into any transactions withderivative financial instruments for trading purposes.

 

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

###  

We maintain disclosure controls and procedures that are designed toensure that information required to be disclosed in our Exchange Acts reportsare recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms, and that such information isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosure based on the definition of “disclosure controlsand procedures” in Rule 13a-15(e).  Indesigning and evaluating the disclosure controls and procedures, managementrecognizes that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and management necessarily is required to apply itsjudgment in evaluating the cost-benefit relationship of possible controls andprocedures.

 

We carried out an evaluation, under the supervision and with theparticipation of our senior management, including our Chief Executive Officerand Chief Financial Officer, of the effectiveness of the design and operationof our disclosure controls and procedures as of January 26, 2008, the end ofthe period covered by this periodic SEC report. Based upon the foregoing, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures werenot effective at that date due to a material weakness relating to a lack ofqualified  resources within theaccounting department.  Management hasalready taken steps to remediate this matter as outlined below.

 

The Company maintains internal controls and procedures requiring thataccounts be reconciled internally on a prompt and regular basis, and alwaysprior to the end of a reporting period. Account reconciliation is to be performed by qualified accountingpersonnel and subjected to review by separate supervisory personnel prior to theend of each reporting period.

 

 

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A number of substantial challenges were presented to the accountingdepartment of the Company in closing the first quarter of fiscal 2008.

 
    - The Company     underwent a change in management in fiscal 2007 including the hiring of a     new Chief Executive Officer during second quarter 2007, Chief Financial     Officer and Controller during the fourth quarter of fiscal 2007.

 
    - In connection     with the adoption of Staff Accounting Bulletin 108 “Considering the     Effects of Prior Year Misstatements when Quantifying Misstatements in     Current Year Financial Statements”(“SAB 108”) the Company invested     significant resources to assess the magnitude of the adjustment to     beginning retained earnings for prior period errors.  The application of SAB 108, including     documenting the impact on prior years, involved significant time from key     accounting personnel.   The result     of this assessment was that the Company strengthened control procedures     related to ensuring that timely account reconciliations are     performed.  
    - The Company     implemented a new PeopleSoft Pay-Bill technology platform at the beginning     of the period covered by this periodic report.  A number of issues with the     implementation arose that were not detected during testing of the     technology.  These issues caused     disruption to the Company’s business and customer relationships and     required substantial manual intervention from the accounting department to     resolve, including material amounts of time from key accounting personnel     of the Company.  

 
    - The fiscal     2007 audit was the first conducted by our new audit firm and was not     concluded prior to end of our first quarter of fiscal 2008.

 

These factors together with the fact that the first quarter consistedof 12 weeks which ended prior to issuance of our November 3, 2007 auditedfinancial statements resulted in a failure of our internal review process todetect inadequately prepared account reconciliations on a timely basis.  Supervisory review of account reconciliationshas been identified by management as a key control.

 

In recognition of the importance of a strong control environment theCompany has taken and will continue to take a number of steps to improve thefunction of its accounting department in implementing existing controlprocedures, including changes in personnel, increases in the level of seniorityand credentials of senior accounting managers, the hiring of a new financialreporting manager, and changes in internal reporting relationships to improvethe ability of senior accounting managers to ensure that existing controls andprocedures are implemented on a timely basis. The Company believes that these changes will allow the controlprocedures as designed to operate effectively for the second and futurequarters.

 

### **Part II.   Other Information**

###  

### **Item1.    Legal Proceedings**

###  

In theordinary course of our business, we are periodically threatened with or namedas a defendant in various lawsuits.  Theprincipal risks that we insure against are workers’ compensation, generalliability, automobile liability, property damage, alternative staffing errorsand omissions, fiduciary liability and fidelity losses.

 

During the fourth quarter offiscal 2005, we were notified by the EDD that our domestic operating subsidiariesunemployment tax rates would be increased retroactively for both calendar years2005 and 2004, which would result in additional unemployment taxes ofapproximately $0.9 million together with interest at applicable statutoryrates. Management believes that it has properly calculated its unemploymentinsurance tax and is in compliance with all applicable laws and regulations. Wehave timely appealed the ruling by the EDD and are working with our outsidecounsel to resolve this matter.  Ahearing officer has been assigned to the matter.  We are awaiting confirmation of a hearingdate from the EDD.

