<PAGE>1

                             PAYLESS CASHWAYS, INC.
                               1997 ANNUAL REPORT




ABOUT THE COMPANY

Payless Cashways,  Inc. is a full-line  building  materials  specialty  retailer
concentrating on remodelers,  residential and commercial  contractors,  property
management and industrial  firms, and  project-oriented  do-it-yourselfers.  The
Company is the fifth largest  retailer in the industry as measured by sales.  At
the end of fiscal 1997, the Company operated 164 building materials stores in 20
states  located in the Midwest,  Southwest,  Pacific  Coast,  and Rocky Mountain
areas under the names of Payless Cashways,  Furrow,  Lumberjack,  Hugh M. Woods,
Knox Lumber, and Contractor Supply.

Each full-line store is designed as a one-stop source to provide  customers with
a complete selection of quality products and services needed to build,  improve,
or maintain their home,  business,  farm or ranch  properties.  The  merchandise
assortment  includes  approximately  31,000 items in the  following  categories:
lumber  and  building  materials;  doors,  windows  and trim;  tools;  hardware;
electrical  and  plumbing  products;  paint;  lighting;  home  decor;  kitchens;
decorative  plumbing;  heating/cooling/ventilation;   and  seasonal  items.  The
Company employs approximately 12,800 people, most of whom work in the stores and
have  the  opportunity  to be  trained  and  certified  in a number  of  product
categories.  The Company's  strategy is to serve the  professional  customer and
project-oriented  do-it-yourselfer with a full-line lumberyard,  a broad product
selection, a high level of customer assistance and competitive pricing.

In July 1997,  the Company filed for relief under  Chapter 11 of the  Bankruptcy
Code. The Court confirmed the Company's First Amended Plan of Reorganization and
the  Company   emerged  from   Chapter  11  on  December  2,  1997.   With  this
restructuring,  the Company believes it has a more appropriate balance sheet for
the highly competitive environment in which it operates.


--------------------------------------------------------------------------------


                          TABLE OF CONTENTS

          Letter to Stockholders                   2
          Quarterly Statement of Operations        5
          Management's Discussion and Analysis
           of the Financial Condition and Results
           of Operations                           7
          Statements of Operations                14
          Balance Sheets                          15
          Statements of Cash Flows                17
          Statements of Stockholders' Equity      18
          Notes to Financial Statements           19
          Independent Auditors' Report            34
          Five-Year Financial Summary             35
          Five-Year Operational Summary           36
          Board of Directors and Officers         37
          1997 Store Locations                    38
          Stockholder Information                 39


<PAGE>2


                                                              
Payless Cashways, Inc.

LETTER TO STOCKHOLDERS



To Our Stockholders:

On July 21, 1997, Payless Cashways' struggle against the weight of its debt load
culminated in a filing under Chapter 11 of the United  States  Bankruptcy  Code.
While not the preferred course of action,  the Company  determined that it could
not withstand the competitive  environment  without a significant  change in its
balance sheet. After  disappointing  results in the first and second quarters of
1997, it became  apparent to the Board of Directors  and  management in place at
that  time,  as  well  as  to  the  Company's  secured  lenders,   that  a  deep
restructuring  would have to be considered.  After evaluating the  alternatives,
the Company filed for protection under Chapter 11 and began a fast-track process
of restructuring.  On December 2, 1997, the Company's Plan of Reorganization was
consummated, and Payless Cashways emerged from bankruptcy as a newly reorganized
Delaware corporation with a new Board of Directors.

The new  Board of  Directors  is a group of  strong  and  capable  leaders  with
experience  in  the  building   materials   industry,   finance  and  marketing.
Individually, the members of the Board have led large and successful businesses.
By way of  brief  introduction,  we are  Peter G.  Danis,  President  and  Chief
Executive  Officer of Boise Cascade Office  Products,  serving as  non-executive
Chairman of the Board, and Donald E. Roller,  former  President/Chief  Executive
Officer of U.S. Gypsum Company, serving as Acting Chief Executive Officer. Other
members of the Board include David M. Chamberlain, Chairman of Genesco, Inc.; H.
D. (Harry) Cleberg,  President/Chief  Executive Officer of Farmland  Industries,
Inc.; David G. Gundling,  President/Chief  Executive  Officer of Hagemeyer Foods
N.A.,  Inc.;  Max D. Hopper,  Principal of Max D. Hopper  Associates,  Inc.; and
Peter M. Wood,  Former  Managing  Director of J.P.  Morgan & Company,  Inc.  Our
colleagues on the Board are dedicated  individuals who have already demonstrated
their willingness to make difficult  decisions in order to move Payless Cashways
toward profitability.  We recognize the difficulty of the challenge,  but we are
committed to restore Payless to a position of strength in the industry.

The new Board of Directors  accepted  long-time  Chief  Executive  Officer David
Stanley's  decision  to retire  and  determined  to  combine  the  positions  of
President and CEO.  President Susan Stanton announced her resignation on January
5. A  nationwide  search  is under  way for a  permanent  President/CEO.  In the
interim, Donald E. Roller serves in that capacity.

On January 19, working closely with the senior  management  team, we announced a
25% reduction in force at the headquarters  and the regional  offices  including
five additional  officers.  While the individuals who have left Payless Cashways
have served with great energy and dedication,  we are fortunate to have depth of
management  in the Company.  Stanley K. Boyd,  Louise R.  Iennaccaro,  Robert S.
Islinger,  Richard G. Luse and the four remaining regional vice presidents,  all
having been with the Company for some time,  assumed the duties of the departing
officers.

In addition,  changes have been made to place a dedicated store manager in every
location to ensure execution of plans and excellent customer service. Stanley K.
Boyd, Senior Vice President - Store Operations,  and Robert S. Islinger,  Senior
Vice President - Marketing and Merchandising, are directing sales initiatives to
regain sales momentum.  The Board and senior management have assembled a team to
review the Company's competitive


<PAGE>3


Payless Cashways, Inc.

LETTER TO STOCKHOLDERS (cont'd.)


strategy. While more time is needed for them to complete their work, progress is
being made. The capital  expenditure  plan has been greatly reduced for 1998 and
is targeted to maximize return.

The financial results for the year reflect both continuing competitive pressure,
and,  particularly in the second half, the effects of the Chapter 11 filing. For
the fourth quarter and the fiscal year, sales,  EBITDA,  and earnings  decreased
compared  to the prior year.  Losses for the quarter  reflect the impact of both
competition  and the period  spent in Chapter  11.  Negative  pressure  on sales
continued into December with same-store  sales down 12.2% compared to last year.
For the month of January, same-store sales comparisons improved.

Net sales for the fourth quarter were $504.4 million, a total decrease of 23.8%,
and 12.1% on a same-store  sales basis compared to the same quarter of 1996 when
presented  on a  thirteen-week  basis.  The total sales  decrease  reflects  the
closing of 29 stores during the quarter.  For financial reporting purposes,  the
fourth  quarter  of  1996  was  a  fourteen-week  sales  period  compared  to  a
thirteen-week  sales period for the fourth quarter of 1997. On that basis, total
sales  for  the  quarter  decreased  29.0%.  Earnings  before  interest,  taxes,
depreciation,  and amortization  (EBITDA),  a measure of the Company's operating
cash flow,  decreased to $17.3 million  compared to $43.4 million for the fourth
quarter of last year.  Fourth quarter 1997 EBITDA  benefited from a $5.1 million
LIFO credit compared to a $7.5 million LIFO credit in the same period of 1996.

During the fourth  quarter of fiscal  1997,  the  Company  recorded  non-routine
charges in  connection  with its  reorganization  under  Chapter 11. The Company
incurred  reorganization  charges of $20.3 million  ($12.5 million after tax) in
the quarter  ended  November 29, 1997,  which were  primarily  professional  and
administrative fees incurred in connection with the  reorganization,  as well as
amounts  accrued  under an  employee  retention  program.  The  Company  adopted
fresh-start  accounting as of November 29, 1997,  and recorded a $355.6  million
($312.1 million after tax) fresh-start  revaluation  charge and an extraordinary
gain, net of tax, of $138.2 million  related to the discharge of indebtedness in
the case. The Company also recorded an extraordinary charge, net of tax, of $5.0
million related to the early  extinguishment of the Amended Credit Agreement and
a mortgage loan on December 2, 1997.
Both of these debt instruments were replaced with new debt instruments.

The Company reported fourth quarter pro forma net loss of $10.4 million compared
to fourth quarter 1996 net income of $5.6 million. Pro forma net loss for fourth
quarter 1997 excludes the reorganization items, fresh-start revaluation charges,
and extraordinary  items related to the Company's  reorganization  under Chapter
11. Including these  non-routine  charges recorded in the quarter,  net loss for
the fourth quarter of 1997 was $201.8 million.

Net sales for the 1997  fiscal  year were $2.3  billion,  a decrease of 11.9% in
total,  and 6.6% on a same-store basis compared to fiscal 1996 when presented on
a 52-week  basis.  Again,  the total sales  decrease  reflects the closing of 29
stores during the fourth quarter of 1997. For financial reporting purposes,  the
1996 fiscal year was a 53-week  sales period  compared to a 52-week sales period
for the 1997 fiscal year.  Without  adjusting  for the 53rd week of 1996,  total
sales for the 1997 fiscal year decreased  13.5%.  Pro forma EBITDA  decreased to
$65.4  million  compared to $134.6  million for last year.  Pro forma EBITDA for
1997 excludes third quarter 1997


<PAGE>4


Payless Cashways, Inc.

LETTER TO STOCKHOLDERS (cont'd.)


inventory   write-downs   of  $10.7  million   related  to  the  closing  of  29
under-performing  stores,  and pro forma EBITDA for 1996 excludes  third quarter
1996  inventory  write-downs  of $5.8  million  related  to the  closing of nine
under-performing  stores.  EBITDA for fiscal 1997  benefited from a $0.7 million
LIFO credit compared to a $3.2 million LIFO credit in fiscal 1996.

For the 1997  fiscal  year,  the Company  reported a net loss of $288.6  million
compared to a net loss of $19.1 million in the previous  year.  The net loss for
the 1997 fiscal year  reflects  reorganization  items,  fresh-start  revaluation
charges,  a store closing charge, an asset impairment  charge, and extraordinary
items  recorded  in the  third  and  fourth  quarters  of  1997.  Excluding  the
non-routine  items  recorded in these  quarters of 1997 and the third quarter of
1996,  pro forma net loss for the 1997 fiscal year would have been $35.5 million
compared to net income for the 1996 fiscal year of $7.4 million.

Payless Cashways still faces  challenges.  Early operating  results for 1998 are
tracking below Company expectations.  Same-store sales for the month of December
1997, the first month of fiscal 1998, of $143.7 million,  as mentioned  earlier,
were 12.2% below last year. The Company expected some improvement  after exiting
the  Chapter  11  reorganization,  but  negative  fourth  quarter  sales  trends
continued into the new fiscal year. The impact of the Chapter 11  reorganization
has not yet  dissipated.  Soft sales in the early weeks of fiscal 1998  increase
the need for a strong spring selling season and continued tight expense control.

Payless  Cashways  is a company  with a strong  tradition  of  perseverance  and
commitment.  It has  struggled  under a heavy load of debt,  as the  competitive
landscape has become more and more challenging.  We believe it has the potential
to continue to be among the best building  materials  retailers in the industry,
serving  millions of  customers  each  month.  We have been  impressed  with the
quality of both the people and the facilities at Payless Cashways. The challenge
is to successfully attract and retain customers.  This Board and management team
are committed to that challenge.




Peter G. Danis                             Donald E. Roller
Non-executive Chairman of the Board        Acting Chief Executive Officer


<PAGE>5


Payless Cashways, Inc.

QUARTERLY STATEMENTS OF OPERATIONS (unaudited)

<TABLE>

In thousands, except per share amounts
<CAPTION>
                                                                                          Predecessor Company
                                                                     First           Second             Third           Fourth
Fiscal Year Ended November 29, 1997                                 Quarter          Quarter           Quarter          Quarter
-------------------------------------------------------------------------------------------------------------------------------
<S>                                                              <C>               <C>              <C>               <C>  

Income
   Net sales                                                     $  487,550        $  661,191       $  632,107        $  504,433
   Other income                                                       1,205             1,264            1,191             1,274
                                                                 ---------------------------------------------------------------
                                                                    488,755           662,455          633,298           505,707

Costs and expenses
   Cost of merchandise sold                                         348,247           483,093          478,038           367,280
   Selling, general and administrative                              138,407           151,147          148,166           121,097
   Reorganization items                                                  --                --            5,121            20,334
   Fresh-start revaluation                                               --                --               --           355,559
   Special charges                                                       --                --           13,056                --
   Asset impairment charges                                              --                --           60,483                --
   Provision for depreciation and amortization                       12,804            13,037           12,768            12,501
   Interest expense                                                  16,055            16,274           14,663            14,259
                                                                 ---------------------------------------------------------------
                                                                    515,513           663,551          732,295           891,030
                                                                 ---------------------------------------------------------------
     LOSS BEFORE INCOME TAXES                                       (26,758)           (1,096)         (98,997)         (385,323)

Federal and state income taxes                                      (18,623)           12,133          (33,595)          (50,321)
                                                                 ----------------------------------------------------------------

Loss before extraordinary items                                      (8,135)          (13,229)         (65,402)         (335,002)

Extraordinary items, net of income taxes                                 --                --               --           133,176
                                                                 ---------------------------------------------------------------

                                   NET LOSS                      $   (8,135)       $  (13,229)      $  (65,402)       $ (201,826)
                                                                 ================================================================

</TABLE>


In connection  with its Chapter 11 filing on July 21, 1997,  discussed at Note A
to the Financial  Statements,  the Company recorded  reorganization items in the
third  and  fourth   quarters   ($3.2  million  and  $12.5  million  after  tax,
respectively).  The Company also adopted  fresh-start  accounting,  discussed at
Note B to the Financial Statements,  as of November 29, 1997, as a result of its
emergence  from  bankruptcy  under its plan of  reorganization  effective  date,
December  2, 1997.  Fresh-start  revaluation  charges,  after tax,  were  $312.1
million.  An  extraordinary  gain of $138.2  million  after tax  related  to the
discharge of debt pursuant to the  consummation  of the Plan was recorded in the
fourth quarter. In addition,  an extraordinary  charge of $5.0 million after tax
related  to the early  extinguishment  of debt was also  recorded  in the fourth
quarter. A lower-than-anticipated rate of inflation decreased the LIFO inventory
provision,  after tax, by $3.0 million in the fourth  quarter.  Special  charges
($8.1  million  after  tax)  reflected  in the third  quarter  consist  of costs
associated with the closing of 29 stores. Third quarter cost of merchandise sold
reflects an inventory  write-down  ($6.6 million  after tax) in connection  with
these store  closings.  The Company  also  recorded an asset  impairment  charge
($43.9 million after tax) in the third quarter.



