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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-Q

(MARK ONE)

For the quarterly period ended July 13, 2002

For the transition period from                              to                             

Commission file number 0-24990

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

301 Lennon Lane
Walnut Creek, California 94598-2453
(Address of registrant's principal executive offices, including zip code)

(925) 930-5300
(Registrant's telephone number)

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

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

WESTAFF, INC. AND SUBSIDIARIES

INDEX

Part I. Financial Information

Item 1. Financial Statements

Westaff, Inc.

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

See accompanying notes to condensed consolidated financial statements.

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Westaff, Inc.
Condensed Consolidated Statements of Operations (Unaudited)
(In thousands except per share amounts)

See accompanying notes to condensed consolidated financial statements.

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Westaff, Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)

See accompanying notes to condensed consolidated financial statements.

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Westaff, Inc.

Notes to Condensed Consolidated Financial Statements (Unaudited)
(In thousands except per share amounts)

1.    Basis of Presentation

        The accompanying condensed consolidated financial statements of Westaff, Inc. and its domestic and foreign subsidiaries (together, the Company), as of and for the 12 and 36 week periods ended July 13, 2002 and July 7, 2001 are unaudited. Material intercompany accounts and transactions have been eliminated.

        The condensed consolidated financial statements, in the opinion of management, reflect all adjustments, which are of a normal recurring nature, necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented.

        Certain financial information which is normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States, but which is not required for interim reporting purposes, has been condensed or omitted. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended November 3, 2001.

        The Company's fiscal year is a 52 or 53 week period ending the Saturday nearest the end of October. For interim reporting purposes, the first three fiscal quarters comprise 12 weeks each while the fourth fiscal quarter consists of 16 or 17 weeks. The results of operations for the 12 and 36 week periods ended July 13, 2002 are not necessarily indicative of the results to be expected for the full fiscal year or for any future period.

        In November 1998, the Company announced its plan to sell its medical business, primarily operating through Western Medical Services, Inc. (Western Medical), a wholly-owned subsidiary. As a result of this decision, the medical operations are classified as discontinued operations and presented as such in these condensed consolidated financial statements and notes thereto.

        In January 2001 the Financial Accounting Standards Board (FASB) issued EITF Issue No. 01-14 (formerly EITF Abstracts, Topic No. D-103), "Income Statement Characterization of Reimbursements Received for "Out-of-Pocket" Expenses Incurred", which requires that revenues and expenses be reported gross of such "out-of-pocket" expenses. Application was effective for financial reporting periods beginning after December 15, 2001 with prior periods reclassified to comply with the guidance. Accordingly, sales of services and costs of services for the 12 and 36 weeks ended July 7, 2001 have been reclassified to conform with the presentation adopted for fiscal 2002.

        In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". The new standard supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of". The new standard also supercedes the provisions of Accounting Principles Board No. 30, "Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" and will require expected future operating losses from discontinued operations to be displayed in discontinued operations in the period(s) in which the losses are incurred, rather than as of the measurement date as presently required. The provisions of SFAS No. 144 are effective on a prospective basis for financial statements with fiscal years beginning after December 15, 2001. The Company currently does not anticipate that SFAS No. 144 will have a material impact on its financial statements in the year of adoption.

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        In June 2002 the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires recognition of a liability for a cost associated with an exit or disposal activity when the liabiliity is incurred, as opposed to when the entity commits to an exit plan under EITF Issue No. 94-3. The Company is required to adopt SFAS No. 146 for exit or disposal activities that are initiated after December 31, 2002, and currently does not anticipate that the provisions of the new statement will have a material impact on its financial statements in the year of adoption.

2.    Discontinued Operations

        During fiscal 1999, the Company sold certain of its franchise agent and Company-owned medical offices and entered into a termination agreement with one of its medical licensees. During the fourth quarter of fiscal 1999 the Company completed the sale of the remaining medical business to Intrepid U.S.A. Inc. (Intrepid) under an asset purchase agreement. Under the terms of the sale, the Company retained the trade and Medicare accounts receivable balances as well as the due from licensee balances.

        In August 2000, Intrepid filed a demand for arbitration seeking compensatory and punitive damages alleging, among other things, that the Company made misrepresentations and otherwise breached the asset purchase agreement. In fiscal 2001, the arbitrator awarded Intrepid $1,085 mainly for breaches of certain representations, warranties and covenants in the asset purchase agreement, plus arbitration expenses and legal and accounting fees of approximately $425. Primarily due to the unfavorable arbitration award, the Company recorded an after-tax loss from discontinued operations of $1,794, or $0.11 per share, in the second quarter of fiscal 2001. The after-tax loss included approximately $904 for the arbitration loss and expenses, $640 for losses on settlements of outstanding Medicare cost reports and other settlements and $250 in valuation allowances for medical operations' net operating loss carryforwards which the Company believes will expire unused over the next two fiscal years. Included in the current assets of discontinued operations at July 13, 2002 is a $631 receivable for recoveries on 1997 Medicare cost reports. The remaining $953 of net current liabilities at July 13, 2002 comprise estimated reserves for pending liability claims of former Western Medical franchise agents, licensees or employees.

