Overview

We provide human resource management services, comprised principally of staffing services and PEO services. We generate staffing services revenues primarily from short-term staffing, contract staffing, on-site management and direct placement services. Our PEO service fees are generated from contractual agreements with our PEO clients under which we become a co-employer of our client's workforce with responsibility for some or all of the client's human resource functions. We recognize revenues from our staffing services for all amounts invoiced, including direct payroll, employer payroll-related taxes, workers' compensation coverage and a service fee (equivalent to a mark-up percentage). PEO service fee revenues are recognized on a net basis in accordance with Emerging Issues Task Force No. 99-19, "Reporting Revenues Gross as a Principal Versus Net as an Agent" ("EITF No. 99-19"). Consequently, our PEO service fee revenues represent the gross margin generated from our PEO services after deducting the amounts invoiced to PEO customers for direct payroll expenses such as salaries, wages, health insurance and employee out-of-pocket expenses incurred incidental to employment. These amounts are also excluded from cost of revenues. PEO service fees also include amounts invoiced to our clients for employer payroll-related taxes and workers' compensation coverage.

Through centralized operations at our headquarters in Vancouver, Washington, we prepare invoices weekly for our staffing services customers and following the end of each payroll processing cycle for PEO clients. We invoice our customers and clients as each payroll is processed. Payment terms for staffing customers are generally 30 days, while PEO clients' invoices are generally due on the invoice date.

Our business is concentrated in California and Oregon and we expect to continue to derive a majority of our revenues from these markets in the future. Revenues generated in our California and Oregon offices accounted for 65% of our total revenues in 2008, 72% in 2007 and 74% in 2006. Consequently, any weakness in economic conditions or changes in the regulatory environments in these regions could have a material adverse effect on our financial results.

We offer cash safety incentives to certain PEO clients for maintaining safe-work practices in order to minimize workplace injuries. The cash incentive is based on a percentage of annual payroll and is paid annually to customers who meet predetermined workers' compensation claims cost objectives. Safety incentive payments are made only after closure of all workers' compensation claims incurred during the customer's contract period. The safety incentive expense is also netted against PEO revenues on our statements of operations.

Our cost of revenues is comprised of direct payroll costs for staffing services, employer payroll-related taxes and employee benefits and workers' compensation. Direct payroll costs represent the gross payroll earned by staffing services employees based on salary or hourly wages. Payroll taxes and employee benefits consist of the employer's portion of Social Security and Medicare taxes, federal unemployment taxes, state unemployment taxes and staffing services employee reimbursements for materials, supplies and other

expenses, which are paid by the customer. Workers' compensation expense consists primarily of the costs associated with our self-insured workers' compensation program, such as claims reserves, claims administration fees, legal fees, state administrative agency fees and excess insurance costs for catastrophic injuries. We also maintain separate workers' compensation insurance policies for employees working in states where we are not self-insured.

The largest portion of workers' compensation expense is the cost of workplace injury claims. When an injury occurs and is reported to us, our respective independent third-party claims administrator ("TPA") or our internal claims management personnel analyze the details of the injury and develop a case reserve, which becomes the estimate of the cost of the claim based on similar injuries and their professional judgment. We then record or accrue an expense and a corresponding liability based upon our estimate of the ultimate claim cost. As cash payments are made by our TPA against specific case reserves, the accrued liability is reduced by the corresponding payment amount. The TPA and our in-house claims administrators also review existing injury claims on an on-going basis and adjust the case reserves as new or additional information for each claim becomes available. Our reserve includes a provision for both future anticipated increases in costs ("adverse loss development") of the claims reserves for open claims and for claims incurred but not reported related to prior and current periods. We believe our operational policies and internal claims reporting system help to limit the occurrence of unreported incurred claims.

Selling, general and administrative expenses represent both branch office and corporate-level operating expenses. Branch operating expenses consist primarily of branch office staff payroll and personnel related costs, advertising, rent, office supplies, depreciation and branch incentive compensation. Corporate-level operating expenses consist primarily of executive and office staff payroll and personnel related costs, professional and legal fees, travel, depreciation, occupancy costs, information systems costs and executive and corporate staff incentive compensation.

Amortization of intangible assets consists of the amortization of software costs, covenants not to compete, and if material, customer related intangibles. These costs are amortized using the straight-line method over their estimated useful lives, which range from two to ten years.

