Notes to Consolidated Financial Statements

NOTE 1: ACCOUNTING PRINCIPLES AND PRACTICES

The accompanying unaudited consolidated financial statements are prepared in accordance with generally accepted accounting principles for interim financial information and rules and regulations of the Securities and Exchange Commission.  Accordingly, certain information and footnote disclosures usually found in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted.  The unaudited consolidated financial statements reflect all adjustments, including normal recurring adjustments, which in the opinion of management are necessary to fairly state the financial position, results of operations and cash flows for the interim periods presented.  These financial statements should be read in conjunction with the consolidated financial statements and related notes included in our annual report on Form 10-K for the year ended December 29, 2006. Operating results for the thirteen week period ended March 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 28, 2007.

The consolidated financial statements are presented on a 52/53-week fiscal year end basis, with the last day of the fiscal year ending on the last Friday of December. Fiscal years 2007 and 2006 are 52-week years.

Revenue recognition

Revenue from services is recognized at the time the service is performed and is net of adjustments related to customer credits.  A portion of our revenue is derived from cash dispensing machine (“CDM”) fees, which are immaterial for all periods presented.  Sales coupons or other incentives are recognized in the period the related revenue is earned.

Cost of services

Cost of services includes the wages of temporary employees, related payroll taxes, workers’ compensation expenses and transportation.

Stock-based compensation

We account for stock-based compensation under the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised), Share-Based Payment , using the modified-prospective transition method.  Under this transition method, we recognize stock-based compensation expense for stock-based awards granted subsequent to the year ended December 30, 2005 in accordance with the provisions of SFAS No. 123R, and the estimated expense for the portion vesting in the period for options granted prior to, but not vested as of December 30, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123.  Compensation cost for all stock-based awards is recognized using the straight-line method.

Total stock-based compensation expense recognized in the consolidated financial statements for the thirteen weeks ended March 30, 2007 was $2.4 million, before income taxes, compared to total stock-based compensation expense for the thirteen weeks ended March 31, 2006 of $2.5 million, before income taxes.

See further discussion of stock-based compensation in Note 10.

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New accounting pronouncements

We adopted the provisions of Financial Standards Accounting Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”) an interpretation of FASB Statement No. 109 (“SFAS 109”) on December 30, 2006, the first day of our 2007 fiscal year.  See Note 12 for further discussion.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which establishes a framework for measuring fair value and requires expanded disclosure about the information used to measure fair value. The statement applies whenever other statements require, or permit, assets or liabilities to be measured at fair value. The statement does not expand the use of fair value in any new circumstances and is effective for fiscal years, and interim periods within those fiscal years, beginning after November 15, 2007, with early adoption encouraged. We are currently evaluating the impact of SFAS No. 157 and whether our adoption of SFAS No. 157 will have a material effect on our consolidated financial position, results of operations or cash flows.

In February, 2007, the FASB issued SFAS No. 159 , The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of SFAS No. 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.  Most of the provisions of SFAS No. 159 apply only to entities that elect the fair value option. However, the amendment to FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, which modifies certain presentation and disclosure requirements in the Consolidated Balance Sheets and applies to all entities with available-for-sale and trading securities. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.  We do not anticipate the adoption of SFAS No. 159 will have a material effect on our consolidated financial position, results of operations or cash flows.

NOTE 2: MARKETABLE SECURITIES

Management determines the appropriate classification, pursuant to SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities , of our investments in debt securities (“Marketable Securities”) at the time of purchase and re-evaluates such determination at each balance sheet date.  Marketable Securities consist of revenue bonds and other municipal obligations, which usually have maturities or reset dates of one year or less.   At March 30, 2007 and December 29, 2006, those securities were classified as available-for-sale and stated at fair value, with the unrealized holding gains and losses reported in the shareholders’ equity section of our Consolidated Balance Sheets. There were no material unrealized holding gains or losses at March 30, 2007 or December 29, 2006. The specific identification method is used for computing realized gains and losses on the sale of available-for-sale securities.  For the thirteen weeks ended March 30, 2007 and March 31, 2006, there were no material realized gains or losses on sales of available-for-sale securities. These marketable securities are available to fund current operations, if necessary.

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(1) We have agreements with certain financial institutions through our wholly-owned and consolidated subsidiary, Workers’ Assurance of Hawaii, Inc. (our “Workers’ Assurance Program”), that allow us to restrict cash for the purpose of providing cash-backed instruments for our workers’ compensation collateral.  These instruments include cash-backed letters of credit, cash held in trusts as well as cash deposits held by our insurance carriers.  Committed collateral represents instruments that have been provided or pledged to an insurance company to cover the cost of claims in the event we are unable to make payment.  Uncommitted cash represents cash available for funding future commitments.