<PAGE>6


Payless Cashways, Inc.

QUARTERLY STATEMENTS OF OPERATIONS (unaudited) (cont'd.)
<TABLE>


In thousands, except per share amounts
<CAPTION>
                                                                                          Predecessor Company
                                                                     First           Second             Third           Fourth
Fiscal Year Ended November 30, 1996                                 Quarter          Quarter           Quarter          Quarter
-------------------------------------------------------------------------------------------------------------------------------
<S>                                                             <C>               <C>              <C>               <C>    

Income
    Net sales                                                   $  526,767        $  682,252       $  723,793        $  710,017
    Other income                                                     1,597             1,521            1,481             3,477
                                                                ---------------------------------------------------------------
                                                                   528,364           683,773          725,274           713,494

Costs and expenses
    Cost of merchandise sold                                       372,916           491,500          535,956           506,362
    Selling, general and administrative                            141,405           152,929          157,403           163,729
    Special charges                                                     --                --            8,184                --
    Asset impairment charges                                            --                --           59,697                --
    Provision for depreciation and amortization                     13,184            13,586           14,007            14,239
    Interest expense                                                15,352            14,606           14,438            16,092
    Interest income                                                     --                --           (4,900)               --
                                                                ---------------------------------------------------------------
                                                                   542,857           672,621          784,785           700,422
                                                                ---------------------------------------------------------------
         INCOME (LOSS) BEFORE INCOME TAXES                         (14,493)           11,152          (59,511)           13,072

Federal and state income taxes                                      (6,870)            5,286          (36,633)            7,515
                                                                ---------------------------------------------------------------


                                 NET INCOME (LOSS)              $   (7,623)       $    5,866       $  (22,878)       $    5,557
                                                                ===============================================================
</TABLE>



Special  charges ($5.0 million after tax) reflected in the third quarter consist
of costs  associated  with the closing of nine  stores,  eight of which had been
closed at November 30, 1996.  Third quarter cost of merchandise sold reflects an
inventory  write-down  ($3.5 million  after tax) in connection  with these store
closings.  The Company recorded an asset impairment  charge ($44.6 million after
tax) in the  third  quarter  as well as a  federal  income  tax  benefit  ($23.7
million)  and related  interest  income  ($2.9  million  after tax)  pursuant to
legislation and a settlement with the Internal Revenue Service. A liquidation of
LIFO inventories and a  lower-than-anticipated  rate of inflation  decreased the
LIFO inventory provision, after tax, by $4.0 million in the fourth quarter.



<PAGE>7


Payless Cashways, Inc.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Petition For Relief Under Chapter 11
------------------------------------

While the Company had sufficient  liquidity to fund its current operations,  the
operating  performance  of the Company during the second quarter of fiscal 1997,
which was well below the Company's expectations, led management to conclude that
it was  unlikely  that the Company  would be able to comply  with the  covenants
contained in its principal credit agreements at the end of the 1997 fiscal year.
In the course of the Company's  subsequent  negotiations with its senior lenders
to  restructure  its debt and  after  considering  with its  financial  adviser,
Houlihan Lokey Howard & Zukin, all other alternatives, including the sale of the
Company and  liquidation,  the Company  concluded  that a Chapter 11  proceeding
provided the best approach for a comprehensive  financial  restructuring  of the
Company.  This action was intended to improve the Company's competitive position
by establishing a more appropriate  capital structure to operate the business in
this period of unprecedented competitive pressure after a decade of dealing with
a highly leveraged balance sheet, which had limited capital expenditures.

On July 21, 1997,  the Company filed a voluntary  petition to  reorganize  under
Chapter 11 and filed a plan of reorganization  for its emergence from Chapter 11
(the "Plan" or "Plan of Reorganization") as well as a Disclosure Statement.  The
Company  operated  its  business  as  a  debtor-in-possession,  subject  to  the
jurisdiction of the Court, while pursuing its reorganization plan to restructure
the  Company's  capitalization.  The Chapter 11 filing  resulted in an automatic
stay of the commencement or prosecution of claims against the Company that arose
before the petition date.

The  Disclosure  Statement  and Plan were  subsequently  amended on September 5,
1997, and modified on October 9, 1997. On October 10, 1997, the Court determined
that  the  Disclosure  Statement  contained  adequate  information  to  permit a
creditor to make an informed  decision  about the Plan.  The Company's  impaired
creditors and equity security holders accepted the Plan, the Court confirmed the
Plan  on  November  19,  1997,  and,  after  the  satisfaction  of a  number  of
conditions,  the Plan became effective  December 2, 1997 (the "Effective Date").
For a  summary  description  of the  Plan,  see  Note A to  Notes  to  Financial
Statements.

Results of Operations
---------------------

The following  discussion of the  Company's  financial  condition and results of
operations should be read in conjunction with the Financial Statements and notes
thereto included  elsewhere in this Annual Report to  Stockholders.  The Company
has implemented the required accounting for entities emerging from Chapter 11 in
accordance  with  the  American  Institute  of  Certified  Public   Accountants'
Statement of Position  90-7 ("SOP  90-7"),  "Financial  Reporting by Entities in
Reorganization   Under  the  Bankruptcy  Code"  ("fresh-start   reporting")  and
reflected  the effects of such  adoption in the balance sheet as of November 29,
1997.  Under  fresh-start  reporting,  the balance  sheet of November  29, 1997,
became the opening  balance  sheet of the  Reorganized  Company.  The  financial
statements of the Predecessor  Company as of November 29, 1997 and prior are not
comparable  in material  respects to the  financial  statements of the Successor
Company.
<TABLE>

Operating Data                                                                      
<CAPTION>
                                                                                            Predecessor Company
                                                                                --------------------------------------------
                                                                                             Fiscal Year Ended
                                                                                --------------------------------------------
percent of net sales                                                            Nov. 29,         Nov. 30,           Nov 25,
                                                                                  1997             1996              1995
                                                                                ---------        ----------         --------
<S>                                                                             <C>              <C>                <C>   

Net sales.......................................................                  100.0 %           100.0 %          100.0 %
Other income....................................................                     .2                .3               .2
Cost of merchandise sold........................................                   73.4              72.1             71.4
Selling, general and administrative.............................                   24.4              23.3             23.1
Reorganization items............................................                    1.1                --               --
Fresh-start revaluation.........................................                   15.6                --               --
Special charges.................................................                     .6                .3              5.7
Asset impairment charges........................................                    2.6               2.3               --
Provision for depreciation and amortization.....................                    2.2               2.1              2.3
Interest expense................................................                    2.7               2.3              2.3
Interest income.................................................                    --                (.2)              --
                                                                                --------------------------------------------
Income (loss) before income taxes...............................                  (22.4)             (1.9)            (4.6)

Federal and state income taxes..................................                   (4.0)             (1.2)             (.2)
Equity in loss of joint venture.................................                     --                --              (.4)
                                                                                --------------------------------------------
Income (loss) before extraordinary items........................                  (18.4)              (.7)            (4.8)

Extraordinary items.............................................                    5.8                --               --
                                                                                --------------------------------------------
Net income (loss)...............................................                  (12.6)%             (.7)%           (4.8)%
                                                                                ============================================
</TABLE>


<PAGE>8


Payless Cashways, Inc.

MANAGEMENT'S  DISCUSSION AND ANALYSIS OF THE FINANCIAL  CONDITION AND RESULTS OF
OPERATIONS (cont'd.)


Sales

Net sales for fiscal 1997, a 52-week year,  decreased  13.5% from fiscal 1996, a
53-week  year,  and fiscal 1996 net sales  decreased  1.4% from fiscal  1995,  a
52-week year. On a 52-week basis, net sales for fiscal year 1997 decreased 11.9%
compared to fiscal 1996 and net sales for 1996 decreased 3.0% compared to fiscal
1995. Same-store sales (sales from stores that have been open one full year), on
a 52-week  basis,  decreased by 6.6% for fiscal  1997,  and  decreased  2.5% for
fiscal 1996. Net sales for 1997 reflect continuing  competitive pressure and, in
the second  half,  the  disruption  in the supply of product  and the erosion of
customer  confidence  caused by the Chapter 11 filing.  On a  same-store  basis,
sales from professional  customers increased 0.2%, while sales from the consumer
side of the business  decreased  11.9% in fiscal 1997.  Twenty-four  stores were
closed during the third quarter of 1997 (one closing of which had been announced
in fiscal 1996), and an additional six stores were closed in the fourth quarter.
The Company  closed six stores in early fiscal 1996 and another  eight stores in
the fourth  quarter of 1996. Net sales for 1996 reflect  increasing  competitive
pressure on the Company's consumer business, although there was strong growth in
the professional  business aided by improved external conditions such as housing
activity and consumer sentiment.  On a same-store basis, sales from professional
customers  increased  7.7%,  while sales from the consumer  side of the business
decreased  8.1% in fiscal  1996.  The  stores  closed  in  fiscal  1996 and 1997
accounted  for  $213.3  million  and  $388.7  million  sales in 1996  and  1997,
respectively.

Gains of $2.3 million,  before tax, related to insurance  settlement proceeds in
excess of net book value for buildings  and  equipment  destroyed in a 1995 fire
loss, are included in other income for fiscal 1996.

Costs and Expenses

The cost of merchandise  sold, as a percent of sales,  was 73.4% in fiscal 1997,
72.1% in fiscal 1996,  and 71.4% in fiscal 1995. A third quarter 1997  inventory
write-down  of $10.7  million,  related  to the  closing  of 29  underperforming
stores, was 0.5% of sales for fiscal 1997.  Likewise,  a third quarter inventory
write-down  of $5.8  million,  related to the  closing  of nine  underperforming
stores, was 0.2% of sales for fiscal 1996. Excluding the effect of both the 1997
and 1996  inventory  write-downs,  the decrease in gross margins during 1997 was
primarily  due  to  competitive   pressure  and  the  growth  in  sales  to  the
professional customer whose merchandise purchases include a higher percentage of
commodity goods at margin rates somewhat lower than the Company's  average.  The
disruption in the supply of product  resulting from the Chapter 11 filing caused
some  increase in cost of goods sold due to  purchasing  product from  secondary
sources at higher  costs.  The  decrease in 1996 gross  margins was also due, in
part, to the growth in sales to the  professional  customer and to the Company's
pricing initiatives.  Cost of merchandise sold in fiscal 1997 and 1996 benefited
from a $0.7 million and a $3.2 million  LIFO  credit,  respectively,  related to
liquidations of LIFO inventories and deflation,  compared to a $4.2 million LIFO
charge in fiscal 1995.

Selling, general and administrative expenses, as a percent of sales, were 24.4%,
23.3%, and 23.1% for fiscal 1997, 1996 and 1995, respectively.  The increases as
a percent of sales for fiscal 1997 and 1996 were due  primarily  to lower sales.
The 1997 and 1996  decrease in dollars  was due  primarily  to savings  from the
store closings discussed above.

Interest expense increased $0.8 million to $61.3 million in fiscal 1997 compared
to fiscal 1996 due  primarily to higher  interest  rates.  Interest  expense for
fiscal 1997 would have increased an additional $5.7 million had certain debt not
been  compromised  by the Chapter 11 filing.  Interest  expense  decreased  $0.6
million in fiscal 1996  compared to fiscal 1995 due  primarily to  retirement of
long-term debt, some of which was replaced with lower interest-bearing debt. The
Company also recorded  interest  income of $4.9 million ($2.9 million after tax)
in the third  quarter of 1996,  related to a pending  tax refund  arising out of
recent legislation and a settlement with the Internal Revenue Service ("IRS").

In connection with its Chapter 11 filing,  the Company  recorded  reorganization
items  of  $25.5  million  during  fiscal  1997.   Additional   details  on  the
reorganization  items are set forth in Note J to the Financial  Statements.  The
Company  also  recorded  fresh-start  revaluation  charges of $355.6  million in
fiscal  1997.  See  Note B to the  Financial  Statements  for  more  details  on
fresh-start reporting and these related charges.


<PAGE>9


Payless Cashways, Inc.

MANAGEMENT'S  DISCUSSION AND ANALYSIS OF THE FINANCIAL  CONDITION AND RESULTS OF
OPERATIONS (cont'd.)


A special  charge of $13.0 million  ($8.1  million after tax),  primarily a cash
charge,  was recorded in the third quarter of fiscal 1997 to reflect real estate
disposal   and   severance   costs   related  to  the  closing  of   twenty-nine
underperforming stores as part of the Company's reorganization under Chapter 11.
A special  charge of $8.2 million  ($5.0  million  after tax),  primarily a cash
charge, was recorded in the third quarter of fiscal 1996 to reflect future store
rentals  and  real  estate  disposal  costs  related  to  the  closing  of  nine
underperforming stores. A special charge of $153.7 million ($133.1 million after
tax) was  recorded  in the  fourth  quarter  of  fiscal  1995 to  reflect  costs
associated   with  a   restructuring   which   included   the   closing  of  six
underperforming  stores  on  December  30,  1995,  the sale of an  underutilized
distribution  center on December  22,  1995,  and,  during the first  quarter of
fiscal  1996,  the  reorientation  of  several  stores  to  concentrate  on  the
professional  customer.  Additional details on the special charges are set forth
in Note L to the Financial Statements.