 

Otherthan the action listed above, we are not currently a party to any materiallitigation. However, from time to time we have been threatened with, or namedas a defendant in litigation brought by former franchisees or licensees, andadministrative claims and lawsuits brought by employees or former employees.Management believes the resolution of these matters will not have a materialadverse effect on our financial statements.

 

### **Item1A.  Risk Factors**

 

This Quarterly Report on Form 10-Q containsforward-looking statements concerning our future programs, products, expenses,revenue, liquidity and cash needs as well as our plans and strategies. Theseforward-looking statements are based on current expectations, and we assume noobligation to update this information, except as required by applicable lawsand regulations. Numerous factors could cause actual results to differsignificantly from the results described in these forward-looking statements,including the following risk factors.

Investing in our securities involves risk. Thefollowing risk factors, issues and uncertainties should be considered whenevaluating our future prospects. In particular, please consider these riskfactors when reading “forward-looking” statements which appear throughout thisreport. Forward-looking statements relate to our expectations for future eventsand time periods. Generally, words such as “expect,” “intend,” “anticipate” andsimilar expressions identify forward-looking statements. Each of theseforward-looking statements involves risks and uncertainties, and future eventsand circumstances could differ significantly from those anticipated in theforward-looking statements. Any one of the following risks could harm ouroperating results or financial condition and could result in a significantdecline in the value of an investment in us. Further, additional risks anduncertainties that have not yet been identified or which we currently believeare immaterial may also harm our operating results and financial condition.  Certain of the risk factors set forth in the Company’sAnnual Report on Form 10-K for the fiscal year ended November 3, 2007 havematerially changed.  Accordingly, we haveupdated and restated our risk factors in their entirety below.

 

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*We have significant workingcapital requirements and are heavily dependent upon our ability to borrow moneyto meet these working capital requirements.*

We require significant amounts of working capital tooperate our business and to pay expenses relating to employment of temporaryemployees.  Temporary personnel aregenerally paid on a weekly basis while payments from customers are generallyreceived 30 to 60 days after billing. As a result, we must maintain sufficientcash availability to pay temporary personnel prior to receiving payment fromcustomers.  Any lack of access to liquidworking capital would have an immediate, material, and adverse impact on ourbusiness.

To date, we have financed, and expect to continue tofinance, our operations primarily through borrowings under our revolving creditfacilities and also through cash generated by our operating activities.  As of January 26, 2008, our total borrowingcapacity was $11.4 million, consisting of $5.9 million for the domesticoperations, $1.6 million for Australia and $3.9 million for the United Kingdom.  On February 14, 2008, we entered into a newFinancing Agreement with U.S. Bank and Wells Fargo Bank that provides for a newfive-year US$50 million revolving credit facility, which includes a letter ofcredit sub-limit of US$35 million.  Thenew Financing Agreement replaced the $55 million U.S. Revolving Loan Commitmentand the £2.74 million U.K. Revolving Loan Commitment under our creditfacilities with GE Capital.  OurAustralian subsidiary continues to maintain a A$12 million Australian dollarfacility agreement with GE Capital that expires in May 2009.

The amounts we are entitled to borrow under ourrevolving credit facilities with US Bank and Wells Fargo Bank in the UnitedStates and with GE Capital in Australia are calculated daily and is dependenton eligible trade accounts receivable generated from operations, which areaffected by financial, business, economic and other factors, as well as by thedaily timing of cash collections and cash outflows.  If we experience a significant and sustaineddrop in operating profits, or if there are unanticipated reductions in cash inflowsor increases in cash outlays, we may be subject to cash shortfalls.  If such a shortfall were to occur for even abrief period of time, it may have a significant adverse effect on our business,financial condition or results of operations. Furthermore, our receivables may not be adequate to allow for borrowingsfor other corporate purposes, such as capital expenditures or growthopportunities, and we would be less able to respond to changes in market orindustry conditions.

We typically experience significant seasonal and otherfluctuations in our borrowings and borrowing availability, particularly in theUnited States, and have, in the past, been required to aggressively manage ourcash to ensure adequate funds to meet working capital requirements.  Such steps included working to improvecollections and adjusting the timing of cash expenditures, reducing operatingexpenses where feasible and working to generate cash from a variety of othersources.