Critical Accounting Policies

We have identified the following policies as critical to our business and the understanding of our results of operations. For a detailed discussion of the application of these and other accounting policies, see Note 1 to the audited consolidated financial statements included in Item 15 of this Report. Note that the preparation of this Annual Report on Form 10-K requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Self-Insured Workers' Compensation Reserves. We are self-insured for workers' compensation coverage in a majority of our employee work sites in Oregon, California, Maryland, Delaware and Colorado and for staffing services and management employees only in Washington. The estimated liability for unsettled workers' compensation claims represents our best estimate, which includes an evaluation of information provided by our internal claims adjusters and our third-party claims administrators, coupled with management's evaluations of historical claims development and conversion factors and other trends. These elements serve as the basis for our overall estimate for workers' compensation claims liabilities, which include more specifically the following components:
case reserve estimates for reported losses, plus additional amounts for estimated future development of reported claims and incurred but not reported claims (together IBNR). These estimates are continually reviewed and adjustments to liabilities are reflected in current operating results as they become known. We believe that the amounts recorded for our estimated liabilities are reasonable and objective and are based upon facts and development factors and other trends associated with the Company's historical universe of claims data. Nevertheless, it is reasonably possible that adjustments to such estimates may be required in future periods if the development of claim costs varies materially from our estimates and such adjustments, if necessary, could be material to results of operations.

Safety Incentives Liability. Our accrued safety incentives represent cash incentives paid to certain PEO client companies for maintaining safe-work practices in order to minimize workplace injuries. The incentive is based on a percentage of annual payroll and is paid annually to customers who meet predetermined workers' compensation claims cost objectives. Safety incentive payments are made only after closure of all workers' compensation claims incurred during the customer's contract period. The liability is estimated and accrued each month based upon the then-current amount of the customer's estimated workers' compensation claims reserves as established by our internal claims adjusters and our third party administrators.

Allowance for Doubtful Accounts. We are required to make estimates of the collectibility of accounts receivables. Management analyzes historical bad debts, customer concentrations, customer creditworthiness, current economic trends and changes in the customers' payment tendencies when evaluating the adequacy of the allowance for doubtful accounts. If the financial condition of our customers deteriorates, resulting in an impairment of their ability to make payments, additional allowances may be required.

Goodwill. We assess the recoverability of goodwill annually and whenever events or changes in circumstances indicate that the carrying value might be impaired. Factors that are considered include significant underperformance relative to expected historical or projected future operating results, significant negative industry trends and significant change in the manner of use of the acquired assets. Management's current assessment of the carrying value of goodwill indicates there was no impairment as of December 31, 2008. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets, as of the date of our annual assessment on December 31.

Investments in Marketable Securities. We consider available evidence in evaluating potential impairment of our investments, including the duration and extent to which fair value is less than cost and our ability and intent to hold the investment. Investments in securities

classified as trading are reported at fair value, with unrealized gains or losses reported in other income in our consolidated statements of operations. Investments in securities classified as available-for-sale are reported at fair value, with unrealized gains or losses reported net of tax in other comprehensive income (loss) in stockholders' equity. In the event a loss on our available-for-sale investments is determined to be other-than-temporary, the loss will be recognized in our statement of operations.

Income Taxes. Our incomes taxes are accounted for using an asset and liability approach. This requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement and tax basis of assets and liabilities at the applicable tax rates. A valuation allowance is recorded against deferred tax assets if, based on the weight of the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

The determination of our provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. Significant judgment is required in assessing the timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions. The impact of uncertain tax positions would be recorded in our financial statements only after determining a more-likely-than-not probability that the uncertain tax positions would withstand challenge, if any, from taxing authorities. As facts and circumstances change, we reassess these probabilities and would record any changes in the financial statements as appropriate. On January 1, 2007, we adopted the provisions of Financial Accounting Standards Board Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"), which sets out the framework by which such judgments are to be made.

Recent Accounting Pronouncements

For a discussion of recent accounting pronouncements and their potential effect on the Company's results of operations and financial condition, refer to Note 1 in the Notes to the Financial Statements beginning at page F-6 of this Annual Report on Form 10-K.

Forward-Looking Information

Statements in this Item or in Items 1 and 1A of this Report which are not historical in nature, including discussion of economic conditions in the Company's market areas and effect on revenue levels, the potential for and effect of past and future acquisitions, the effect of changes in the Company's mix of services on gross margin, the adequacy of the Company's workers' compensation reserves and allowance for doubtful accounts, the effect of the Company's formation of a wholly owned, fully licensed captive insurance subsidiary and becoming self-insured for certain business risks, the financial viability of the Company's excess insurance carrier, the effectiveness of the Company's management information systems, payment of future dividends and the availability of financing and working capital to meet the Company's funding requirements, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company or industry to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors with respect to the Company include difficulties associated with integrating acquired businesses and clients into the Company's operations,

economic trends in the Company's service areas, material deviations from expected future workers' compensation claims experience, the effect of changes in the workers' compensation regulatory environment in one or more of the Company's primary markets, collectibility of accounts receivable, the carrying values of deferred income tax assets and goodwill, which may be affected by the Company's future operating results, the availability of capital or letters of credit necessary to meet state-mandated surety deposit requirements for maintaining the Company's status as a qualified self-insured employer for workers' compensation coverage, and the use of $61 million in cash and marketable securities, among others. The Company disclaims any obligation to update any such factors or to publicly announce the result of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.