The Company recorded an asset impairment  charge of $60.5 million ($43.9 million
after tax) and $59.7 million  ($44.6 million after tax) in the third quarters of
1997 and 1996,  respectively.  Primarily  because the  environment  for building
materials  retailing has continued to be increasingly  competitive,  the Company
first  conducted its review in the third quarter of 1996 and determined  certain
assets were impaired.  In the third quarter of 1997, the Company again conducted
a review of underperforming stores and determined that certain additional assets
were impaired, including assets related to twenty-nine stores, which the Company
closed. The asset impairment charges were recorded after considering current and
expected  future  operating  cash flows for  certain  stores  together  with the
proceeds  the Company  could  expect to receive  upon the sale of these  assets.
Additional  details on the asset  impairment  charges are set forth in Note K to
the  Financial  Statements.  The  Company  will  continue  to review  assets for
impairment,  particularly given the ongoing competitive environment for building
materials retailing.

The effective tax rates for fiscal 1997,  1996, and 1995 were different from the
35% statutory rate primarily due to the effect of goodwill  amortization and the
write-off of goodwill, both of which are non-deductible for income tax purposes.
In addition,  for fiscal 1996, the effective tax rate was significantly affected
by the tax benefit related to income tax  legislation and an IRS settlement.  On
August 20, 1996,  the Small  Business Job Protection Act of 1996 was signed into
law. Certain provisions of this legislation clarified the Tax Reform Act of 1986
and made  retroactively  tax  deductible  certain costs and expenses  previously
recorded by the Company  without any related tax benefit.  In  addition,  during
1996,  the Company  settled  with the IRS  regarding  several  tax issues.  As a
result, the Company recorded a tax benefit of $23.7 million and related interest
income, discussed earlier.

Net Income (Loss)

The  Company  had a loss  before  extraordinary  item of $421.8  million in 1997
compared  to $19.1  million  in 1996 and $128.5  million in 1995.  The 1997 loss
before extraordinary item reflects reorganization items, fresh-start revaluation
charges,  store closing charges,  and an asset impairment  charge, all discussed
above. The 1996 loss before  extraordinary  item reflects store closing charges,
an asset  impairment  charge,  a federal income tax benefit and related interest
income,  all discussed above. The 1995 loss before  extraordinary  item reflects
the special charge in connection  with the  restructuring,  discussed  above, as
well as the Company's share in its Mexican joint venture's  operating loss prior
to the sale of this  investment in October 1995.  The 1995 equity in the loss of
joint venture also includes an $8.0  million,  pretax,  loss on the sale of this
investment.  Excluding the  non-routine  items recorded during fiscal 1997, 1996
and 1995,  net loss for 1997,  would have been $35.5  million and net income for
1996 and 1995 would have been $7.4 million and $12.5 million, respectively.


<PAGE>10


Payless Cashways, Inc.

MANAGEMENT'S  DISCUSSION AND ANALYSIS OF THE FINANCIAL  CONDITION AND RESULTS OF
OPERATIONS (cont'd.)


Comparative Operating Data 
<TABLE>
<CAPTION>
                                                           Predecessor Company
                                                -----------------------------------------
                                                    Fiscal Year Ended November 29, 1997
                                                -----------------------------------------
In thousands, except per share amounts                Pro Forma          Historical
                                                     (Excluding          (Including
                                                 Non-Routine Items)    Non-Routine Items)
                                                -------------------   -------------------
<S>                                                <C>                    <C>

Net sales and other income                         $  2,290,215           $  2,290,215
Income from operations before interest,
  depreciation and amortization                    $     65,433           $   (399,813)
Net income (loss)                                  $    (35,451)          $   (288,592)
</TABLE>

<TABLE>
<CAPTION>
                                                    Fiscal Year Ended November 30, 1996
                                                -----------------------------------------
                                                      Pro Forma          Historical
                                                     (Excluding          (Including
                                                 Non-Routine Items)    Non-Routine Items)
                                                -------------------   -------------------
<S>                                                <C>                    <C>

Net sales and other income                         $  2,650,905           $  2,650,905
Income from operations before interest,
  depreciation and amortization                    $    134,552           $     60,824
Net income (loss)                                  $      7,428           $    (19,078)
</TABLE>

<TABLE>
<CAPTION>


                                                    Fiscal Year Ended November 25, 1995
                                                -----------------------------------------
                                                      Pro Forma          Historical
                                                     (Excluding          (Including
                                                 Non-Routine Items)    Non-Routine Items)
                                                -------------------   -------------------
<S>                                                <C>                    <C>

Net sales and other income                         $  2,685,670           $  2,685,670
Income from operations before interest,
  depreciation and amortization                    $    153,461           $       (206)
Net income (loss)                                  $     12,499           $   (128,549)
</TABLE>


Future Operating Results
------------------------

The Company expects that openings by warehouse-format competitors will continue.
The negative  sales trends of fiscal 1997 continued into the first two months of
fiscal 1998  causing the new board of  directors  and senior  management  of the
Company  to  implement  changes  designed  to have an  immediate  impact  on the
Company's   financial  results.   These  changes  included  the  elimination  of
approximately  25% of the  staff  at the  Company's  headquarters  and  regional
administrative  centers,  including senior  management,  and the assignment of a
dedicated  store  manager in each  retail  location.  It is  anticipated  that a
special  charge of  approximately  $5.6  million  will be  recorded in the first
quarter of fiscal 1998 to reflect severance costs related to these changes.  The
CEO and President positions are being consolidated and the Company is conducting
a national  search for a  candidate  to fill this  position.  In  addition,  new
merchandising and sales initiatives are being implemented.

Effects of Inflation
--------------------

The Company  experienced  slight deflation in its non-lumber  inventories during
fiscal 1997 and fiscal 1996.  Approximately  82% of the  Company's  inventory is
valued using the LIFO inventory accounting method; therefore,  current costs are
reflected in the cost of merchandise  sold,  rather than in inventory  balances.
During 1995, the Company  experienced  price  deflation in its lumber  inventory
which is  valued  using  the  FIFO  inventory  accounting  method.  The  Company
estimates  that this price  deflation  had a negative  1.6% impact on same-store
sales.




<PAGE>11


Payless Cashways, Inc.

MANAGEMENT'S  DISCUSSION AND ANALYSIS OF THE FINANCIAL  CONDITION AND RESULTS OF
OPERATIONS (cont'd.)


Financing Activities
--------------------

As a result of the  Chapter  11 filing on July 21,  1997,  borrowings  under the
revolving credit facility of the Amended Credit  Agreement,  defined below, were
no longer available to the Company. During the period from July 21, 1997 through
December 2, 1997,  the Company  utilized  debtor-in-possession  financing  which
consisted of a $125 million revolving credit facility (the "DIP Agreement").  On
or prior to the Effective Date, the Company paid all amounts  outstanding  under
the DIP Agreement and the Amended  Credit  Agreement with cash, New Common Stock
and new notes under the Exit Financing  Agreement.  The Exit Financing Agreement
includes  term  loans of $283.1  million  and a $150  million  revolving  credit
facility with a $40 million letters of credit  sublimit.  In accordance with the
Plan of  Reorganization,  on the  Effective  Date the Company's  mortgage  loan,
secured by certain  real estate,  was retired and  replaced  with a new mortgage
loan secured by the same real estate and the Company's senior subordinated notes
were  terminated  and  canceled.  Holders of these  subordinated  notes now hold
general unsecured claims under the Plan. On the Effective Date, the Company also
issued a note for $16 million, secured by three store facilities,  in settlement
of the secured  portion of the claims arising from a lease  agreement  involving
five store  facilities.  At the Effective Date the Company obtained a commitment
from the mortgage  lender to borrow an additional $13 million under the mortgage
loan  described  above,  and the  Company  intends to prepay  this note in full.
Although  this  transaction  has  not  been  completed,  it  is  expected  to be
consummated in the first half of fiscal 1998.

On October 3, 1996,  the Company  amended its $408 million  credit  agreement to
include two tranches of term loans in the aggregate  amount of $273  million,  a
revolving  credit  facility of $135  million and a $60 million  working  capital
facility (the "Amended Credit Agreement").  As part of the amendment,  permitted
levels of capital expenditures were increased,  additional collateral (including
substantially  all merchandise  inventories) was added,  various  covenants were
modified or eliminated  and interest  rates were  increased.  The Amended Credit
Agreement was designed to give the Company additional  flexibility and liquidity
and provide the banks with additional security.

On December 22, 1995, the Company made a $16.5 million  mortgage loan prepayment
in connection with the sale of a distribution center described below and in Note
L to the Financial Statements.

In  November  1995,  the Company  amended  and  restated  its  five-year  credit
agreement  to  include a $40.0  million  term loan and to reduce  the  revolving
credit facility to $380.0 million.  As part of the amendment,  various covenants
were  modified and interest  rates were  increased.  In addition,  in 1995,  the
Company  entered into an interest  rate cap limiting the interest  rates on $100
million of its floating  rate debt to 8% LIBOR through  January 20, 1998.  Also,
during 1995,  the Company  entered into an interest  rate swap  agreement  under
which it agreed to pay  quarterly  a 6-9/16%  fixed rate of  interest  effective
December 1, 1995, through December 1, 1999, in exchange for quarterly receipt of
LIBOR on $36.0 million.

At  the  Effective  Date  of  its  Plan  of  Reorganization,   the  Company  had
approximately  $433.4 million of indebtedness.  The Company expects from time to
time to incur additional seasonal indebtedness.

The Year 2000 Issue
-------------------

The Year 2000 issue is the result of computer  programs  being written using two
digits rather than four to define the  applicable  year.  Any programs that have
time-sensitive  software may recognize a date using "00" as the year 1900 rather
than the year 2000.  This could result in system failure or miscalculations.

The Company has  completed an  assessment  of the impact of the year 2000 on its
computer systems, both hardware and software, and has developed a plan to timely
address the Year 2000 issue.  The Company is executing  that plan and  currently
believes  that it will  complete  all phases of the plan  without  any  material
adverse consequences to its business,  operations,  or financial condition.  The
Company estimates that expenditures related to executing the Year 2000 plan will
range from $5 million to $8 million over the next two years.  Such  expenditures
are being charged to expense as incurred.

The  Company  has not  communicated  with all of its  significant  suppliers  to
determine  the extent to which the Company is vulnerable to the failure of those
third  parties to  remediate  their own Year 2000  issues.  The Company does not
anticipate the cost of Year 2000  compliance by suppliers to be passed on to the
Company.  However,  there can be no assurances  that failure to address the Year
2000 issue by a third party on whom the Company's  systems rely would not have a
material adverse effect on the Company.


<PAGE>12



Payless Cashways, Inc.

MANAGEMENT'S  DISCUSSION AND ANALYSIS OF THE FINANCIAL  CONDITION AND RESULTS OF
OPERATIONS (cont'd.)


Liquidity and Capital Resources
-------------------------------

The  Company's  principal  source of cash is from  operations.  Cash provided by
operating  activities  was $32.0  million  for fiscal  1997,  compared  to $32.4
million for fiscal 1996 and $108.4  million for fiscal  1995.  Cash  provided by
operating activities in 1997 benefited from the compromise and extinguishment of
general unsecured claims, including trade accounts payable, pursuant to the Plan
of Reorganization  that would have otherwise required cash. The 1996 decrease in
cash  provided  by  operating  activities  was  primarily  due to a decrease  in
accounts  payable  and an  increase  in  merchandise  inventories,  as  well  as
decreased  operating  income.  The 1996  decrease  in  accounts  payable  levels
compared to year-ago  levels is primarily  due to slower  inventory  turns and a
shift in the mix of purchases between commodity products (shorter payment terms)
and non-commodity products (longer payment terms).

Borrowings are available  under the Exit Financing  Agreement to supplement cash
generated by operations.  At December 2, 1997,  $106.8 million was available for
borrowing.  Working  capital was $258.4 million and $131.0 million at the end of
fiscal 1997 and fiscal 1996,  respectively.  The current ratio was 2.15 to 1 and
1.41 to 1 at the end of fiscal 1997 and fiscal 1996,  respectively.  The primary
reasons  for the  increase  in working  capital  and the  current  ratio was the
restructuring  under  Chapter  11 that took place  during  1997.  The  Company's
inventory levels are at the lowest levels during the seasonally low sales months
of  December  through  February  and are at the highest  levels  during the peak
selling months of May through  September.  During the peak period,  inventory is
financed by cash from operations and trade accounts  payable.  During the winter
months,  inventory is financed by cash from  operations,  trade accounts payable
and  borrowings  under the Exit  Financing  Agreement,  as needed.  The  Company
believes that cash  generated  from  operations  and  borrowings  under the Exit
Financing Agreement will adequately meet its working capital needs, debt service
and other obligations that will become due in fiscal 1998.

During fiscal 1997,  the Company's  primary  investing  activities  were capital
expenditures  principally  for  strategic  initiatives,  renovation  of existing
stores and additional equipment. The Exit Financing Agreement governs the amount
of capital  expenditures  that can be made and the  permitted  levels of capital
expenditures in the future are as follows:  $59.6 million in 1998; $52.1 million
in 1999;  $41.2  million in 2000;  $51.3  million in 2001;  and $52.3 million in
2002. The Company spent  approximately  $62.9  million,  $41.7 million and $67.3
million in fiscal 1997, 1996 and 1995, respectively,  for strategic initiatives,
including the acquisition of a door and trim manufacturer in Phoenix, AZ, during
January 1996, renovation of existing stores, additional equipment and, in fiscal
1995,  new stores.  For fiscal 1997 and 1996,  the Company  shifted its emphasis
from new store  openings to  initiatives  that further  address the needs of the
professional  and  do-it-yourself  customers.  Several stores were reoriented to
concentrate on the professional customer and merchandise assortment was added to
many stores to address do-it-yourself customer demand for more choices of price,
quality and style. During fiscal 1996, in support of the professional  customer,
the Company  completed the acquisition of the  manufacturer  mentioned above and
expanded the manufacturing capability of one of its existing door plants. During
1997, the Company sold eight real estate properties related to the closing of 14
stores in 1996 for approximately $14.3 million of cash proceeds.  Sale of closed
store properties will continue in fiscal 1998. During the first quarter of 1996,
the Company sold a distribution center in connection with the 1995 restructuring
plan, providing approximately $11.9 million of cash proceeds. The Company leased
one new  store in 1996,  which it  opened  in 1997.  In  addition,  the  Company
purchased and opened an existing  store facility  during 1997.  During 1995, six
new stores  were  opened and two stores were sold.  The  Company's  new Board of
Directors is currently  analyzing the Company's  competitive  positioning in the
market and the related capital  investments.  Until such evaluation is complete,
budgeted capital  expenditures for 1998 will be limited to normal  renovation of
existing  stores and routine  equipment  purchases,  which will be financed with
funds  generated  from  operations  and  borrowings  under  the  Exit  Financing
Agreement.