NOTE 4: RECEIVABLES FROM INSURANCE COMPANIES

For workers’ compensation claims originating in self-insured states, the majority of our current workers’ compensation insurance policies from independent, third-party carriers, cover any claims for a particular event above a $2.0 million deductible, on a “per occurrence” basis.

Our workers’ compensation reserves include not only estimated expenses for claims within our deductible layer but also estimated expenses related to claims above our deductible limits (“excess claims”).  We record an estimated receivable for the insurance coverage on excess claims based on the contractual policy agreements we have with insurance companies.  We discount this receivable to its estimated net present value using the risk-free rates associated with the weighted average lives of our excess claims.  The weighted average claim lives are actuarially determined.  When appropriate, based on our best estimate, we record a valuation allowance against the insurance receivable to reflect amounts that may not be realized.

Two of the workers’ compensation insurance companies (“Troubled Insurance Companies”) with which we formerly did business are in liquidation and have failed to pay a number of excess claims to date.  These excess claims have been presented to the state guaranty funds of the states in which the claims originated.  Certain of these excess claims have been rejected by the state guaranty funds due to statutory eligibility limitations.  We have concluded that recovery is unlikely on a portion of these claims. Therefore, we have recorded a valuation allowance against the insurance receivables from the Troubled Insurance Companies not covered by state guaranty funds.

Our valuation allowance against receivables from Troubled Insurance Companies as of March 30, 2007 and December 29, 2006 is $5.0 million and $2.5 million, respectively.  Total discounted receivables from insurance companies, net of related valuation allowance, as of March 30, 2007 and December 29, 2006 are $14.8 million and $16.6 million, respectively and are included in Other assets, net in the accompanying Consolidated Balance Sheets.

We also record a receivable for other matters where we expect reimbursement from our insurance company.  Included in prepaid expenses, deposits and other in the accompanying Consolidated Balance Sheets at March 30, 2007 is a receivable from our insurance company of $1.8 million in connection with certain litigation.

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Intangible assets recorded as a result of the CLP Resources acquisition in May 2005 and the Spartan Staffing acquisition in April 2004 totaled $20.1 million. Intangible assets are amortized using the straight line method over their estimated useful lives. Unamortized intangible assets of $7.4 million consist entirely of Customer relationships resulting from the CLP acquisition with an estimated useful life of 6.5 years. The majority of our trade name/trademarks do not have definite lives and, accordingly, are not amortized. All other intangible assets are fully amortized. Amortization expense of our amortizable intangible assets was $0.4 million and $0.8 million for the thirteen weeks ended March 30, 2007 and March 31, 2006, respectively.

The following table provides estimated amortization expense of intangible assets other than goodwill for the next five years and thereafter (in thousands):

Goodwill totaled $37.4 million at March 30, 2007 and December 29, 2006.  Goodwill recorded as a result of the CLP Resources acquisition in 2005 totaled $31.0 million.  Goodwill recorded as a result of the Spartan Staffing acquisition in 2004 totaled $6.4 million.

NOTE 6: WORKERS’ COMPENSATION INSURANCE AND RESERVES

We provide workers’ compensation insurance to our temporary and permanent employees.  Our workers’ compensation insurance policies must be renewed annually.  Our current coverage with American International Group, Inc. (“AIG”) is for occurences during the period from July 2006 through June 2007.  While we have primary responsibility for all claims, our insurance coverage provides reimbursement for certain losses and expenses beyond the deductible limits.  For workers’ compensation claims originating in self-insured states, the majority of our current workers’ compensation insurance policies cover any claims for a particular event above a $2.0 million deductible, on a “per occurrence” basis.  This results in our being substantially self-insured. Furthermore, we have full liability for all further payments on claims which originated between January 2001 and June 2003, without recourse to any third party insurer as the result of a novation agreement we entered into with Kemper Insurance Company in December 2004.

Our workers’ compensation reserve is discounted to its estimated net present value using  discount rates based on average returns of “risk-free” Treasury instruments, which are evaluated on a quarterly basis.  At March 30, 2007, our reserves are discounted at rates ranging from 4.31% to 6.00%.  Included in the accompanying Consolidated Balance Sheets as of March 30, 2007 and December 29, 2006 are discounted workers’ compensation claims reserves in the amounts of $187.8 million and $189.4 million, respectively.

For workers’ compensation claims originating in Washington, West Virginia, North Dakota, Wyoming, Canada and Puerto Rico (our “monopolistic jurisdictions”) we pay workers’ compensation insurance premiums and obtain full coverage under government-administered programs.  Accordingly, because we are not the primary obligor, our financial statements do not reflect the liability for workers’ compensation claims in these monopolistic jurisdictions.