We have historically experienced periods of negative cashflow from operations and investment activities, especially during seasonalpeaks in revenue experienced in the third and fourth fiscal quarters of theyear.  In addition, we are required topledge amounts to secure letters of credit that collateralize certain workers’compensation obligations, and these amounts may increase in futureperiods.  Any such increase in pledgedamounts or sustained negative cash flows would decrease amounts available forworking capital purposes and could have a material adverse effect on ourliquidity and financial condition.

*The staffing industry is highly competitive withlimited barriers to entry which could limit our ability to maintain or increasemarket share.*

The staffing industry is highly competitive withlimited barriers to entry and continues to undergo consolidation.  We compete in regional and local markets withlarge full service agencies, specialized temporary and permanent placementservices agencies and small local companies. While some competitors are smaller than us, they may enjoy an advantagein discrete geographic markets because of a stronger local presence.  Other competitors have greater marketing,financial and other resources than us that, among other things, could enablethem to attempt to maintain or increase their market share by reducingprices.  Furthermore, in past years therehas been an increase in the number of customers consolidating their staffingservices purchases with a single provider or with a small number ofproviders.  The trend to consolidatestaffing services purchases has in some cases made it more difficult for us toobtain or retain business.

*Price competition in the staffing industrycontinues to be intense, and pricing pressures from both competitors andcustomers could adversely impact our financial decisions.*

We expect the level of competition to remain high inthe future, and competitive pricing pressures will continue to make itdifficult for us to raise our prices to immediately and fully offset increasedcosts of doing business, including increased labor costs, costs for workers’compensation and, domestically, state unemployment insurance.  If we are not able to effectively compete inour targeted markets, our operating margins and other financial results will beharmed and the price of our securities could decline.  We also face the risk that our current orprospective customers may decide to provide services internally.

*We have had significant turnover in our managementteam and further loss of any of our key personnel could harm our business.*

On May 1, 2007, our former Chief Executive Officerresigned from the Company and was replaced by Michael T. Willis.  On June 29, 2007, our Chief Financial Officerresigned from the company.  We hired anew Chief Financial Officer, Dawn M. Jaffray, effective August 7, 2007.   Our VP of Information Services, Eric Person,resigned on January 25, 2008.  Wecurrently have an interim Chief Information Officer with industry experienceand are searching for a full time replacement.

*Our future financial performance is significantlyimpacted by our ability to attract, motivate and retain key managementpersonnel and other members of the senior management team.*

 

26

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Competition for qualified management personnel isintense and in the event that we experience turnover in senior managementpositions, we cannot assure that we will be able to recruit suitablereplacements on a timely basis.  We mustalso successfully integrate all new management and other key positions withinour organization to achieve our operating objectives.  Even if we are successful, turnover in keymanagement positions could temporarily harm our financial performance andresults of operations until the new management becomes familiar with ourbusiness.

 

*Failure to implement our new strategies couldimpede our growth and result in significant added costs.*

 

In fiscal 2007, we made significant changes to ourfield structure and hired several new key executives late in such fiscal year toseek to grow new business markets for the Company.  Our failure to implement these new strategiescould impede our growth and result in significant added costs.  Even if our new strategies are successfullyimplemented, they may not have the favorable impact on our business andoperations that we anticipate.

 

*Our principal stockholder, together with itsaffiliates, controls a significant amount of our outstanding common stock thusallowing them to exert significant influence on our management and affairs.*

As of January 26, 2008, our principal stockholder,DelStaff LLC (“DelStaff’), together with its affiliates, controls approximately49.6% of the total outstanding shares of our common stock.  The members of DelStaff are H.I.G. Staffing,2007, Ltd., Alarian Associates, Inc. and Michael T. Willis. As our principalstockholder, DelStaff and its affiliates have the ability to significantlyinfluence all matters submitted to our stockholders for approval, including theelection of directors, and to exert significant influence over our managementand affairs.  On April 30, 2007, weentered into a Governance Agreement with DelStaff, Mr. Willis and Mr. Stover.Pursuant to the terms of the Governance Agreement, on May 9, 2007, we expandedthe size of our Board of Directors from five to nine directors and appointedthe following DelStaff nominees to the Board: Michael T. Willis, John R. Black,Michael R. Phillips, Gerald E. Wedren and John G. Ball.  DelStaff also has the ability to stronglyinfluence any merger, consolidation, sale of substantially all of our assets orother strategic decisions affecting us or the market value of the stock.  This concentration of stock and voting powercould be used by DelStaff to delay or prevent an acquisition of Westaff orother strategic action or result in strategic decisions that could negativelyimpact the value and liquidity of our outstanding stock.