During fiscal 1995, the Company also invested $9.3 million in its joint venture,
Total Home de Mexico,  S.A.  de C.V.,  prior to the sale of this  investment  in
October 1995.  Significant  changes in the Mexican economy caused the Company to
reassess  its position  and sell its Mexican  investment  to an affiliate of its
former joint venture partner.


<PAGE>13


Payless Cashways, Inc.

MANAGEMENT'S  DISCUSSION AND ANALYSIS OF THE FINANCIAL  CONDITION AND RESULTS OF
OPERATIONS (cont'd.)


The Company's most significant financing activity is and will continue to be the
retirement of indebtedness.  As a result of the Company's  reorganization  under
Chapter 11, the indebtedness of the Company was reduced  significantly in fiscal
1997 as described  above in "Financing  Activities"  and in Notes A, B, and D to
the Financial Statements.  Although the Company's  consolidated  indebtedness is
and will continue to be substantial,  management  believes that,  based upon its
analysis of the Company's  financial  condition,  the cash flow  generated  from
operations  during the past 12 months and the expected  results of operations in
the future, cash flow from operations and borrowing  availability under the Exit
Financing  Agreement  should  provide  sufficient  liquidity  to meet  all  cash
requirements for the next 12 months without additional financing. As a result of
the Chapter 11 filing,  trade  creditors  have  significantly  shortened  credit
terms. The Company  believes that progress with regard to lengthening  terms and
reestablishing  trade credit is  continuing,  but  availability  of trade credit
cannot be assured.  The Exit Financing  Agreement contains a number of financial
covenants  with which the Company must comply.  Certain of these  covenants  are
detailed in Note D to the Financial  Statements.  First quarter 1998 results are
likely to be below  results for the same  quarter of the prior year.  Management
currently  expects  that  it  will  achieve   compliance  with  these  covenants
throughout  1998;  however,  factors  beyond  management's  control,   including
competitive  conditions,  economic conditions,  supplier support, lumber prices,
and weather,  could cause  noncompliance.  If compliance with these covenants is
not achieved,  the Company may be required to renegotiate its existing covenants
with  lenders  or  to  refinance  borrowings.  Success  in  achieving  any  such
renegotiations or refinancing, or the specific terms thereof, including interest
rates,  capital expenditure limits or borrowing capacity,  cannot be assured. If
the Company fails to achieve  compliance with these covenants or, in the absence
of such  compliance,  if the Company fails to amend such financial  covenants on
terms  favorable  to the  Company,  the  Company  may be in  default  under such
covenants.  If such default occurred,  it would permit  acceleration of its debt
under the Exit Financing  Agreement which, in turn, would permit acceleration of
substantially all of the Company's other long-term debt.

Forward-Looking Statements
--------------------------

Statements  above in the  subsections  entitled  "Costs and  Expenses,"  "Future
Operating  Results,"  and "The Year 2000 Issue," and in this  subsection of this
Annual Report such as "unlikely",  "intend",  "estimated",  "believe", "expect",
"anticipate"   and   similar   expressions   which   are  not   historical   are
forward-looking statements that involve risks and uncertainties. Such statements
include, without limitation, the Company's expectation as to future performance.

Such forward-looking  statements are made pursuant to the safe harbor provisions
of the  Private  Securities  Litigation  Reform Act of 1995.  There are  certain
important  factors  that could  cause  results to differ  materially  from those
anticipated  by  the  forward-looking   statements  made  above.  Investors  are
cautioned that all  forward-looking  statements  involve risks and  uncertainty.
Among the factors that could cause actual  results to differ  materially are the
following:  sales levels;  competitor activities;  stability of the sales force;
supplier  support;  consumer spending and debt levels;  interest rates;  housing
activity,  including  existing home turnover and new home  construction;  lumber
prices;  product mix; growth of certain market segments; and an excess of retail
space  devoted  to  the  sale  of  building  materials.  Additional  information
concerning these and other factors is contained in the Company's  Securities and
Exchange Commission filings,  including but not limited to the Form 10-K, copies
of which are available  from the Company  without charge or on the Company's web
site, payless.cashways.com.


<PAGE>14


Payless Cashways, Inc.

STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>

                                                                                          Predecessor Company
                                                                       --------------------------------------------------------
                                                                                           Fiscal Year Ended
                                                                       --------------------------------------------------------
                                                                        November 29,         November 30,         November 25,
In thousands, except per share amounts                                      1997                 1996                 1995
-------------------------------------------------------------------------------------------------------------------------------
<S>                                                                    <C>                   <C>                  <C>
Income
     Net sales                                                         $    2,285,281        $   2,642,829        $   2,680,186
     Other income--Note C                                                       4,934                8,076                5,484
                                                                       --------------------------------------------------------
                                                                            2,290,215            2,650,905            2,685,670
Costs and expenses
     Cost of merchandise sold                                               1,676,658            1,906,734            1,912,620
     Selling, general and
         administrative--Notes G, H and I                                     558,817              615,466              619,589
     Reorganization items--Note J                                              25,455                   --                   --
     Fresh-start revaluation--Note B                                          355,559                   --                   --
     Special charges--Note L                                                   13,056                8,184              153,667
     Asset impairment charges--Note K                                          60,483               59,697                   --
     Provision for depreciation and amortization                               51,110               55,016               60,356
     Interest expense (contractual interest of
         $66,973 in 1997)--Note D                                              61,251               60,488               61,067
     Interest income--Note F                                                       --               (4,900)                  --
                                                                       --------------------------------------------------------
                                                                            2,802,389            2,700,685            2,807,299
                                                                       --------------------------------------------------------

                                       LOSS BEFORE INCOME TAXES              (512,174)             (49,780)            (121,629)

Federal and state income taxes--Note F                                        (90,406)             (30,702)              (4,911)
                                                                       ---------------------------------------------------------

Loss before equity in loss of joint venture
   and extraordinary items                                                   (421,768)             (19,078)            (116,718)

Equity in loss of joint venture--Note C                                            --                   --              (11,831)
                                                                        --------------------------------------------------------

Loss before extraordinary item                                               (421,768)             (19,078)            (128,549)

Extraordinary items, net of income taxes--Notes B and D                       133,176                   --                   --
                                                                       --------------------------------------------------------

                                                       NET LOSS        $     (288,592)       $     (19,078)       $    (128,549)
                                                                       =========================================================


See notes to financial statements
</TABLE>



<PAGE>15


Payless Cashways, Inc.

BALANCE SHEETS
<TABLE>
<CAPTION>
                                                                                        Reorganized      |    Predecessor
                                                                                          Company        |      Company
                                                                                     ---------------     |  -------------
                                                                                       November 29,      |   November 30,
In thousands                                                                               1997          |       1996
-------------------------------------------------------------------------------------------------------------------------
<S>                                                                                   <C>                   <C>  
ASSETS                                                                                                   |
                                                                                                         |
     CURRENT ASSETS                                                                                      |
         Cash and cash equivalents                                                    $     11,961       |  $        425
         Merchandise inventories--Notes C and D                                            414,882       |       399,010
         Prepaid expenses and other current assets                                          14,705       |        22,281
         Income taxes receivable--Note F                                                    32,232       |        15,200
         Deferred income taxes--Note F                                                       8,665       |        13,681
                                                                                      -----------------------------------
                                             TOTAL CURRENT ASSETS                          482,445       |       450,597
                                                                                                         |
                                                                                                         |
     OTHER ASSETS                                                                                        |
         Real estate held for sale--Note K                                                  48,562       |        18,529
         Cost in excess of net assets acquired,                                                          |
           less accumulated amortization of                                                              |
           $105,198 in 1996--Notes C, K and L                                                   --       |       292,946
         Deferred financing costs--Notes C and D                                             2,600       |        12,837
         Other                                                                              14,316       |        12,917
                                                                                                         |
                                                                                                         |
     LAND, BUILDINGS AND EQUIPMENT--Notes C and D                                                        |
         Land and land improvements                                                         98,390       |       179,633
         Buildings                                                                         219,244       |       476,144
         Equipment                                                                          35,048       |        98,304
         Automobiles and trucks                                                              2,196       |        24,264
         Construction in progress                                                            8,540       |         4,590
         Allowance for depreciation and amortization                                            --       |      (277,643)
                                                                                      -----------------------------------
                              TOTAL LAND, BUILDINGS AND EQUIPMENT                          363,418       |       505,292
                                                                                      -----------------------------------
                                                                                      $    911,341       |  $  1,293,118
                                                                                      ===================================

See notes to financial statements
</TABLE>



<PAGE>16


Payless Cashways, Inc.

BALANCE SHEETS (cont'd.)
<TABLE>
<CAPTION>
                                                                                        Reorganized      |    Predecessor
                                                                                          Company        |      Company
                                                                                      --------------     |  --------------
                                                                                       November 29,      |   November 30,
In thousands                                                                               1997          |       1996
--------------------------------------------------------------------------------------------------------------------------
<S>                                                                                   <C>                   <C>
                                                                                                         |
LIABILITIES AND STOCKHOLDERS' EQUITY                                                                     |
                                                                                                         |
     CURRENT LIABILITIES                                                                                 |
         Current portion of long-term debt--Note D                                    $      9,354       |  $     18,340
         Trade accounts payable                                                             75,583       |       121,891
         Salaries, wages and bonuses                                                        29,051       |        31,052
         Accrued interest                                                                      213       |         3,193
         Insurance reserves                                                                  1,500       |        25,713
         Future store lease payments--Note K                                                    --       |        17,460
         Other accrued expense--Notes G, K and L                                            84,978       |        71,182
         Taxes, other than income taxes                                                     20,999       |        24,318
         Income taxes payable--Note F                                                        2,362       |         6,444
                                                                                      -----------------------------------
                                                 TOTAL CURRENT LIABILITIES                 224,040       |       319,593
                                                                                                         |
                                                                                                         |
     LONG-TERM DEBT, less portion classified as current                                                  |
         liability--Note D                                                                 424,031       |       618,667
                                                                                                         |
     NON-CURRENT LIABILITIES                                                                     |
         Deferred income taxes--Note F                                                      58,788       |        41,665
         Other--Note H                                                                      20,682       |        23,462
                                                                                                         |
     STOCKHOLDERS' EQUITY--Notes A, C, D and E                                                           |
         Common Stock, $.01 par value, 50,000,000 shares authorized,                                     |
           20,000,000 shares issued in 1997                                                    200       |            --
         Preferred Stock, $1.00 par value, 25,000,000                                                    |
           shares authorized:                                                                            |
              Cumulative Preferred Stock, 406,000 shares issued                                          |
                and $78,563 aggregate liquidation preference in 1996                            --       |        40,600
         Common Stock, $.01 par value:                                                                   |
           Voting, 150,000,000 shares authorized,                                                        |
              37,709,028 shares issued in 1996                                                  --       |           377
           Non-Voting Class A, 5,000,000 shares authorized,                                              |
              2,250,000 shares issued in 1996                                                   --       |            23
         Additional paid-in capital                                                        183,600       |       487,728
         Accumulated deficit                                                                    --       |      (238,997)
                                                                                      -----------------------------------
                                                TOTAL STOCKHOLDERS' EQUITY                 183,800       |       289,731
                                                                                      -----------------------------------
     COMMITMENTS AND CONTINGENCIES--Notes G, H, I and M                                                  |
                                                                                      $    911,341       |  $  1,293,118
                                                                                      ===================================

See notes to financial statements
</TABLE>



<PAGE>17


Payless Cashways, Inc.

STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>

                                                                                           Predecessor Company
                                                                         -------------------------------------------------------
                                                                                            Fiscal Year Ended
                                                                         -------------------------------------------------------
                                                                          November 29,         November 30,        November 25,
In thousands                                                                  1997                 1996                1995
--------------------------------------------------------------------------------------------------------------------------------
<S>                                                                      <C>                   <C>                 <C>
Cash Flows from Operating Activities
      Net loss                                                           $   (288,592)         $    (19,078)       $   (128,549)
      Adjustments to reconcile net loss
          to net cash provided by operating activities:
        Depreciation and amortization                                          51,110                55,016              60,356
        Asset impairment charges--Note K                                       60,483                59,697                  --
        Deferred income taxes                                                 (72,237)              (12,270)            (22,326)
        Non-cash reorganization items--Note J                                   2,481                    --                  --
        Non-cash interest                                                       5,031                 2,534               2,351
        Non-cash extraordinary items--Notes B and D                          (133,176)                   --                  --
        Fresh-start revaluation--Notes A and B                                355,559                    --                  --
        Equity in loss of joint venture--Note C                                    --                    --              11,831
        Special charges--Note L                                                13,056                 8,184             153,667
        Other                                                                  (1,467)                1,337                 927
      Changes in assets and liabilities:
        Decrease in trade receivables                                              --                    --               5,858
        Decrease (increase) in merchandise inventories                          7,462                (6,406)              4,062
        Decrease (increase) in prepaid expenses
             and other current assets                                           6,926                (4,763)              9,532
        Increase in income taxes receivable                                   (14,505)              (15,200)                 --
        (Decrease) increase in trade accounts payable                          44,252               (37,953)              8,785
        Increase in other current liabilities                                  (4,359)                1,349               1,934
                                                                         -------------------------------------------------------
    NET CASH PROVIDED BY OPERATING ACTIVITIES                                  32,024                32,447             108,428

Cash Flows from Investing Activities
      Additions to land, buildings and equipment                              (61,925)              (40,117)            (67,281)
      Proceeds from sale of land, buildings and equipment                      18,775                14,709                 467
      Acquisition of business, excluding working capital:
        Land, buildings and equipment                                              --                  (193)                 --
        Purchase price in excess of net assets acquired                        (1,015)               (1,360)                 --
      Investment in joint venture--Note C                                          --                    --              (9,254)
      Decrease (increase) in other assets                                      (1,745)                1,435               3,049
                                                                         -------------------------------------------------------
    NET CASH USED IN INVESTING ACTIVITIES                                     (45,910)              (25,526)            (73,019)

Cash Flows from Financing Activities
      Net proceeds from revolving credit facility--Note D                      62,386                28,000                  --
      Principal payments on long-term debt--Note D                            (32,795)              (31,092)            (34,301)
      Fees and financing costs paid in connection with debt
        refinancing--Note D                                                    (3,365)               (3,670)             (1,267)
      Sale of Common Stock under stock option plan                                 --                    94                  16
      Other                                                                      (804)                 (788)             (1,577)
                                                                         -------------------------------------------------------
    NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                        25,422                (7,456)            (37,129)
                                                                         -------------------------------------------------------

Net increase (decrease) in cash and cash equivalents                           11,536                  (535)             (1,720)
Cash and cash equivalents, beginning of period                                    425                   960               2,680
                                                                         -------------------------------------------------------
Cash and cash equivalents, end of period                                 $     11,961          $        425        $        960
                                                                         =======================================================

See notes to financial statements
</TABLE>



<PAGE>18


Payless Cashways, Inc.

STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
                                            Preferred        Common    Additional   Foreign    Adjustment for
                                              Stock          Stock      Paid-in    Currency   Minimum Pension   Accumulated
In thousands                             $1.00 Par Value $.01 Par Value  Capital  Translation   Liability        Deficit     Total
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>           <C>          <C>         <C>         <C>           <C>          <C>
Balance at November 26, 1994                $  40,600     $    399     $ 486,326   $   (90)    $      --     $   (91,370) $ 435,865

   Net loss for the year                                                                                        (128,549)  (128,549)
   Sale of Voting Common Stock under
     stock option plan                                          --            77                                                 77
   Tax benefit from stock option
      exercises--Note F                                                      325                                                325
   Restricted Stock--Note E                                     --           355                                                355
   Foreign currency translation adjustment                                          (2,499)                                  (2,499)
   Sale of joint venture stock                                                       2,589                                    2,589
                                            ---------------------------------------------------------------------------------------

Balance at November 25, 1995                $  40,600     $    399     $ 487,083   $    --     $      --     $  (219,919) $ 308,163

   Net loss for the year                                                                                         (19,078)   (19,078)
   Sale of Voting Common Stock under
     stock option plan                                           1           463                                                464
   Tax benefit from stock option
     exercises--Note F                                                       (24)                                               (24)
   Restricted Stock--Note E                                     --           206                                                206
                                            ---------------------------------------------------------------------------------------

Balance at November 30, 1996                $  40,600     $    400     $ 487,728   $    --     $      --     $  (238,997) $ 289,731

   Net loss for the year                                                                                        (288,592)  (288,592)
   Restricted Stock--Note E                                     --           131                                                131
   Issuance of Voting Common Stock
     under Director Deferred
     Compensation Plan                                          --            17                                                 17
   Conversion of Non-Voting Class A
     Common Stock to Voting Common
     Stock--Note E                                              --                                                               --
   Minimum pension liability
     adjustment--Note G                                                                           (1,287)                    (1,287)
   Eliminate predecessor equity accounts
     in connection with fresh start
     reporting--Note B                        (40,600)        (400)     (487,876)                  1,287         527,589         --
   Issuance of New Common
     Stock pursuant to Plan of
     Reorganization--Notes A, B and E                          200       183,600                                            183,800
                                            ---------------------------------------------------------------------------------------

Balance at November 29, 1997                $      --     $    200     $ 183,600   $    --     $      --     $        --  $ 183,800


See notes to financial statements
</TABLE>



<PAGE>19


Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS


Note A-Reorganization and Emergence From Chapter 11

On July 21, 1997 (the "Petition  Date"),  the Company commenced a reorganization
case (the "Case") by filing a voluntary  petition  for relief under  Chapter 11,
Title 11 of the United States Code ("Chapter 11") in the U.S.  Bankruptcy  Court
for the Western District of Missouri in Kansas City (the "Court").

While the Company had sufficient  liquidity to fund its current operations,  the
operating  performance  of the Company during the second quarter of fiscal 1997,
which was well below the Company's expectations, led management to conclude that
it was  unlikely  that the Company  would be able to comply  with the  covenants
contained in its principal  credit  agreements at the end of fiscal 1997. In the
course of the  Company's  subsequent  negotiations  with its  senior  lenders to
restructure  its debt, and after  considering  all other  alternatives  with its
financial  adviser,  Houlihan  Lokey Howard & Zukin,  including  the sale of the
Company and  liquidation,  the Company  concluded  that a Chapter 11  proceeding
provided the best approach for a comprehensive  financial  restructuring  of the
Company.

On the Petition  Date,  the Company  filed a Disclosure  Statement and a Plan of
Reorganization  with the  Court.  The  Disclosure  Statement  and the Plan  were
subsequently  amended on September 5, 1997, and modified on October 9, 1997. The
Plan of  Reorganization,  as amended and modified,  is referred to herein as the
"Plan" or "Plan of  Reorganization."  The  following  summary  of the Plan omits
certain  information  set forth in the Plan.  Any  statements  contained  herein
concerning  the Plan are not  necessarily  complete,  and in each such  instance
reference is made to the Plan.  On November 19, 1997,  the Court  confirmed  the
Plan and  after the  satisfaction  of a number of  conditions,  the Plan  became
effective December 2, 1997 (the "Effective Date").

Under the  Plan,  the  Company  reincorporated  as a  Delaware  corporation  and
canceled   outstanding   shares  of  common  and  preferred   stock  and  issued
approximately 20,000,000 shares of newly reorganized Payless Cashways, Inc. (the
"Reorganized  Company")  common  stock (the "New Common  Stock"),  as  described
below.

The Plan generally provided for the following:  (I) The secured bank group under
the existing credit agreement (the "Amended Credit  Agreement"),  on or prior to
the Effective Date, received (a) payment of accrued interest, fees and expenses,
(b) Net Cash  Proceeds  (as  defined  in the  Plan)  from  the  sale of  certain
collateral  securing the Amended Credit  Agreement and the collection of certain
promissory notes pledged to the secured bank group, (c) their allocable  portion
of $283.1  million  of new term  loans and (d)  10,730,671  shares of New Common
Stock  (approximately  54% of the shares of the newly reorganized  Company),  of
which 460,000 shares were  distributed  to the lenders  providing a $150 million
revolving credit facility to supply post-emergence  working capital financing in
consideration  for their  commitment to provide such facility.  See Note D for a
description of the term loans and the revolving credit facility  (together,  the
"Exit Financing  Agreement").  (II) On the Effective Date, UBS Mortgage Finance,
Inc. ("UBS"), the holders of notes under an existing mortgage loan, received new
notes  pursuant to a new mortgage  loan. See Note D for a description of the new
mortgage  loan.  (III)  Unsecured  claims  against  the  Company by vendors  and
suppliers for goods delivered and services  rendered prior to the Petition Date,
claims  in  respect  of  the  9-1/8%  senior  subordinated   notes,   contingent
unliquidated  claims and claims for damage  arising  from the  rejection  by the
Company  pursuant to Section 365 of the Bankruptcy  Code of executory  contracts
and unexpired leases  (collectively,  "General  Unsecured  Claims") will receive
their pro rata share of 8,269,329  shares of New Common  Stock or  approximately
41% of the shares of the newly reorganized Company. Holders of General Unsecured
Claims  began   receiving   their  first   distribution  of  shares  in  partial
satisfaction  and  discharge of their  allowed  claims on or about  December 15,
1997. The remaining shares of New Common Stock are held for future distributions
to holders of General Unsecured Claims, pending the final resolution of disputed
claims.  (IV) The holder of issued and outstanding  shares of existing preferred
stock  ("Old  Preferred  Stock")  received  600,000  shares of New Common  Stock
(approximately 3% of the shares of the newly reorganized  Company).  (V) Holders
of issued and  outstanding  shares of existing common stock ("Old Common Stock")
will  receive  their  pro rata  share of  400,000  shares  of New  Common  Stock
(approximately 2% of the shares of the newly reorganized Company) upon surrender
of  their  Old  Common  Stock.  In  addition,  any  stock  options  relating  to
outstanding  Old  Preferred  Stock and Old  Common  Stock were  canceled  on the
Effective Date.

Fractional  shares  of New  Common  Stock  will not be issued  to  creditors  or
stockholders in connection  with the Plan. In addition,  no distribution of less
than $5.00 will be made for  fractional  share  interests.  As a result of these
provisions,  many holders of Old Common Stock will  receive no  distribution  of
stock or cash under the Plan.

On July 21, 1997,  the Company also announced its plan to close 29 stores and to
eliminate  approximately  15% of the  staff at the  Company's  headquarters  and
regional  administrative  centers. The Court subsequently  approved such plan on
August 6, 1997.

See Notes J, K, and L for a description of related charges recorded in the third
quarter of 1997.


<PAGE>20


Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS (cont'd.)


Note B-Fresh Start Reporting

On December 2, 1997, the Company emerged from bankruptcy. In accordance with the
American Institute of Certified Public  Accountants'  Statement of Position 90-7
("SOP  90-7"),  "Financial  Reporting  by Entities in  Reorganization  Under the
Bankruptcy  Code," the Company  adopted  fresh-start  reporting.  For accounting
purposes, the Effective Date was deemed to be November 29, 1997.

In fresh-start  reporting,  an aggregate value of $183.8 million was assigned to
the  Company's  New Common  Stock.  Management  established  this value with the
assistance of its financial  advisors.  This valuation  considered the Company's
expected future  performance,  relevant  industry and economic  conditions,  and
analyses and comparisons with comparable companies.

The  reorganization  value of the Company has been allocated to the  Reorganized
Company's  assets and  liabilities in a manner similar to the purchase method of
accounting  for a business  combination.  Management  obtained  valuations  from
independent third parties which, along with other market and related information
and analyses, were utilized in assigning fair values to assets and liabilities.

A summary of the impact of the Plan and the related  fresh-start  adjustments is
presented below:
<TABLE>
<CAPTION>
                                                                               November 29, 1997
                                         ------------------------------------------------------------------------------------------
                                             Predecessor       Discharge of       Fresh-Start            Other          Reorganized
                                               Company       Indebtedness (a)   Adjustments (b)     Adjustments (c)       Company
                                         -----------------  ----------------  ------------------  -----------------  --------------
<S>                                      <C>                <C>               <C>                 <C>                <C>
Current Assets:
    Cash and cash equivalents            $     11,961       $                 $                   $                  $     11,961
    Merchandise inventories                   391,548                                 23,334                              414,882
    Prepaid expenses and
       other current assets                    15,702                                   (997)                              14,705
    Income taxes receivable                    29,705              2,527                                                   32,232
    Deferred income taxes                      24,070             (9,448)             (5,957)                               8,665
                                         -----------------  ----------------  ------------------  -----------------  --------------
       Total Current Assets                   472,986             (6,921)             16,380                --            482,445

Other Assets:
    Real estate held for sale                  37,078                                 11,484                               48,562
    Cost in excess of net
       assets acquired                        265,949                               (265,949)                                  --
    Deferred financing costs                    8,690             (7,590)              1,500                                2,600
    Other                                      14,663                                   (347)                              14,316

Land, Buildings and Equipment, net            456,736                                (93,318)                             363,418
                                         -----------------  ----------------  ------------------  -----------------  --------------
    TOTAL ASSETS                         $  1,256,102       $    (14,511)     $     (330,250)     $         --       $    911,341
                                         =================  ================  ==================  =================  ==============
</TABLE>


<PAGE>21


Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS (cont'd.)
<TABLE>
<CAPTION>
                                                                               November 29, 1997
                                       --------------------------------------------------------------------------------------------
                                             Predecessor       Discharge of       Fresh-Start            Other          Reorganized
                                               Company       Indebtedness (a)   Adjustments (b)     Adjustments (c)       Company
                                       -------------------  ----------------  ------------------  -----------------  --------------
<S>                                    <C>                  <C>               <C>                 <C>                <C>
Current Liabilities:
    Current portion of long-term debt  $     492,930        $                 $     (483,576)     $                  $      9,354
    Trade accounts payable                    54,203              21,380                                                   75,583
    Other current liabilities                128,755                                   7,986                              136,741
    Income taxes payable                       8,711                                  (6,349)                               2,362
                                       -------------------  ----------------  ------------------  -----------------  --------------
       Total Current Liabilities             684,599              21,380            (481,939)               --            224,040

Long-Term Debt                                    --                                 424,031                              424,031

Non-Current Liabilities:
    Deferred income taxes                     16,961              84,928             (43,101)                              58,788
    Other                                     24,272                                  (3,590)                              20,682
                                       -------------------  ----------------  ------------------  -----------------  --------------
       Total Non-Current Liabilities          41,233              84,928             (46,691)               --             79,470

Liabilities Subject to Compromise            351,381            (329,990)            (21,391)                                  --

Stockholders' Equity:
    Old Preferred Stock                       40,600                                                   (40,600)                --
    Old Common Stock                             400                                                      (400)                --
    New Common Stock                              --                  83                 117                                  200
    Additional paid-in capital               487,876              75,912             107,688          (487,876)           183,600
    Adjustment for minimum pension
       liability                              (1,287)                                                    1,287                 --
    Accumulated deficit                     (348,700)            133,176            (312,065)          527,589                 --
                                       -------------------  ----------------  ------------------  -----------------  --------------
       Total Stockholders' Equity            178,889             209,171            (204,260)               --            183,800
                                       -------------------  ----------------  ------------------  -----------------  --------------

    TOTAL LIABILITIES AND
       STOCKHOLDERS' EQUITY            $   1,256,102        $    (14,511)     $     (330,250)     $         --       $    911,341
                                       ===================  ================  ==================  =================  ==============
</TABLE>

(a)  To  record  the  discharge  of  indebtedness  pursuant  to the  Plan and to
     write-off deferred  financing costs related to the early  extinguishment of
     certain predecessor company debt; see Note D. The discharge of indebtedness
     relates  to all  general  unsecured  claims,  as  described  in  Note A. It
     includes the elimination and, in certain cases, the reclassification of the
     liabilities  subject to compromise related to these claims, the issuance of
     New Common Stock in  settlement  of unsecured  claims,  and the related tax
     effect of these  transactions.  The excess of indebtedness  eliminated over
     the estimated  fair value of  securities  issued in settlement of claims is
     reflected as an extraordinary  gain of $232.6 million ($138.2 million after
     tax) in the accompanying 1997 statement of operations.