        Summarized balance sheet data on the discontinued operations, which includes the trade and Medicare accounts receivable and due from licensee balances retained by the Company, is as follows:

3.    Restructuring Charges

        In January 2002, the Company implemented a restructuring plan designed to improve the Company's profitability. The restructuring plan resulted in a first quarter fiscal 2002 pretax charge to operations of $1,896. Of this amount, $993 was the result of abandoning front and back office management information systems that were under development in conjunction with two software vendors. One of these vendors chose to cease further development of its portion of the project and that caused the continued development of these systems to no longer be cost-effective for the Company. In conjunction with this abandonment, the Company recognized the historical fees paid to vendors, fees

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paid to consultants and certain in-house development costs as expenses, all of which had been previously capitalized awaiting the completion of the systems. An additional $629 resulted from severance and other employment termination costs due to the planned personnel reductions of 70 full time employees. Finally, as of the date the restructuring plan was finalized, the Company decided to close at least 18 offices within the United States and the resulting termination costs, including lease terminations, were estimated to be $274.

        The activity impacting the accrual for restructuring charges is summarized in the table below:

4.    Earnings Per Share

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

        Anti-dilutive weighted shares represent options to purchase shares of common stock which were outstanding but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares during the period, and therefore the effect would be anti-dilutive. For the 12 and 36 weeks ended July 13, 2002, dilutive securities have not been included in the weighted average shares used for the calculation of earnings per share because the effect of such securities would be anti-dilutive as a result of the loss from continuing operations.

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5.    Comprehensive Income (Loss)

        Comprehensive income (loss) consists of the following:

6.    Short-term Borrowings and Loans Payable

        On May 17, 2002 the Company entered into agreements with GE Capital, as primary agent, to provide senior secured credit facilities totaling $65,000. The new credit facilities replace a credit facility that was to expire on March 31, 2003. The facilities comprise a five-year syndicated Multicurrency Credit Agreement consisting of a $50,000 US Revolving Loan Commitment, a £2,740 UK Revolving Loan Commitment (US dollar equivalent of approximately $4,000 at the date of the agreement), and a $5,000 term loan (the Term Loan). In addition, a five-year Australian dollar facility agreement (the A$ Facility Agreement) was executed on May 16, 2002, consisting of an A$12,000 revolving credit facility (US dollar equivalent of approximately $6,000 at the date of the agreement). Each Agreement includes a letter of credit sub-facility. Concurrent with the execution of these new credit facilities, the Company repaid all outstanding principal and interest under its 10-year senior secured notes, which totaled $30,999. In addition, $17,343 in letters of credit were issued under the new facility to replace $11,843 in outstanding letters of credit and $5,500 of cash on deposit with the Company's workers' compensation insurance carrier.

        The US Revolving Loan Commitment provides for an aggregate $50,000 commitment subject to a borrowing base calculation on eligible domestic accounts receivable. Direct advances are also limited by outstanding irrevocable standby letters of credit up to a maximum of $35,000. Interest on borrowings under the commitment is based either on an index rate equal to the higher of the bank prime loan rate or the Federal Funds Rate plus 0.50%, plus applicable margins ranging from 0.25% to 1.25%, or on LIBOR plus margins ranging from 2.50% to 3.50%. Borrowings outstanding under the US Revolving Loan Commitment at July 13, 2002 were $14,558 at a weighted average interest rate of 5.27%.

        The Term Loan bears interest at a variable index rate equal to the higher of the bank prime loan rate or the Federal Funds Rate plus 0.50%. Applicable margins above the index rate vary from 5.5% to 6.5%. The interest rate in effect at July 13, 2002 was 10.75%. The Term Loan is payable in nineteen consecutive quarterly installments of $250 each, beginning July 1, 2002. At July 13, 2002 borrowings of $4,750 were outstanding on the Term Loan.

        The UK Revolving Loan Commitment is subject to a borrowing base calculation on eligible Westaff (U.K.) accounts receivable. Interest on outstanding borrowings is based on the British prime rate plus applicable margins ranging from 0.25% to 1.25%. At July 13, 2002, borrowings of approximately US$703 were outstanding under the UK Revolving Loan Commitment at an interest rate of 4.75%.