*The amount of collateral that we are required tomaintain to support our workers’ compensation obligations could increase,reducing the amount of capital that we have available to support and grow ourfield operations.*

We are contractually obligated to collateralize ourworkers’ compensation obligations under our workers’ compensation programthrough irrevocable letters of credit, surety bonds or cash.  As of January 26, 2008, our aggregatecollateral requirements under these contracts have been secured through $27.3million of letters of credit.  Further,our workers’ compensation program expires November 1, 2008, and as part of therenewal, could be subject to an increase in collateral.  These collateral requirements are significantand place pressure on our liquidity and working capital capacity.  We believe that our current sources ofliquidity are adequate to satisfy our immediate needs for these obligations;however, our available sources of capital are limited.  Depending on future changes in collateralrequirements, we could be required to seek additional sources of capital in thefuture, which may not be available on commercially reasonable terms.

*Our reserves for workers’ compensation claims maybe inadequate to cover our ultimate liability, and we may incur additionalcharges if the actual amounts exceed the reserved amounts.*

We maintain reserves to cover our estimated liabilitiesfor workers’ compensation claims based upon actuarial estimates of the futurecost of claims and related expenses which have been reported but not settled,and that have been incurred but not yet reported.  The determination of these reserves is based ona number of factors, including current and historical claims activity, medicalcost trends and developments in existing claims.  Reserves do not represent an exactcalculation of liability and are affected by both internal and external events,such as adverse development on existing claims, changes in medical costs,claims handling procedures, administrative costs, inflation, legal trends andlegislative changes.  Reserves areadjusted as necessary to reflect new claims and existing claims development, andsuch adjustments are reflected in the results of the periods in which thereserves are adjusted.  While we believeour judgments and estimates are adequate, if our reserves are insufficient tocover our actual losses, an adjustment could be charged to expense that may bematerial to our earnings.

*Workers’ compensation costs for temporary employeesmay continue to rise and reduce margins and require more liquidity.*

In the United States, weare responsible for and pay workers’ compensation costs for our regular andtemporary employees.  In recent years,these costs have risen substantially as a result of increased claims, generaleconomic conditions, increases in healthcare costs and governmentalregulations.  In fiscal 2007, theincrease in the volume of claims has fallen despite an increase in our domesticrevenue, yet the increases in cost per claim have continued.  Under our workers’ compensation insuranceprogram, we maintain “per occurrence” insurance, which only covers claims for aparticular event above a $500,000 deductible. This deductible has been increased for our policy year ending November1, 2008 to $750,000.  Our workers’compensation insurance policy expires November 1, 2008 and we cannot guaranteethat we will be able to successfully renew such policy.  Further, there are covenants associated withthe continuation of the policy and there can be no guarantee that we willcontinue to meet those covenants going forward. Should our workers’ compensation premium costs continue to increase inthe future, there can be no assurance that we will be able to increase the feescharged to our customers to keep pace with increased costs or if we were unableto obtain insurance on reasonable terms or forced to significantly increase ourdeductible per claim, our results of operations, financial condition andliquidity could be adversely affected.

 

27

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*Any significant economic downturn could result inour customers using fewer staffing services, which could materially adverselyaffect our business.*

Demand for staffing services is significantly affectedby the general level of economic activity.  There are indications that the economy iscurrently softening, which we expect will continue to impact the demand for staffingservices and the Company’s performance.  Aseconomic activity slows, many customers reduce their utilization of temporaryemployees before undertaking layoffs of their regular full-time employees.  Further, demand for permanent placementservices also slows as the labor pool directly available to our customer’sincreases, making it easier for them to identify new employees directly.  Typically, we may experience increasedpricing pressures from other staffing companies during periods of economic downturn,which could have a material adverse effect on our financial condition.Additionally, in geographic areas where we derive a significant amount ofbusiness, a regional or localized economic downturn could adversely affect ouroperating results and financial position.