(b)  To record transactions with the secured creditors and holders of Old Common
     Stock and Old Preferred Stock, as described at Note A, and to adjust assets
     and liabilities to fair values.

     Transactions  include the  extinguishment  of old debt; the issuance of new
     debt and New Common  Stock;  the  reclassification  of accrued  interest to
     principal and the reclassification of debt between current and non-current,
     based upon debt agreement terms.

     Significant   elements  of  the  fair  value   adjustments  to  assets  and
     liabilities are summarized below:

       --Adjustment to reflect  inventories at current market value
       --Adjustments to write-up real estate held for sale to fair market value
       --Adjustment to eliminate cost in excess of net assets acquired
       --Adjustments to eliminate  accumulated  depreciation  and to write-down
         land,  buildings,  and equipment to fair market value  Adjustments  to
         reflect  liabilities at fair market value  including:  the reversal of
         unrecognized prior service costs and unrecognized gains and losses on
         the Company's pension and post-retirement  benefit  plans (see also
         Notes G and H); the write-off of deferred rent liabilities due to lease
         amendments and  terminations; and the elimination of insurance accruals
         covered by bank letters of credit
       --Adjustments to deferred and currently payable tax accounts to record 
         the tax effect of all fresh-start reporting adjustments


<PAGE>22


Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS (cont'd.)


         Fresh-start  adjustments of $355.6 million  ($312.1 million net of tax)
         are reflected  as fresh-start  revaluation charges in the  accompanying
         1997 statement of operations.

(c)  To record the elimination of the Old Preferred Stock, Old Common Stock, and
     predecessor  company  additional  paid-in-capital  and accumulated  deficit
     after reflecting the adjustments at (a) and (b) above.


Note C-Summary of Significant Accounting Policies

Fresh-Start  Reporting:  The Company has implemented the required accounting for
entities  emerging from Chapter 11 in accordance with SOP 90-7 and reflected the
effects of such  adoption in the balance  sheet as of November 29,  1997.  Under
fresh-start  reporting,  the balance  sheet of  November  29,  1997,  became the
opening balance sheet of the Reorganized  Company.  The financial  statements of
the Predecessor Company are not comparable in material respects to the financial
statements of the Reorganized Company.  Accordingly, a vertical line is shown to
separate  financial  information of the Predecessor  Company and the Reorganized
Company.

Principles of Consolidation:  During fiscal 1996,  Payless  Cashways,  Inc. (the
"Company")  merged its wholly owned  subsidiary into the Company.  The financial
statements prior to fiscal 1996 include the accounts of Payless  Cashways,  Inc.
and its wholly owned subsidiary.  All significant intercompany  transactions and
balances have been eliminated in the accompanying  financial statements prior to
fiscal 1996.

The Company was a 49%  investor in Total Home de Mexico,  S.A. de C.V.,  a joint
venture with a Mexican company,  Alfa, S.A. de C.V. ("Alfa"),  until October 24,
1995. At that time,  the Company sold its ownership  interest to an affiliate of
Alfa and an $8.0 million loss on the sale has been reflected in the accompanying
1995 statements of operations as equity in loss of joint venture.
The Company had accounted for this investment on the equity method.

Description   of  Business:   The  Company  is  engaged  in  only  one  line  of
business--the  retail sale of building  materials and supplies.  At November 29,
1997,  the  Company  operated  164 stores in 20 states  located in the  Midwest,
Southwest,  Pacific Coast,  Rocky Mountain and New England areas.  The Company's
primary customers include professionals and project-oriented  do-it-yourselfers.
In recent  years,  the building  materials  retailing  industry has  experienced
increased  levels of competition as several  national chains have expanded their
operations.

Use of Estimates and Other Uncertainties:  In preparing the financial statements
in conformity with generally accepted accounting principles, management has made
estimates  and  assumptions  that  affect  the  reported  amounts  of assets and
liabilities at the date of the financial  statements and the reported amounts of
revenues and expenses during the reporting  period.  Actual results could differ
from those estimates.

The Company's future results could be adversely affected by a number of factors,
including:  competitive  pressure  on sales and  pricing  from  well-capitalized
warehouse-format  home centers; the Company's ability to effectively execute its
business  strategy;  weather  conditions;  consumer  spending  and debt  levels;
interest rates; housing activity,  including existing-home turnover and new-home
construction;  lumber  prices;  product mix; sales of real estate held for sale;
and growth of certain market segments.

Merchandise   Inventories:   Inventories   are  stated  at  the  lower  of  cost
(approximately 80% at last-in,  first-out method, and the remainder at first-in,
first-out  method) or market.  Had the first-in,  first-out method been used for
all inventories,  the carrying value of these  inventories  would have increased
approximately  $24.3  million at  November  30,  1996.  At  November  29,  1997,
inventories  were  reflected  using  the  first-in,   first-out  method  due  to
revaluation to fair market value related to fresh-start  accounting as described
at Note B. During  fiscal 1997 and 1996,  the  liquidation  of LIFO  inventories
decreased cost of  merchandise  sold and,  therefore,  decreased the loss before
income taxes by $0.9 million and $1.2 million, respectively.

Property and  Depreciation:  Provisions for  depreciation of land  improvements,
buildings and equipment are computed primarily by the straight-line  method over
the  estimated  useful  lives of the assets or the terms of the related  leases,
which range from three to 39 years.

The  accompanying  1996  statements of operations  reflect $2.3 million as other
income  related to an insurance  reimbursement  for lost profits and  settlement
proceeds in excess of net book value for buildings and equipment  destroyed in a
fire loss.


<PAGE>23


Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS (cont'd.)


Deferred Financing Costs:  Deferred financing costs are being amortized over the
respective borrowing terms using the interest method.

Foreign Currency Translation: Prior to the sale of the investment on October 24,
1995,  adjustments  resulting from the currency translation of the Mexican joint
venture financial statements into U.S. dollars as of the balance sheet date were
reflected as a separate component of stockholders' equity.

Cost in  Excess  of Net  Assets  Acquired:  Prior to  fresh-start  reporting  at
November 29, 1997,  the cost in excess of the fair value of net assets  acquired
(goodwill)  was amortized  using the  straight-line  method over 40 years.  When
facts and circumstances  indicates potential  impairment,  the Company evaluates
the  recoverability  of asset carrying values,  including  associated  goodwill,
using  estimates of  undiscounted  future cash flows over remaining asset lives.
When  impairment is indicated,  any impairment loss is measured by the excess of
carrying  values over fair values.  The Company  adopted  Statement of Financial
Accounting  Standards  No. 121,  "Accounting  for the  Impairment  of Long-Lived
Assets and for  Long-Lived  Assets to Be Disposed  Of," in the third  quarter of
fiscal 1996. See Note K.

Net Loss Per Common  Share:  Net loss per common share has not been computed for
the Predecessor Company because, as described at Note A, Old Preferred Stock and
Old Common Stock were canceled on the Plan Effective  Date.  Presentation of net
loss per common share based on Predecessor  Company  average shares  outstanding
would therefore not be meaningful.  New Common Stock was not outstanding  during
fiscal years 1997, 1996 and 1995.

Income  Taxes:  The Company  accounts  for income  taxes based on  Statement  of
Financial  Accounting  Standards  No. 109 ("SFAS 109"),  "Accounting  for Income
Taxes."  Under the asset and liability  method of SFAS 109,  deferred tax assets
and liabilities are recognized for the future tax  consequences  attributable to
differences  between the financial statement carrying amounts of existing assets
and  liabilities  and their  respective  tax  bases.  Deferred  tax  assets  and
liabilities  are measured  using enacted tax rates applied to taxable  income in
the years in which those  temporary  differences are expected to be recovered or
settled.  Under SFAS 109, the effect on deferred tax assets and liabilities of a
change in tax rates is  recognized  in income in the period  that  includes  the
enactment date.

Statement  of Cash Flows:  For  purposes  of the  statement  of cash flows,  the
Company  considers  investments in debt instruments with original  maturities of
three months or less to be cash equivalents.

During  fiscal  1997 and 1996,  federal  and state  income tax  refunds,  net of
payments,  were $0.6 million and $8.8 million,  respectively,  and during fiscal
1995 federal and state income taxes paid, net of refunds, were $21.0 million.

Cash paid for interest,  net of interest capitalized,  was $55.4 million,  $62.2
million, and $60.0 million during fiscal 1997, 1996, and 1995, respectively.

Sale of  Receivables:  The Company  sells its  commercial  credit  accounts to a
third-party administrator pursuant to an agreement. A substantial portion of the
Company's  commercial credit sales are to remodelers and contractors.  Under the
agreement,  the Company  pays a servicing  fee and assumes the credit  risk.  At
November 29, 1997, and November 30, 1996, the outstanding  balance of commercial
credit accounts sold to the third-party  administrator was  approximately  $87.5
million and $104.7 million,  respectively. The Company has provided a reserve of
$5.9 million at November 29, 1997, and $5.7 million at November 30, 1996,  which
is believed to adequately cover its credit risk related to these accounts.

Under  a  third-party  administrative  servicing  agreement  for  the  Company's
private-label  charge  card  program,  charge  card  accounts  are  sold  to the
administrator and the Company assumes no credit risk.

Real Estate Held for Sale:  Real estate held for sale,  consisting  primarily of
closed store  facilities,  is  reflected  at the lower of cost less  accumulated
depreciation or estimated fair value less cost to sell.

Advertising Costs: Advertising costs, which are expensed as incurred, aggregated
$27.5 million,  $26.0 million and $31.6 million for fiscal 1997,  1996 and 1995,
respectively.

<PAGE>24


Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS (cont'd.)


Fair Value of Financial  Instruments:  Based on the  borrowing  rates  currently
available to the Company for debt issuances  with similar terms and  maturities,
the fair value of long-term debt including the current portion is  approximately
$433.4  million and $564  million at November  29, 1997 and  November  30, 1996,
respectively.  The  Company  believes  the  carrying  amounts  of cash  and cash
equivalents,  trade receivables, trade accounts payable and accrued expenses are
a reasonable estimate of their fair value.

Derivative Financial Instruments:  Premiums paid for purchased interest rate cap
agreements  are  amortized to interest  expense over the term of the  agreement.
Unamortized  premiums  are included in deferred  financing  costs in the balance
sheets.  If  amounts  were  received  under  the cap  agreement,  they  would be
reflected as a reduction of interest expense. Amounts received or paid under the
interest  rate  swap  agreement  discussed  at Note I have been  reflected  as a
reduction or increase of rent expense prior to fresh-start accounting.

At  November  29,  1997,  the  premiums  paid for  purchased  interest  rate cap
agreements were fully amortized. The estimated amount the Company would have had
to pay at November  29,  1997,  to cancel or transfer  the  agreements  to other
parties, was approximately $0.7 million.

Accounting  Period:  The  Company's  fiscal  year ends on the last  Saturday  in
November.  Fiscal years 1997 and 1995 consisted of 52 weeks each and fiscal year
1996 consisted of 53 weeks.

Note D--Long-Term Debt

Long-term debt consisted of the following:
<TABLE>
<CAPTION>

In thousands                                                                                1997              1996
                                                                                       -------------------------------
<S>                                                                                    <C>                 <C>
Exit Financing Agreement, secured by inventory,
   certain real estate, and equipment, variable interest
   rate, payable in varying amounts through 2002                                       $  317,133          $       --

Mortgage loan, secured by certain real estate, variable
   interest rate, payable in varying amounts through 2004                                 102,010                  --

Note payable, secured by certain real estate, variable
   interest rate, payable in 2002                                                          13,000                  --

Amended Credit Agreement, secured by inventory,
   certain real estate, and equipment, variable interest
   rate, payable in varying amounts through 2000                                               --             354,000

Mortgage loan, secured by certain real estate,
   11.04% to 11.21%, payable in varying amounts through 2003                                   --             108,000

Senior subordinated notes, 9-1/8%, due 2003                                                    --             173,655

Other senior debt, 11% to 12%, payable in varying
   amounts through 2004                                                                     1,242               1,352
                                                                                       -------------------------------
                                                                                          433,385             637,007
Less portion classified as current liability                                               (9,354)            (18,340)
                                                                                       -------------------------------
                                                                                       $  424,031          $  618,667
                                                                                       ==============================
</TABLE>
As a result of the  Chapter  11 filing on July 21,  1997,  borrowings  under the
revolving  credit  facility  of the  Amended  Credit  Agreement  were no  longer
available to the Company.  During the period from July 21, 1997 through December
2, 1997, the Company utilized debtor-in-possession  financing which consisted of
a $125 million revolving credit facility (the "DIP Agreement").