Results of Operations

The following table sets forth the percentages of total revenues represented by selected items in the Company's Statements of Operations for the years ended December 31, 2008, 2007 and 2006, included in Item 15 of this report. References to the Notes to Financial Statements appearing below are to the notes to the Company's financial statements included in Item 15 of this report.

                                                   Percentage of Total Net Revenues
                                                       Year Ended December 31,
                                                   2008            2007         2006
Revenues:
Staffing services                                     55.1 %         50.9 %       47.6 %
Professional employer service fees                    44.9           49.1         52.4

Total                                                100.0          100.0        100.0

Cost of revenues:
Direct payroll costs                                  40.8           39.2         35.8
Payroll taxes and benefits                            30.5           30.4         32.3
Workers' compensation                                 11.0           10.0         10.5

Total                                                 82.3           79.6         78.6

Gross margin                                          17.7           20.4         21.4
Selling, general and administrative expenses          13.2           12.0         12.2
Depreciation and amortization                          0.5            0.5          0.5

Income from operations                                 4.0            7.9          8.7
Loss on impairment of investments                     (1.2 )            -            -
Other income                                           0.7            1.1          1.1

Pretax income                                          3.5            9.0          9.8
Provision for income taxes                             1.3            3.2          3.5

Net income                                             2.2 %          5.8 %        6.3 %

We report PEO revenues in accordance with the requirements of EITF No. 99-19 which requires us to report such revenues on a net basis because we are not the primary obligor for the services provided by our PEO clients to their customers pursuant to our PEO contracts. We present for comparison purposes the gross revenues and cost of revenues information for the years ended December 31, 2008 and 2007 set forth in the table below.

Although not in accordance with generally accepted accounting principles in the United States ("GAAP"), management believes this information is more informative as to the level of our business activity and more illustrative of how we manage our operations, including the preparation of our internal operating forecasts, because it presents our PEO services on a basis comparable to our staffing services.

The presentation of revenues on the net basis and the relative contributions of staffing and PEO revenues can create volatility in our gross margin percentage. The general impact of fluctuations in our revenue mix is described below.

• A relative increase in staffing revenues will typically result in a lower gross margin percentage. Staffing revenues are presented at gross with the related direct costs reported in cost of sales. While staffing relationships typically have higher margins than PEO relationships, an increase in staffing revenues and related costs presented at gross dilutes the impact of the net PEO revenue on gross margin percentage.

• A relative increase in PEO revenue will result in higher gross margin percentage. Improvement in gross margin percentage occurs because incremental PEO revenue dollars are reported as revenue net of all related direct costs.

                                                      Year Ended
              (in thousands)                         December 31,
                                                  2008          2007
              Revenues:
              Staffing services                $   154,565   $   147,221
              Professional employer services       926,028       968,576

              Total revenues                     1,080,593     1,115,797

              Cost of revenues:
              Direct payroll costs                 908,410       935,697
              Payroll taxes and benefits            85,531        87,822
              Workers' compensation                 37,042        33,368

              Total cost of revenues             1,030,983     1,056,887

              Gross margin                     $    49,610   $    58,910

A reconciliation of non-GAAP gross revenues to net revenues is as follows for the years ended December 31, 2008 and 2007 (in thousands):

                                 Gross Revenue                                            Net Revenue
                               Reporting Method            Reclassification            Reporting Method
                              2008          2007          2008           2007          2008        2007
Revenues:
Staffing services          $   154,565   $   147,221   $        -     $        -     $ 154,565   $ 147,221
Professional employer
services                       926,028       968,576     (800,125 )     (826,584 )     125,903     141,992

Total revenues             $ 1,080,593   $ 1,115,797   $ (800,125 )   $ (826,584 )   $ 280,468   $ 289,213

Cost of revenues:          $ 1,030,983   $ 1,056,887   $ (800,125 )   $ (826,584 )   $ 230,858   $ 230,303

The amount of the reclassification is comprised of direct payroll costs and safety incentives attributable to our PEO client companies.

Years Ended December 31, 2008 and 2007

Net income for 2008 amounted to $6.3 million, a decline of 62.7% or $10.5 million from net income of $16.8 million for 2007. The decline for 2008 was primarily due to lower gross margin dollars as a result of a decline in revenues and higher direct payroll costs and higher workers' compensation expense, a $3.5 million impairment charge on investments and higher SG&A expenses. Diluted earnings per share for 2008 was $.56 compared to $1.44 for 2007.