*We are exposed to credit risks on collections fromour customers due to, among other things, our assumption of the obligation tomake wage, tax, and regulatory payments to our temporary employees.*

We are exposed to the credit risk of some of ourcustomers.  Temporary personnel aretypically paid on a weekly basis while payments from customers are generallyreceived 30 to 60 days after billing.  Wegenerally assume responsibility for and manage the risks associated with ourpayroll obligations, including liability for payment of salaries and wages,payroll taxes as well as group health insurance.  These obligations are fixed and become aliability of ours, whether or not the associated client to whom these employeeshave been assigned makes payments required by our service agreement, whichexposes us to credit risks.  We attemptto mitigate these risks by billing on a frequent basis, which typically occursdaily or weekly.  In addition, weestablish an allowance for doubtful accounts for estimated losses resultingfrom the inability of our customers to make required and timely payments.  Further, we carefully monitor the timelinessof our customers’ payments and impose strict credit standards.  However, there can be no assurance that suchsteps will be effective in reducing these risks.  Finally, the majority of our accountsreceivable is used to secure our revolving credit facilities, which we rely onfor liquidity.  If we fail to adequatelymanage our credit risks associated with accounts receivable, our financialposition could be adversely impacted. Additionally, to the extent that recent turmoil in the credit marketsmakes it more difficult for some customers to obtain financing, thosecustomers’ ability to pay could be adversely impacted, which in turn could havea material adverse effect on our business, financial condition or results ofoperations.

*We derive a significant portion of our revenue fromfranchise agent operations.*

Franchise agent operations comprise a significantportion of our revenue.  Franchiseesrepresented 27.6% of gross receipts in the first quarter of fiscal 2008.  In addition, our ten largest franchise agentsaccounted for 18.6% of our revenue. There can be no assurances that we will be able to attract newfranchisees or that we will be able to retain our existing franchisees.  The loss of one or more of our franchiseagents and any associated loss of customers and sales could have a materialadverse effect on our results of operations.

*We are subject to business risks associated withinternational operations and fluctuating exchange rates.*

We presently have operations in the United Kingdom,Australia and New Zealand, which comprised 30.7% of our revenue for 12-weekperiod ended January 26, 2008. Operations in foreign markets are inherently subject to certain risks,including in particular:

*•*                                            differences in cultures and business practices;

*•*                                                 overlapping or differing tax laws and regulations;

*•*                                            economic and political uncertainties;

*•*                                            differences in accounting and reporting requirements;

*•*                                            changing, complex or ambiguous foreign laws andregulations, particularly as they relate to employment; and

*•*                                            litigation and claims.

All of our sales outside of the United States aredenominated in local currencies and, accordingly, we are subject to risksassociated with fluctuations in exchange rates, which could cause a reductionin our profits.  There can be noassurance that any of these factors will not have a material adverse effect onour business, results of operations, cash flows or financial condition.

*Our success is impacted by our ability to attractand retain qualified temporary and permanent candidates.*

We compete with other staffing services to meet ourcustomers’ needs, and we must continuously attract reliable candidates to meetthe staffing requirements of our customers. Consequently, we must continuouslyevaluate and upgrade our base of available qualified personnel to keep pacewith changing customer needs and emerging technologies.  Furthermore, a substantial number of ourtemporary employees during any given year will terminate their employment withus and accept regular staff employment with our customers.  Competition for individuals with provenskills remains intense, and demand for these individuals is expected to remainstrong for the foreseeable future.  Therecan be no assurance that qualified candidates will continue to be available tous in sufficient numbers and on acceptable terms to us.  The failure to identify, recruit, train andplace candidates as well as retain qualified temporary employees over a longperiod of time could materially adversely affect our business.

 

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*Our service agreements may be terminated on shortnotice, leaving us vulnerable to loss of a significant amount of customers in ashort period of time.*

Our service agreements are generally cancellable withlittle or no notice by the customer to us. As a result, our customers canterminate their agreement with us at any time, making us particularlyvulnerable to a significant decrease in revenue within a short period of timethat could be difficult to quickly replace.

*The cost of unemployment insurance for temporaryemployees may rise and reduce our margins.*

In the United States, we are responsible for and payunemployment insurance premiums for our temporary and regular employees.  At times, these costs have risen as a resultof increased claims, general economic conditions and government regulations.  Should these costs continue to increase, therecan be no assurance that we will be able to increase the fees charged to ourcustomers in the future to keep pace with the increased costs, and if we donot, our results of operations and liquidity could be adversely affected.

*Our information technology systems are critical tothe operations of our business.*

Our information management systems are essential fordata exchange and operational communications with branches spread across largegeographical distances.  We have replacedkey component hardware and software including backup systems within the pasttwelve months.