As described at Note A, on or prior to the Effective Date, December 2, 1997, the
Company paid all amounts  outstanding  under the DIP  Agreement  and the Amended
Credit  Agreement  with  cash,  New  Common  Stock and new notes  under the Exit
Financing Agreement.  The Exit Financing Agreement includes term loans of $283.1
million and a $150 million revolving credit facility with


<PAGE>25

Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS (cont'd.)


a $40  million  letters of credit  sublimit.  At  December  2, 1997,  there were
combined borrowings under the agreement of $317.1 million as well as outstanding
standby letters of credit of $2.6 million and outstanding documentary letters of
credit of $6.6 million.  The Company had $106.8 million  available for borrowing
under this  agreement  at  December  2,  1997.  The term  loans  require  annual
principal  payments  of $3 million  beginning  September  15,  1998,  with final
maturity on November 30, 2002. The revolving  credit facility matures on May 31,
2002. In addition,  the Company will be required to repay  borrowings  under the
Exit Financing  Agreement with proceeds of certain  collateral sales and certain
other  transactions and with 65% of excess cash flow, as defined.  The effect of
these provisions is generally to require that  substantially  all cash flows not
applied to the repayment of other indebtedness or permitted capital expenditures
are to be  applied  to the  repayment  of  borrowings  under the Exit  Financing
Agreement.  The loans bear interest at fluctuating rates of either the alternate
base rate (8-1/2% at November 29, 1997) plus 1-1/2% per annum or LIBOR (5-11/16%
at December  2, 1997) plus 2-1/2% per annum.  The Exit  Financing  Agreement  is
secured by  substantially  all  merchandise  inventories,  certain  real  estate
including  second priority liens on all real estate pledged to other  creditors,
and substantially all the equipment of the Company.

The Exit Financing Agreement contains a number of covenants,  including, but not
limited to,  minimum  cash flow  (defined as earnings  before  interest,  taxes,
depreciation,  and amortization,  "EBITDA"), a maximum debt to EBITDA ratio, and
limitations on capital  expenditures and capitalized leases. The Company is also
prohibited  from  incurring  additional   indebtedness,   with  certain  limited
exceptions,  and making  dividend,  redemption and certain other payments on its
capital stock.  The Exit Financing  Agreement  also contains  certain  customary
financial covenants and events of default for financing of this type,  including
a change of control  covenant.  Compliance  with the  minimum  cash flow and the
maximum debt to EBITDA covenants is determined on a rolling-four-quarter  basis.
For the fiscal year ended November 29, 1997, actual EBITDA was $65.4 million and
the ratio of debt to EBITDA was 6.6 to 1. The  measurements for those covenants,
over the term of the Exit Financing Agreement, are as follows:
<TABLE>
<CAPTION>
                                                      Minimum Cash Flow          Maximum Debt to
                           Fiscal Quarter  Ending         (EBITDA)                   EBITDA
                           ----------------------     -----------------          ---------------
                           <S>                          <C>                        <C>

                           February 1998                 49,000,000                11.9 to 1
                           May 1998                      39,400,000                15.0 to 1
                           August 1998                   45,000,000                11.9 to 1
                           November 1998                 59,300,000                 7.2 to 1
                           February 1999                 62,400,000                 7.3 to 1
                           May 1999                      66,500,000                 6.9 to 1
                           August 1999                   70,600,000                 6.1 to 1
                           November 1999                 74,500,000                 5.6 to 1
                           February 2000                 78,800,000                 5.6 to 1
                           May 2000                      87,000,000                 4.9 to 1
                           August 2000                   95,700,000                 4.2 to 1
                           November 2000                101,000,000                 3.7 to 1
                           February 2001                103,000,000                 4.0 to 1
                           May 2001                     106,200,000                 3.9 to 1
                           August 2001                  109,100,000                 3.6 to 1
                           November 2001                113,400,000                 3.3 to 1
                           February 2002                113,700,000                 3.7 to 1
                           May 2002                     113,100,000                 3.7 to 1
                           August 2002                  115,800,000                 3.4 to 1
</TABLE>

Also  described at Note A, the  Company's  mortgage  loan and  interest  thereon
accrued through December 2, 1997, secured by certain real estate, was retired on
the  Effective  Date and replaced  with a new mortgage  loan secured by the same
real  estate.  This real  estate  had a net book value of  approximately  $227.3
million at November 29, 1997. The new mortgage loan bears interest at LIBOR plus
4% per annum and  interest  is paid  monthly.  Annual  principal  payments of $4
million are required beginning December 2, 1998, with final maturity on December
2, 2004.  Prepayments are required when collateral is sold and such  prepayments
are applied as a credit toward the  scheduled  annual  payment.  On December 22,
1995, the Company made a $16.5 million  prepayment on the previous mortgage loan
in connection with the sale of a distribution center described at Note L.

The early  extinguishment  of the Amended Credit  Agreement and the old mortgage
loan, both described above, resulted in an extraordinary charge of approximately
$5.0 million, net of tax, in the accompanying 1997 statement of operations.

On the  Effective  Date,  in  settlement  of the  secured  portion of the claims
arising from a lease  agreement  involving five store  facilities,  described at
Note I, the Company  issued a note for $16 million.  This note bears interest at
LIBOR plus 3-1/2% per annum,  is secured by three of the  formerly  leased store
facilities  having a net book value of  approximately  $13.7 million at November
29, 1997, and matures on June 2, 2002. The note contains  prepayment  provisions
that allow the Company to prepay the note by certain dates at various discounts.
At the Effective Date the Company obtained a commitment from the mortgage lender
to borrow an additional


<PAGE>26


Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS (cont'd.)


$13 million under the mortgage loan described  above, and the Company intends to
prepay this note in full.  Although this transaction has not been completed,  it
is expected to be consummated in the first half of fiscal 1998.

On April 20, 1993, the Company  issued senior  subordinated  notes.  These notes
were unsecured  obligations,  subordinated to substantially  all indebtedness of
the Company.  As described at Note A, on the  Effective  Date,  these notes were
terminated and canceled and holders of these notes received  treatment under the
Plan as unsecured creditors.

To reduce the impact of changes in  interest  rates with  regard to the  Amended
Credit Agreement, during 1995 the Company entered into an interest rate cap with
an affiliate of an investment  banking  firm,  limiting to 8% LIBOR the interest
rates on $100 million of its floating rate debt through January 20, 1998.  Under
the  agreement,  semiannual  payments,  if any,  would be received,  although no
amounts were received by the Company during fiscal years 1996 or 1997.

The Company  defeased  certain  industrial  revenue  bonds during fiscal 1988 by
placing  government  securities in an irrevocable trust. Such industrial revenue
bond debt is considered to be extinguished and does not appear as a liability in
the  accompanying  balance  sheets.  Bonds in the  amount  of $6.0  million  are
outstanding as of November 29, 1997.

Scheduled  maturities of long-term debt,  including  sinking fund  requirements,
are:


In thousands               1998              $      9,354
                           1999                    11,433
                           2000                    11,451
                           2001                    10,613
                           2002                   309,340
                           Thereafter              81,194
                                             ------------
                                             $    433,385
                                             ============


Note E--Stockholders' Equity

As discussed at Note A, the Company  canceled  existing  shares of Old Preferred
Stock and Old Common  Stock and issued  approximately  20,000,000  shares of New
Common Stock on or about the  Effective  Date.  The Company has the authority to
issue 50,000,000  shares of New Common Stock,  $.01 par value.  Each outstanding
share of New  Common  Stock is  entitled  to one  vote on each  matter  on which
stockholders are entitled to vote.

All classes of Old Common Stock were  substantially  identical except for voting
rights. Shares of Non-Voting Class A Common Stock were convertible at the option
of the holder, subject to certain restrictions,  into a like number of shares of
Voting  Common  Stock.  During  fiscal  1997,  2,250,000  outstanding  shares of
Non-Voting  Class A Common Stock were  converted into a like number of shares of
Voting  Common  Stock under this right of  conversion.  As  described at Note A,
holders  of Old  Common  Stock  received  approximately  2% of the shares of New
Common Stock issued under the Plan.

The Old  Preferred  Stock  was  100%  owned  by Masco  Capital  Corporation,  an
affiliate of one of the Company's suppliers.  As described at Note A, holders of
Old Preferred Stock received  approximately 3% of the shares of New Common Stock
issued  under  the Plan.  The  terms of the Old  Preferred  Stock  provided  for
dividends at an annual rate of 8% until 2008 (at which time the rate  increased)
on a cumulative basis, whether or not declared. At November 30, 1996, cumulative
undeclared  dividends  on the  Preferred  Stock were $38.0  million  ($93.50 per
share).  Each share of Preferred Stock was generally entitled to 5.9994 votes on
all matters on which holders of Common Stock were entitled to vote.

For the benefit of  non-employee  directors,  the Company had adopted a deferred
compensation  plan (the  "Director  Deferred Comp Plan") and an option plan (the
"Director  Option  Plan").  The  Director  Deferred  Comp  Plan  was  terminated
effective as of the Petition Date and options  outstanding and unexercised under
the Director Option Plan were canceled on the Effective Date.

In order to attract and retain outstanding individuals in certain key positions,
the Company had  established  the Payless  Cashways 1992 Incentive Stock Program
(the "Stock Program") and the 1988 Payless  Cashways,  Inc.  Employee Stock Plan
(the "Stock Plan").  Options  outstanding and  unexercised  under both the Stock
Program and the Stock Plan were  canceled on the Effective  Date.  Approximately
40,000  shares of  Restricted  Stock  outstanding  and unvested  under the Stock
Program vested on the Effective Date.


<PAGE>27


Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS (cont'd.)


Note F-Income Taxes

Income taxes for the year ended November 29, 1997, were allocated to loss before
extraordinary items, and to extraordinary items related to the discharge of debt
pursuant to the  consummation  of the Plan and for the early  extinguishment  of
debt;  see  Note  D.  The  income  tax  benefit  allocated  to the  loss  before
extraordinary  items was $90.4 million;  the income tax expense allocated to the
extraordinary  items was $91.8  million.  Included  in the  income  tax  benefit
allocated  to the loss  before  extraordinary  items are income tax  benefits of
$43.5 million resulting from the fresh-start revaluation; see Note B. The income
tax expense allocated to the extraordinary  items of $91.8 million was comprised
of $2.5 million current tax benefit related to the early  extinguishment of debt
and $94.3 million tax expense related to the discharge of debt which resulted in
deferred  tax  balance  changes  from the  write-down  of the tax basis of fixed
assets in  accordance  with the Internal  Revenue Code of 1986,  as amended.  At
November  29,  1997,  the  Company  has  state  income  tax net  operating  loss
carryforwards totaling $11.4 million available over varying periods from 5 to 15
years; net operating loss carryforwards for federal income tax purposes totaling
$6.1  million  expiring in 15 years;  and tax credit  carryforwards  for federal
income tax purposes totaling $13.0 million available over an indefinite period.

For the year ended November 30, 1996, an income tax benefit of $30.7 million was
recorded.  On August 20, 1996, the Small Business Job Protection Act of 1996 was
signed into law.  Certain  provisions  of this Act clarify the Tax Reform Act of
1986 and make retroactively tax deductible certain costs and expenses previously
recorded by the  Company  without any related  tax  benefit.  In  addition,  the
Company settled with the Internal Revenue Service  regarding several tax issues.
As a result, the Company has recorded a tax benefit of $23.7 million and related
interest income of $4.9 million ($2.9 million after tax) in the third quarter of
1996. This tax benefit  includes  recoverable  income taxes of $10.0 million and
non-cash tax benefits of $13.7 million. A debit of $24,000 to additional paid-in
capital  reflected  the tax effect of excess  expense  recognized  for financial
reporting purposes over the tax deduction for employee stock options.

For the year ended  November 25, 1995, an income tax benefit of $4.9 million was
allocated  to the loss  before  equity in loss of joint  venture.  No income tax
benefit was  recorded for the equity in loss of the joint  venture.  A credit of
$325,000 to additional  paid-in  capital  reflected the tax effect of the excess
tax  deduction  for  employee  stock  options  over the expense  recognized  for
financial reporting purposes.

Income tax expense (benefit)  attributable to the income (loss) before equity in
loss of joint venture and extraordinary item consisted of the following:
<TABLE>
<CAPTION>
In thousands
                                                      1997                    1996                 1995
                                                    -------------------------------------------------------
<S>                                                 <C>                   <C>                   <C>
Currently payable (receivable)
     Federal                                        $ (17,169)            $  (18,901)           $   14,915
     State                                             (1,000)                   469                 2,500
                                                    -------------------------------------------------------
                                                      (18,169)               (18,432)               17,415

Deferred
     Federal                                        $ (63,129)            $  (11,534)           $  (20,986)
     State                                             (9,108)                  (736)               (1,340)
                                                    -------------------------------------------------------
                                                      (72,237)               (12,270)              (22,326)
                                                    -------------------------------------------------------
                                                    $ (90,406)            $  (30,702)           $   (4,911)
                                                    =======================================================
</TABLE>


<PAGE>28


Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS (cont'd.)