Workers’ compensation expense is recorded as part of our cost of services and consists of the following components: self-insurance reserves net of changes in discount, monopolistic jurisdictions premiums, insurance premiums and any changes in the valuation allowance related to receivables from Troubled Insurance Companies as described in Note 4. Workers’ compensation expense totaling $14.4 million and $18.4 million was recorded for the thirteen weeks ended March 30, 2007 and March 31, 2006, respectively.

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NOTE 7: NET INCOME PER SHARE

Basic net income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period.  Diluted net income per share is calculated by dividing adjusted net income by the weighted average number of common shares and potential common shares outstanding during the period.  Potential common shares include the dilutive effects of outstanding options and non-vested restricted stock except where their inclusion would be anti-dilutive.

Anti-dilutive shares associated with our stock options relate to those stock options with a grant price higher than the average market value of our stock during the periods presented.  Commencing with fiscal year 2006, post SFAS No. 123R adoption, anti-dilutive shares also include in-the-money options for which the sum of the assumed proceeds, including unrecognized compensation expense, exceeds the average stock price during the quarter.  The weighted average number of anti-dilutive stock options and non-vested restricted stock not considered as part of our calculation were 0.8 million during the thirteen weeks ended March 30, 2007 and 0.3 million during the thirteen weeks ended March 31, 2006.

The following table presents the calculation of Net income per common share- Basic and Diluted (in thousands, except per share data):

The decrease in weighted average shares year over year is primarily due to our extensive share repurchase program. See Note 11 for further discussion.

NOTE 8: COMMITMENTS AND CONTINGENCIES

Revolving Credit Facility

We have an $80.0 million credit agreement with certain unaffiliated financial institutions (the “Revolving Credit Facility”) that expires in November 2008.  The Revolving Credit Facility, which is secured by substantially all our assets except our real estate, provides us with access to loan advances and letters of credit.  The amounts we may borrow (our borrowing capacity) under this agreement are largely a function of the levels of our accounts receivable from time to time, supplemented by pledged collateral. Under the terms of the Revolving Credit Facility, we pay a variable rate of interest based on a margin above LIBOR for borrowings and a variable unused commitment fee, both based on a consolidated leverage ratio of consolidated total debt to consolidated EBITDA.  Fees for letters of credit are based on the margin in effect plus a fee of 0.05%.  As of March 30, 2007, our margin was 0.50% and our unused capacity fee was 0.15%.  At March 30, 2007, we had $45.5 million of letters of credit issued against that borrowing capacity leaving us with $34.5 million available for future borrowings.  The Revolving Credit Facility requires that we comply with certain financial covenants.  Among other things, these covenants require us to maintain certain leverage and coverage ratios.  We are currently in compliance with all covenants related to the Revolving Credit Facility.

Workers’ Compensation Commitments

We are required by our insurance carriers and certain state workers’ compensation programs to collateralize a portion of our workers’ compensation obligation with cash and cash-backed instruments, irrevocable letters of credit, or surety bonds. The letters of credit issued against the Revolving Credit Facility bear fluctuating annual fees, which were approximately 0.55% of the principal amount of the letters of credit outstanding as of March 30, 2007.  The letters of credit issued related to our Workers’ Assurance Program bear fluctuating annual fees, which were approximately 0.46% of the principal amount of the letters of credit outstanding as of March 30, 2007.  The surety bonds bear annual fees based on a percentage of the bond, which is determined by each independent surety carrier but does not exceed 2.0% of the bond amount, subject to a minimum charge.

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At March 30, 2007 and December 29, 2006 we had provided our insurance carriers and certain states with commitments in the form and amounts outlined below (in millions):

(1) We had $3.9 million and $3.8 million of restricted cash collateralizing our surety bonds at March 30, 2007 and December 29, 2006, respectively.

Future minimum lease payments under these non-cancelable capital leases as of March 30, 2007 are $0.8 million for the remainder of 2007 and $0.2 million for 2008.  There are currently no minimum lease payments under non-cancelable capital leases after 2008.

Our capital lease obligations are reported in other liabilities in the Consolidated Balance Sheets. The weighted average interest rate on capitalized leases is approximately 3.0% and the lease terms range from 36 to 60 months.

Operating Leases

We have contractual commitments in the form of operating leases related to branch offices, vehicles and equipment. Future non-cancelable minimum lease payments under our operating lease commitments as of March 30, 2007 for each of the next five years and thereafter are $4.7 million for the remainder of 2007; $5.1 million for 2008; $3.8 million for 2009; $2.9 million for 2010; $2.1 million for 2011 and $3.1 million thereafter.