On November 12, 2007, we implemented a new accountsreceivable billing and temporary payroll system.  The new system receives information from ourcustom built front office system.  Weexperienced technical issues after the conversion that were not detected duringthe testing phases.  These issuesaffected both the payroll and billing systems. We believe that we have identified the significant issues and areworking to resolve those.  These issueswere disruptive to our business and could affect customer and employeerelations.  Additionally, these issuesrequired significant amount of management time that impacted our ability tosell new services during the first quarter of fiscal 2008.  Continued interruption, impairment or loss ofdata integrity or malfunction of these systems could severely impact ourbusiness, especially our ability to timely and accurately pay employees andbill customers.  

*Our business is subject to extensive governmentregulation, which may restrict the types of employment services that we arepermitted to offer or result in additional tax or other costs that adverselyaffect our revenues and earnings.*

We are in the business of employing people and placingthem in the workplace of other businesses on either a temporary or permanentbasis.  As a result, we are subject toextensive laws and regulations relating to employment.  Changes in laws or government regulations mayresult in prohibition or restriction of certain types of employment services weare permitted to offer or the imposition of new or additional benefit,licensing or tax requirements that could reduce our revenues and earnings.  There can be no assurance that we will beable to increase the fees charged to our customers in a timely manner and in asufficient amount to cover increased costs as a result of any changes in lawsor government regulations.  Any futurechanges in laws or government regulations may make it more difficult orexpensive for us to provide staffing services and could have a material adverseeffect on our business, financial condition or results of operations.

*We may be exposed to employment-related claims andcosts that could materially adversely affect our business.*

The risks related to engaging in our business includebut are not limited to:

*•*                                            claims by our placed personnel of discrimination andharassment directed at them, including claims arising from the actions of ourcustomers;

*•*                                            workers’ compensation claims and other similar claims;

*•*                                            violations of wage and hour laws and requirements;

*•*                                            claims of misconduct, including criminal activity ornegligence on the part of our placed personnel;

*•*                                            claims by our customers relating to actions by ourplaced personnel, including property damage and personal injury, misuse ofproprietary information and misappropriation of assets or other similar claims;and

*•*                                            immigration related claims.

In addition, some or all of these claims may give riseto litigation, which could be time-consuming to our management team, andtherefore, could have a negative effect on our business, financial conditionsand results of operations. In some instances, we have agreed to indemnify ourcustomers against some or all of these types of liabilities.  We have policies and guidelines in place tohelp reduce our exposure to these risks and have purchased insurance policiesagainst certain risks in amounts that we currently believe to be adequate.  However, there can be no assurance that ourinsurance will be sufficient in amount or scope to cover these types ofliabilities or that we will be able to secure insurance coverage for such riskson affordable terms.  Furthermore, therecan be no assurance that we will not experience these issues in the future orthat they could have a material adverse effect on our business.

 

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*The market for our stock may be limited, and thestock price may continue to be extremely volatile.*

The average daily trading volume for our common stockon the NASDAQ Global Market was approximately 15,000 shares during the firstquarter of fiscal 2008.  Accordingly, themarket price of our common stock is subject to significant fluctuations thathave been, and may continue to be, exaggerated because an active trading markethas not developed for our common stock. We believe that the price of our commonstock has also been negatively affected by the fact that our common stock isthinly traded and also due to the absence of analyst coverage.  The lack of analyst reports about our stockmay make it difficult for potential investors to make decisions about whetherto purchase our stock and may make it less likely that investors will purchasethe stock, thus further depressing the stock price.  These negative factors may make it difficultfor stockholders to sell our common stock, which may result in losses forinvestors.

*The compliance costs associated with Section 404 andother requirements of the Sarbanes-Oxley Act of 2002 regarding internal controlover financial reporting could be substantial, while failure to achieve andmaintain compliance could have an adverse effect on our stock price.*

Pursuant to Section 404 of the Sarbanes-Oxley Act of2002 and current SEC regulations, beginning with our Annual Report on Form 10-Kfor the fiscal year ending November 1, 2008, we are required to furnish areport by our management on our internal control over financial reporting.  We are currently required to have our auditorattest to management’s assessment on our internal control over financialreporting beginning with our Annual Report on Form 10-K for the fiscal yearending October 31, 2009.  However, onFebruary 1, 2008, the SEC proposed a one-year extension to the auditorattestation requirement, which, if adopted, would require us to first complywith this requirement beginning with our Annual Report on Form 10-K for thefiscal year ending October 30, 2010.  Theprocess of fully documenting and testing our internal control procedures inorder to satisfy these requirements will result in increased general andadministrative expenses and may shift management time and attention from businessactivities to compliance activities. Furthermore, during the course of ourinternal control testing, we may identify deficiencies which we may not be ableto remediate in time to meet the reporting deadline under Section 404.  Failure to achieve and maintain an effectiveinternal control environment or complete our Section 404 certifications couldhave a material adverse effect on our stock price.