Revenues for 2008 totaled $280.5 million, a decrease of approximately $8.7 million or 3.0%, which reflects a decline in the Company's PEO service fee revenue offset in part by an increase in staffing service revenue. PEO service fee revenue decreased approximately $16.1 million or 11.3% from 2007 primarily due to a decline in business with our existing PEO customer base resulting from challenging economic conditions. Staffing service revenue increased approximately $7.3 million or 5.0% over 2007 primarily due to the acquisitions of Strategic Staffing on July 2, 2007, Phillips Temps on December 3, 2007 and First Employment Services on February 4, 2008. The increase was offset in part by a decline in business with existing or former customers in excess of market share gains attributable to new customers. On a comparable branch office basis,
i.e. without the benefit from the incremental revenue generated from the three acquisitions, staffing revenues for the year declined 13.4% or approximately $19.8 million due to a decrease in demand for staffing employees resulting from slower economic conditions in the Company's markets. During 2008, the Company served approximately 2,300 staffing service customers, which compares to a similar number of customers during 2007. Management expects demand for the Company's staffing services will continue to reflect overall uncertain economic conditions in its market areas. During 2008, the Company served approximately 1,600 PEO clients, which compares to approximately 1,500 PEO clients during 2007. Offsetting the increase in the number of PEO clients served in 2008 was a decline in the average number of PEO employees and worker hours per client. Net growth in the Company's PEO business has slowed due to general economic conditions.

Gross margin for 2008 totaled approximately $49.6 million, which represented a decrease of $9.3 million or 15.8% from 2007, primarily due to the 3.0% decline in revenues and higher cost of revenues. The gross margin percent decreased from 20.4% of revenues for 2007 to 17.7% for 2008. The decline in the gross margin percentage was mainly due to higher direct payroll costs, expressed as a percent of revenues. The increase in direct payroll costs, as a percentage of revenues, from 39.28% for 2007 to 40.80% for 2008 reflects the moderate shift in the overall mix of services from PEO services to staffing services in the Company's customer base primarily attributable to the acquisitions of Strategic Staffing, Phillips Temps and First Employment Services and the effect of each customer's unique mark-up percent. Workers' compensation expense, as a percent of revenues, increased from 10.0% in 2007 to 11.0% in 2008. Workers' compensation expense for 2008 totaled $30.9 million, which compares to $29.0 million for 2007. This increase was primarily due to higher estimates for new claim costs and to increases in estimates for existing claims in states where the Company is self-insured as well as to higher insurance premiums in states where the Company is not self-insured. The small increase in payroll taxes and benefits, as a

percentage of revenues, from 30.4% for 2007 to 30.5% for 2008, was primarily due to the effect of growth in staffing services, as well as slightly higher effective state unemployment tax rates in various states in which the Company operates as compared to 2007. We expect gross margin as a percentage of total revenues to continue to be influenced by fluctuations in the mix between staffing and PEO services, as well as changes to our estimates for workers' compensation claims liabilities, if necessary.

During 2008, the Company recorded a non-cash, other-than-temporary impairment charge of approximately $3.5 million relating to its investment in four closed-end bond funds. The impairment charge assumes no income tax benefit given the uncertainty of the Company's ability to generate future taxable investment gains required to utilize these investment losses.

Selling, general and administrative ("SG&A") expenses consist of compensation and other expenses relating to the operation of our headquarters and our branch offices and the marketing of our services. SG&A for 2008 amounted to approximately $36.7 million, an increase of $2.0 million or 5.7% over 2007. SG&A expenses, as a percentage of revenues, increased from 12.0% in 2007 to 13.2% in 2008. The increase over 2007 was primarily attributable to increases in branch management personnel and related expenses as a result of the incremental SG&A expenses associated with the Strategic Staffing, Phillips Temps and First Employment Services acquisitions, which represented $3.5 million, offset in part by lower SG&A expenses from our existing branch offices. On a comparable branch basis, SG&A expenses declined $1.5 million primarily due to lower profit sharing.

Other income for 2008 was $2.1 million compared to other income of $3.1 million for 2007. The decline in other income for 2007 was primarily attributable to decreased investment income earned on the Company's cash and investments due to a decline in investment yields.

Depreciation and amortization totaled $1.5 million for 2008, which compares to $1.4 million for 2007. The increase in the depreciation and amortization expense level compared to 2007 was primarily due to the acquisitions of Strategic Staffing, Phillips Temps and First Employment Services.

Our effective income tax rate for 2008 was 37.3%, as compared to 35.2% for 2007. . . .