The majority of operating leases pertaining to our branch offices provide for renewal options ranging from three to five years. Operating leases are generally renewed in the normal course of business, and most of the options are negotiated at the time of renewal. However, for the majority of our leases, both parties to the lease have the right to cancel the lease with 90 days notice. Accordingly, we have not included these leases in our disclosure of future minimum lease payments. Total branch office rent expense for the thirteen weeks ended March 30, 2007 and March 31, 2006 was approximately $6.5 million and $6.0 million, respectively.

Legal Contingencies and Developments

From time to time we are the subject of compliance audits by federal, state and local authorities relating to a variety of regulations including wage and hour laws, taxes, workers’ compensation, immigration and safety.  From time to time we are also subject to legal proceedings in the ordinary course of our operations. A summary of our most significant pending litigation and regulatory proceedings is set forth below. It is not possible at this time for us to determine fully the effect of all legal proceedings on our consolidated financial position, results of operations or liquidity; however, to the extent possible, where legal liabilities can be estimated and are considered probable, we have recorded a liability. To the extent that an insurance company is contractually obligated to reimburse us for a liability, we record a receivable for the amount of the probable reimbursement. We have

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established reserves for our contingent legal and regulatory liabilities in the amount of $6.5 million at March 30, 2007 and $6.6 million at December 29, 2006. We believe that none of the currently pending legal proceedings, individually or in the aggregate, will have a material adverse impact on our financial position, results of operations or cash flows beyond amounts that have been accrued in the financial statements, although we can make no assurances in this regard.

On July 29, 2002, Marisol Balanderan and 55 other plaintiffs filed an action against us and one of our customers in California State Court, Los Angeles County.  The plaintiffs are temporary employees and job applicants who seek unquantified compensatory and punitive damages based on allegations that they were subjected to discrimination in dispatch to jobs on the basis of their female gender, throughout a period from September 2001 through January 2002. On April 26, 2007, the parties entered into a settlement agreement which resolved all outstanding claims.  The settlement is subject to Court approval.  A hearing for court approval of the settlement terms will occur on May 2, 2007.  All amounts related to settlement are accounted for in our established reserves for our contingent legal and regulatory liabilities.

On February 6, 2003, Scott Romer and Shawna Clark, both former Labor Ready employees, filed an action against us in California State Court, Los Angeles County. The plaintiffs allege that they were wrongfully exempted from overtime pay during their employment. They seek unquantified compensatory damages and certification of a class of similarly situated employees. On January 6, 2004, Patricia Huntley and Brandon McCall filed a complaint in intervention and have been included as plaintiffs in this lawsuit.  This matter has been consolidated with the Recio matter below.

On July 16, 2003, Alecia Recio, Elizabeth Esquivel, Debbie Owen and Barry Selbts, each a current or former Labor Ready employee, jointly filed an action in United States District Court for the Central District of California, alleging failure to pay overtime under state and federal law and seeking unspecified damages and certification of a class of similarly situated employees. On September 23, 2003, the court dismissed the case for improper venue. On October 1, 2003, Recio re-filed her case in California State Court, Los Angeles County, seeking similar relief on behalf of Labor Ready employees employed in the State of California.  On December 14, 2006 the Court denied our motion to transfer venue to the United States District Court for the Western District of Washington.  This matter is currently in the discovery phase.

On January 12, 2005, the New Jersey Division of Taxation (the “Division”) filed a Notice of Assessment Related to Final Audit Determination asserting that we owe $7.0 million for delinquent sales taxes, penalties and interest for the period October 1, 2000 through September 30, 2004. The amount of the assessment is based on the Division’s assertion that 100% of our revenue from New Jersey operations is subject to sales tax. We disputed the Division’s position that we provide taxable services under New Jersey law and filed an administrative protest.  The administrative protest was handled internally by the Division and did not involve any outside or independent governmental bodies.  On September 19, 2006, the Division issued a final determination increasing the amount that we allegedly owe for delinquent sales taxes, penalties and interest to $8.1 million.  We have now sought independent review of this determination by filing a complaint with the Tax Court of New Jersey on December 15, 2006 and accordingly have not reserved for this matter as of March 30, 2007.

On December 15, 2006, Patricia Tennyson, a temporary employee, filed an action in California State Court, Ventura County, alleging that we failed to pay her all hours worked.  The plaintiff further alleges that we engaged in unfair business practices in California.  The plaintiff is seeking unspecified damages and certification of a class of similarly situated employees.   On April 10, 2007, the court granted the plaintiff’s motion to dismiss the matter without prejudice.  This matter is resolved.