        The Multicurrency Credit Agreement calls for a commitment fee, payable monthly in arrears, of 0.50% based on the average daily unused balance of the combined US/UK revolving loan commitment. Additionally, a variable margin ranging from 1.5% to 2.5% of the total outstanding letters of credits is payable monthly in arrears and the agreement requires an annual fee of 0.50% of the face amount of each letter of credit which is issued, renewed or extended. The margin in effect on outstanding letters of credits is 2.0% through July 1, 2003.

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        The A$ Facility Agreement is subject to a borrowing base calculation on eligible Westaff (Australia) accounts receivable. Direct advances are limited by outstanding letters of credit up to a maximum of A$500. Interest on borrowings is based on the Australian 90-day Bank Bill Swap Rate plus a margin of 2.5% to 3.5%. At July 13, 2002, borrowings of approximately US$960 were outstanding under the A$ Facility Agreement at an interest rate of 8.17%. The agreement calls for monthly fees, payable in arrears, of 0.50% of the average daily unused balance of the facility and from 1.5% to 2.5% of total outstanding letters of credit. The margin in effect on outstanding letters of credits is 2.0% through July 1, 2003.

        Applicable margins under both the Multicurrency Credit Agreement and the A$ Facility Agreement are subject to quarterly adjustments, on a prospective basis beginning July 1, 2003, based on the respective borrowers' fixed charge coverage ratio. Letters of credit under the agreements expire one year from date of issuance but are automatically renewed for one additional year unless written notice is given to or from the holder. At July 13, 2002 the Company had approximately $13,079 available under the credit facilities, with $17,343 in letters of credit outstanding.

        The credit facilities are secured by substantially all of the assets of the Company, including a deed of trust on the Company's corporate headquarters. GE Capital, in its role as primary agent under the credit facilities, has sole dominion and control over the Company's primary U.S., United Kingdom and Australia cash receipt accounts. Cash receipts into these accounts are applied against the Company's respective outstanding obligations under the facilities, with additional borrowings under the revolving facilities directed into the Company's disbursement accounts.

        The credit facilities contain covenants which, among other things, require the Company to maintain a minimum fixed charge coverage ratio and a minimum earnings before interest, taxes, depreciation and amortization (EBITDA). The covenants also generally restrict, limit or, in certain circumstances prohibit the Company with respect to capital expenditures, disposition of assets, incurrence of debt, mergers and acquisitions, loans to affiliates and purchases of investments. At July 13, 2002, the Company was in compliance with these covenants; however, based on current projections, the Company's management believes there is a possibility that the Company may not be in compliance with the credit facility's EBITDA covenant on a prospective basis. The Company has notified its lenders of this possibility and negotiations to revise the covenant are currently in process. There can be no assurance that such negotiations will be completed in a manner satisfactory to the Company.

        In addition to its outstanding letters of credit, the Company has an outstanding financial guarantee bond in the amount of $11,842 that secures a portion of its workers' compensation premium and deductible obligations. The bond is renewable annually on November lst and 90-day advance written notice of non-renewal is required. The bondholder has expressed its intent to exit the surety bond market and, consequently, not renew the bond on November 1, 2002. The Company anticipates issuance of additional letters of credit to replace the currently outstanding financial guarantee bond when it expires.

7.    Related Party Transactions

        On April 1, 2002 the Company executed an unsecured subordinated promissory note payable to its principal stockholder and Chairman of the Board of Directors in the amount of $2,000. The initial term of the note was one year, with an interest rate of 12% per annum, payable monthly on the last business day of each calendar month. On May 17, 2002 the note was amended and restated to extend the maturity date to August 18, 2007. Additionally, the interest rate and payment schedule were amended to a rate equal to the US Index Rate as calculated under the Company's Multicurrency Credit Agreement (see Note 6) plus seven percent, compounded monthly and payable 60 calendar days after the end of each of the Company's fiscal quarters. The interest rate in effect on July 13, 2002 was

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11.75%. Payment of interest is contingent on the Company meeting minimum availability requirements under the new credit facilities. Additionally, payments of principal or interest are prohibited in the event of any default under the Multicurrency Credit Agreement or A$ Facility Agreement.

        On May 17, 2002 the Company executed an unsecured subordinated promissory note payable to its President and Chief Executive Officer (CEO) in the amount of $1,000 with a maturity date of August 18, 2007. The note bears interest at a rate equal to the US Index Rate plus the Applicable Term Loan Index Margin as calculated under the Company's Multicurrency Credit Agreement (see Note 6), payable 45 calendar days after the end of each of the Company's fiscal periods. The interest rate in effect on July 13, 2002 was 10.75%. Pursuant to a provision of the promissory note, the Company paid its President and CEO a note fee of $30. Payment of interest is contingent on the Company meeting minimum availability requirements under the new credit facilities. Additionally, payments of principal or interest are prohibited in the event of any default under the Multicurrency Credit Agreement or A$ Facility Agreement.

8.    Operating Segments