*We are involved in an action taken by theCalifornia Employment Development Department.*

During the fourth quarter of fiscal 2005, we werenotified by the California Employment Development Department, or EDD, that ourdomestic operating subsidiaries unemployment tax rates would be increasedretroactively for both calendar years 2005 and 2004, which would result inadditional unemployment taxes of approximately $0.9 million, together withinterest at applicable statutory rates. We have timely appealed the ruling by the EDD and are working with ouroutside counsel to resolve this matter. Although we believe that we haveproperly calculated our unemployment insurance tax and are in compliance withall applicable laws and regulations, there can be no assurances this will besettled in our favor.  

*We have significant amounts of assets on ourbalance sheet for which their realization is dependent on our future profitability.*

As of January 26, 2008 we have deferred tax assets of$22.4 million and goodwill and intangible assets of $16.3 million.  Under U.S. GAAP, we are required to evaluatethe realizability of the deferred tax assets based on our ability to generatefuture taxable income.  Similarly, we arerequired to  periodically compare thecarrying value of our goodwill and intangible assets to their estimated fairvalue to support the current recorded amounts. The estimated fair value will be influenced by our futureprofitability.  If we are unable toreturn to our historical levels of profitability, we may need to write off aportion or all of these assets which would result in a reduction of our assets,stockholders equity and adversely affect our operating results.

*We are a defendant in a variety of litigation andother actions from time to time, which may have a material adverse effect onour business, financial condition and results of operations.*

We are regularly involved in a variety of litigationarising out of our business and, in recent years, have paid significant amountsas a result of adverse arbitration awards. We do not have insurance for some of these claims, and there can be noassurance that the insurance coverage we have will cover all claims that may beasserted against us.  Should the ultimatejudgments or settlements not be covered by insurance or exceed our insurancecoverage, they could have a material adverse effect on our results ofoperations, financial position and cash flows. There can also be no assurance that we will be able to obtain appropriateand sufficient types or levels of insurance in the future or that adequatereplacement policies will be available on acceptable terms, if at all.

*Improper disclosure of employee and customer datacould result in liability and harm to our reputation.*

Our business involves the use, storage andtransmission of information about our employees and their customers.  It is possible that our security controlsover personal data and other practices we and our third party service providersfollow may not prevent the improper access to or disclosure of personallyidentifiable information.  Suchdisclosure could harm our reputation and subject us to liability under ourcontracts and laws that protect personal data, resulting in increased costs orloss of revenue.  Further, data privacyis subject to frequently changing rules and regulations.  Our failure to adhere to or successfullyimplement processes in response to changing regulatory requirements in thisarea could result in legal liability or impairment to our reputation in themarketplace.

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### **Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds**

###  

Not applicable.

 

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

###  

Not applicable.

 

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

###  

None.

 

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

###  

No events.

 

**Item 6.    Exhibits**

 

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

 
| 31.1 |   | Certification of the Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                     |
|------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.2 |   | Certification of the Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                     |
| 32.1 |   | Certification of the Chief Executive Officer  pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2 |   | Certification of the Chief Financial Officer  pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                |   | WESTAFF, INC.                                      |   |
|---------------------|--------|----------------------------------------------------|--------|
|                |   |                                               |   |
|                |   |                                               |   |
| March 11, 2008 |   | /s/ Dawn M. Jaffray                                |   |
| Date                |   | Dawn M. Jaffray                                    |   |
|                |   | Senior Vice President  and Chief Financial Officer |   |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description of Document**                                                                                                                                       | ** ** |
|----------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 31.1                 |       | Certification of the Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                     |       |
|                 |       |                                                                                                                                                              |       |
| 31.2                 |       | Certification of the Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                     |       |
|                 |       |                                                                                                                                                              |       |
| 32.1                 |       | Certification of the Chief Executive Officer  pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |       |
|                 |       |                                                                                                                                                              |       |
| 32.2                 |       | Certification of the Chief Financial Officer  pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |       |

 

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