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NOTE 10: STOCK BASED COMPENSATION

Stock options

We have stock option and incentive plans for directors, officers, and employees, which provide for nonqualified stock options and incentive stock options.  We issue new shares of common stock upon exercise of stock options.  The majority of our stock options vest evenly over a four-year period from the date of grant and expire if not exercised within five years from the date of grant.  The maximum contractual term for our outstanding stock option awards is ten years.

We account for stock-based compensation under the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised), Share-Based Payment , using the modified-prospective transition method.  SFAS No. 123R establishes accounting for stock-based awards exchanged for employee services.  Accordingly, stock-based compensation cost is measured at grant date based on the fair value of the award and recognized in our income statement over the requisite service period.  See information regarding stock-based compensation recorded in our income statement in Note 1 to this Form 10-Q.

A summary of the weighted average assumptions and results for options granted during the periods presented is as follows:

As of March 30, 2007, total unrecognized stock-based compensation expense related to nonvested stock options was approximately $3.2 million, which is expected to be recognized over a weighted average period of 2.0 years through 2011.  Stock option activity follows (shares in thousands):

Restricted Stock

Restricted stock is granted to certain key employees and vests over periods ranging from three to four years.  A retention period following vesting of two to four years is in place for a certain percentage of shares granted to executive officers.  The shares are not subject to forfeiture during the retention period but cannot be sold.  Compensation cost of restricted stock is calculated based on the grant-date market value.  We recognize compensation cost on a straight line basis over the vesting period for the awards that are expected to vest.

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Restricted stock activity follows (shares in thousands):

(1) Weighted average market price on grant date.

As of March 30, 2007, total unrecognized stock-based compensation expense related to non-vested restricted stock was approximately $10.2 million, which is expected to be recognized over a weighted average period of 1.9 years through 2011.

Employee stock purchase plan

Our Employee Stock Purchase Plan (the “ESPP”) provides substantially all permanent employees who have completed six months of service and meet certain limited qualifications, an opportunity to purchase shares of our common stock through payroll deductions.  The ESPP permits payroll deductions up to 10% of eligible after-tax compensation.  Participant account balances are used to purchase shares of common stock at the lesser of 85% of the fair market value of shares on either the first day or the last day of each month.  1.9 million shares of common stock have been reserved for purchase under the ESPP, of which 1.4 million shares have been issued and 0.5 million shares remain available for future issuance.  The ESPP expires on June 30, 2008. During the thirteen weeks ended March 30, 2007 and March 31, 2006, participants purchased 25,000 and 22,000 shares in the ESPP for cash proceeds of $0.4 million and $0.4 million, respectively.

We consider our ESPP to be compensatory under SFAS No. 123R and accordingly we recognize compensation expense over the requisite service period for stock purchases made under the plan.  The requisite service period is one month and begins on the enrollment date and ends on the purchase date.

NOTE 11: STOCK REPURCHASE

On January 31, 2007, we announced that our Board of Directors authorized the future purchase of our common stock in either open market or private transactions at a total cost of up to $75.0 million.  During the thirteen weeks ended March 30, 2007, we purchased and retired 4.1 million shares of our common stock for $76.7 million, including commissions, $13.1 million of which was under a previous repurchase authorization and $63.6 million of which was under the January 31, 2007 authorization.  Share repurchases were funded through cash and cash equivalents.  As of March 30, 2007, we had $11.4 million authorized for future purchases.  As of April 12, 2007 we had completed the January 2007 authorization for the purchase of common stock by purchasing an additional 0.6 million shares of our common stock for $11.4 million.  We did not acquire any shares of our common stock during the thirteen week period ended March 31, 2006.

On April 18, 2007, we announced that our Board of Directors authorized additional repurchases of our common stock in either open market or private transactions at a total cost of up to $100.0 million.

NOTE 12: INCOME TAXES

We adopted the provisions of FIN 48 on December 30, 2006.  Upon adoption of FIN 48, we recognized no material adjustment in the liability for unrecognized income tax benefits.  At the adoption date of December 30, 2006, we had $1.6 million of unrecognized tax benefits, all of which would impact our effective tax rate if recognized. As of March 30, 2007 there have not been any material changes in the amount of the liability for unrecognized tax benefits since the date of adoption.

We continue to recognize interest and penalties related to uncertain tax positions in Interest expense and Selling, general and administrative expenses, respectively.  At the adoption date amounts for accrued interest and penalties were not material.

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The tax years 2002-2006 remain open to examination by the major taxing jurisdictions to which we are subject.