The  differences  between  actual income tax expense and the amount  computed by
applying  the  statutory  federal  income tax rate to the income  (loss)  before
income  taxes,  equity in loss of joint venture and  extraordinary  item were as
follows:
<TABLE>
<CAPTION>
                                                    1997                   1996                  1995
                                                 -------------------------------------------------------
<S>                                               <C>                    <C>                   <C>
Federal statutory rate                            (35.0)%                (35.0)%               (35.0)%
State income taxes,
     net of federal tax benefit                    (2.0)                  (1.5)                 (1.5)
Amortization and write-off of goodwill             20.1                   22.7                  32.9
Benefit from new law and tax settlements           (1.8)                 (47.6)                   --
Permanent tax differences                            .7                     .4                   (.1)
Difference between statutory and
     carry-back tax rates                            .3                     --                    --
Tax credits                                          --                    (.7)                  (.3)
                                                 -------------------------------------------------------
                                                  (17.7)%                (61.7)%                (4.0)%
                                                 =======================================================
</TABLE>


The tax  effects of  temporary  differences  and tax  credits  that give rise to
significant portions of the deferred tax assets and deferred tax liabilities are
as follows:
<TABLE>
<CAPTION>

In thousands                                                                           1997                       1996
                                                                                    -------------------------------------
<S>                                                                                 <C>                       <C>
Deferred tax assets:
     Tax credit and net operating loss carry-forwards                               $   23,000                $    1,127
     Insurance reserves                                                                 10,322                    13,026
     Retirement, deferred compensation, restricted stock
       and stock option plans                                                            8,651                     6,101
     Post-retirement benefits                                                            6,656                     5,706
     Vacation reserves                                                                   3,968                     4,981
     Reserves for bad debts                                                              2,800                     3,056
     Lease liability                                                                     2,615                     7,159
     Other                                                                               8,971                     6,582
                                                                                    -------------------------------------

                                           Total deferred tax assets                    66,983                    47,738
                                           Less valuation allowance                         --                        --
                                                                                    -------------------------------------
                                           Net deferred tax assets                      66,983                    47,738
                                                                                    -------------------------------------

Deferred tax liabilities:
     Land, buildings and equipment                                                     (90,835)                  (54,763)
     Inventory basis difference                                                        (19,441)                  (11,221)
     Other                                                                              (6,830)                   (9,738)
                                                                                    -------------------------------------
                                           Total deferred tax liabilities             (117,106)                  (75,722)
                                                                                    -------------------------------------
                                           Net deferred tax liability               $  (50,123)               $  (27,984)
                                                                                    =====================================
</TABLE>


Note G--Pension Plans

The  Company  has a  non-contributory  defined  benefit  pension  plan  covering
substantially  all  full-time  employees.  Benefits  under the plan are based on
years of service and an employee's average compensation.  Prior to January 1995,
the Company had two defined benefit pension plans that were merged into a single
plan on January 1, 1995. The Company's funding policy is to contribute  annually
the amount actuarially  determined to provide the plan with sufficient assets to
meet  future  benefit  payment  requirements.  Assets  of the  pension  plan are
maintained in trust funds.

Effective  July 21, 1997,  the Company  terminated a  supplemental  pension plan
covering  certain of its  officers.  The plan was an unfunded,  non-contributory
defined  benefit  pension plan.  Benefits  under the plan were based on years of
service, age and the


<PAGE>29


Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS (cont'd.)


employees' average compensation. The supplemental pension plan was terminated as
part of the Plan of  Reorganization.  Net  pension  costs  for the  supplemental
pension  plan were $0.9  million  in 1997 and $1.3  million  in each of 1996 and
1995.

Net pension  cost,  excluding the  terminated  supplemental  pension  plan,  was
comprised of the following components:
<TABLE>
<CAPTION>
In thousands                                                                    1997              1996              1995
                                                                           ------------------------------------------------
<S>                                                                        <C>                <C>               <C>
Service cost - benefits earned during the period                           $      4,280       $      4,548      $     4,098
Interest cost on projected benefit obligation                                     4,256              3,983            3,421
Actual return on plan assets                                                     (7,042)            (8,167)          (6,741)
Net amortization and deferral                                                     2,932              5,074            4,334
                                                                           ------------------------------------------------
Net periodic pension cost                                                  $      4,426       $      5,438      $     5,112
                                                                           ================================================
</TABLE>

A curtailment  gain of $0.2 million was recorded in the year ended  November 29,
1997.  This gain was  recorded  as a result of the  closing  of 29 stores and is
included in special charges in the  accompanying  1997 statements of operations;
see Note L. The Company  wrote off $15.9 million of  unrecognized  prior service
cost and unrecognized net loss from past experience  different from that assumed
as part of the  fresh-start  revaluation in the  accompanying  1997 statement of
operations; see Note B.

Significant  assumptions  used in accounting  for defined  benefit plans were as
follows:
<TABLE>
<CAPTION>
                                                                                1997              1996              1995
                                                                           ---------------------------------------------
<S>                                                                             <C>               <C>               <C>

Weighted average discount rate                                                  7.0%              7.5%              7.5%
Rate of increase in future compensation levels                                  6.0%              5.0%              5.0%
Expected long-term rate of return on plan assets                                8.5%              8.5%              8.5%
</TABLE>


The following  table sets forth the plans' funded status and amounts  recognized
in the balance sheets:
<TABLE>
<CAPTION>
In thousands                                                        1997                       1996
                                                                -------------------------------------------
                                                                                               Supplemental
                                                                   Pension            Pension     Pension
                                                                    Plan               Plan        Plan
                                                                -------------------------------------------
<S>                                                             <C>                  <C>          <C>
Actuarial present value of benefit obligations:
    Accumulated benefit obligation
       Vested                                                   $   57,065           $  41,707    $  6,262
       Non-vested                                                    5,371               4,403       1,505
                                                                -------------------------------------------
       Total                                                        62,436              46,110       7,767
    Increase in benefits due to estimated
       future compensation increases                                14,257              10,988       1,989
                                                                -------------------------------------------
    Projected benefit obligation
       for service rendered to date                                 76,693              57,098       9,756
    Plan assets at fair value, primarily publicly traded
       stocks and U.S. Government obligations                       54,260              48,993          --
                                                                -------------------------------------------

    Projected benefit obligation
       in excess of plan assets                                     22,433               8,105       9,756
    Unrecognized net loss from past
       experience different from that assumed                           --              (1,118)     (1,591)
    Unrecognized prior service cost                                     --              (1,237)       (785)
                                                                -------------------------------------------
    Accrued pension cost included
       in other accrued expenses                                $   22,433           $   5,750    $  7,380
                                                                ===========================================
</TABLE>



<PAGE>30


Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS (cont'd.)


At November  29,  1997,  an  additional  minimum  liability  of $1.6 million was
recorded to reflect the excess of the unfunded  accumulated  benefit  obligation
over accrued pension costs.  This amount,  along with a  corresponding  asset of
$0.3  million and a charge to  additional  paid-in-capital  of $1.3 million were
eliminated in applying fresh-start reporting; see Note B.

In addition, the Company has sponsored several defined contribution plans. Under
the Payless Cashways, Inc. Employee Savings Plan, which covers substantially all
employees, the Company contributed an amount equal to a percentage of the amount
contributed  by employees  into the plan. In fiscal year 1994,  the employees of
Somerville Lumber and Supply Co., Inc. were covered by a profit sharing plan for
which  contributions  were made at the  discretion  of the  Somerville  Board of
Directors and approval of the Company's Compensation  Committee.  On October 23,
1995,  the  profit  sharing  plan was merged  into the  Payless  Cashways,  Inc.
Employee Savings Plan. The aggregate  contributions to all defined  contribution
plans were $2.8 million, $3.1 million, and $2.9 million in 1997, 1996, and 1995,
respectively.


Note H--Post-Retirement Benefit Plans

The Company has certain  unfunded  post-retirement  defined  benefit  plans that
provide health and life insurance benefits for retirees and eligible dependents.
The health plan is  contributory  and  contains  cost-sharing  features  such as
deductibles and coinsurance.

In fiscal 1997,  1996, and 1995, the health-care  cost trend rate was assumed to
decrease gradually to 5.9% by the year 2001 and remain at that level thereafter.
The effect of a 1.0% annual  increase in these  assumed  health-care  cost trend
rates would increase the November 29, 1997, accumulated  post-retirement benefit
obligation  by $879,000  and the  aggregate  of the service  and  interest  cost
components  of net  periodic  post-retirement  benefit  cost for the fiscal year
ended November 29, 1997, by $46,000.

Net post-retirement benefit cost included the following components:
<TABLE>
<CAPTION>
In thousands                                                                    1997               1996              1995
                                                                           -----------------------------------------------
         <S>                                                               <C>                 <C>                <C>

         Service cost - benefits earned during the period                  $     636           $      642         $  1,098
         Interest cost on accumulated post-retirement
           benefit obligation                                                  1,019                1,084            1,309
         Amortization of prior service cost                                       37                   47               47
         Amortization of unrecognized (gain) loss                                (99)                  --               93
                                                                           -----------------------------------------------
         Net periodic post-retirement benefit cost                         $   1,593           $    1,773         $  2,547
                                                                           ===============================================
</TABLE>

A curtailment  gain of $37,000 was recorded in the year ended November 29, 1997.
This gain was  recorded  as a result of the closing of 29 stores and is included
in special charges in the accompanying  1997 statements of operations;  see Note
L. The Company  recognized  a net  $531,000  gain  related to the  write-off  of
unrecognized  prior service cost and  unrecognized net gain from past experience
different  from  that  assumed  as part of the  fresh-start  revaluation  in the
accompanying 1997 statement of operations; see Note B.

The following  table sets forth the plans' funded status and amounts  recognized
in the balance sheets:
<TABLE>
<CAPTION>
In thousands                                                                    1997               1996              1995
                                                                           ------------------------------------------------
         <S>                                                               <C>                 <C>                <C>
         Accumulated post-retirement benefit obligation:
           Retirees and beneficiaries                                      $    9,860          $    8,111         $ 12,144
           Fully eligible active plan participants                              2,219               1,965              781
           Other active plan participants                                       4,610               3,893            3,939
                                                                           ------------------------------------------------
                  Total                                                        16,689              13,969           16,864
         Plan assets at fair value                                                 --                  --               --
                                                                           ------------------------------------------------
         Accumulated post-retirement benefit obligation in excess of
           plan assets                                                         16,689              13,969           16,864
         Unrecognized net gain (loss) from past experience different from
           that assumed                                                            --               3,197             (749)
         Unrecognized prior service cost                                           --                (838)            (885)
                                                                           ------------------------------------------------
         Accrued post-retirement benefit cost included in other
           non-current liabilities                                         $   16,689          $   16,328         $ 15,230
                                                                           ================================================
</TABLE>

<PAGE>31


Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS (cont'd.)


Significant  assumptions  used in accounting for  post-retirement  benefit plans
were as follows:
<TABLE>
<CAPTION>
                                                                                1997               1996              1995
                                                                           ------------------------------------------------
           <S>                                                                   <C>                <C>               <C>
           Weighted average discount rate                                        7.0%               7.5%              7.5%
           Rate of increase in future compensation levels                        6.0%               5.0%              5.0%
           Health-care cost trend rate                                           7.1%               7.6%              8.1%
</TABLE>

Note I--Leases

The Company  leases  certain stores and other  facilities  under  non-cancelable
operating  leases.   Aggregate  minimum  future  rentals  under   non-cancelable
operating  leases  for the next five  years are:  1998 --  $20,867,000;  1999 --
$20,065,000;  2000 --  $18,422,000;  2001 --  $16,354,000;  2002 -- $12,769,000;
thereafter  --  $19,797,000.  Rental  expense under  operating  leases was $29.3
million, $30.6 million and $27.2 million for 1997, 1996, and 1995,respectively.

During 1995, the Company  entered into an agreement  providing for the operating
lease of five stores,  including a new store that opened in 1997. Under the Plan
of  Reorganization,  the Company  acquired three of the stores and issued a note
payable to the lessor as described at Note D.

Rental  payments  under this lease varied with the level of interest  rates.  To
reduce the impact of changes in the interest  rates  related to this lease,  the
Company during 1995 entered into an interest rate swap agreement  under which it
pays a 6-9/16%  fixed rate of interest  quarterly  through  December 1, 1999, in
exchange for quarterly receipt of LIBOR on $36 million.  The Company's liability
with  respect  to the  remaining  term of this  interest  rate  swap  agreement,
estimated to be $0.7 million at November  29, 1997,  was accrued in  fresh-start
accounting.

Note J--Reorganization Items

In connection with its Chapter 11 filing on July 21, 1997,  discussed at Note A,
reorganization  items of $25.5  million are  reflected in the 1997  statement of
operations.  Reorganization items for this period consisted of professional fees
and case  administrative  expenses of $17.6  million,  the write-off of deferred
financing costs of $2.5 million, retention bonuses of $5.7 million, and interest
income of $0.3 million.

Note K--Asset Impairment Charges

The Company recorded an asset impairment  charge of $60.5 million ($43.9 million
after tax) and $59.7 million  ($44.6 million after tax) in the third quarters of
1997 and 1996,  respectively.  The asset impairment  charges were recorded after
considering  current and expected future operating cash flows for certain stores
together  with the proceeds the Company could expect to receive upon the sale of
these assets.

The Company adopted Financial  Accounting Standard No. 121,  "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of," in
1996.  Primarily  because the environment for building  materials  retailing has
continued to be increasingly competitive, the Company first conducted its review
in the third quarter of 1996 and determined certain assets were impaired. In the
third quarter of 1997, the Company again  conducted a review of  underperforming
stores and determined that certain  additional  assets were impaired,  including
assets related to twenty-nine  stores which the Company determined to close (see
Note L). These assets included certain real estate, including future store lease
obligations,  and associated  goodwill which is attributable to those assets and
which was established in 1988 as part of the Company's leveraged buyout.

In 1997 as a result of the  impairment  charge,  certain  real  estate  carrying
values were reduced  $28.8  million,  goodwill was reduced  $18.7  million and a
$13.0 million liability for future store lease payments was recorded. In 1996 as
a result of the impairment charge,  goodwill was reduced $22.4 million,  certain
real estate  carrying  values were  reduced  $25.7  million and a $11.6  million
liability  for future store lease  payments,  net of $6.0 million in amounts the
Company estimated to be recoverable, was recorded.

The Company will continue to review assets for  impairment,  particularly  given
the ongoing competitive environment for building materials retailing.



<PAGE>32


Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS (cont'd.)


Note L--Special Charges

A special  charge of $13.1 million  ($8.1  million after tax),  primarily a cash
charge,  was recorded in the third quarter of fiscal 1997 in connection with the
closing of 29 stores as part of the Company's  reorganization  under Chapter 11.
All 29 stores were closed prior to November 29, 1997.  In addition,  the Company
recorded an inventory  write-down  of $10.7  million  ($6.6  million after tax),
included in cost of merchandise sold, in connection with the store closings.

The fiscal 1997 special charge includes:
<TABLE>
<CAPTION>
                                                        Amount            Amount            Reclass From
                                                        Charged       Utilized Through       1995 & 1996     Reserve at
       In millions                                       1997          Nov. 29, 1997           Reserve       Nov. 29, 1997
                                                    ----------------------------------------------------------------------
       <S>                                           <C>                 <C>                 <C>               <C>
       Real estate disposal costs                    $       6.8         $      4.1          $     3.4         $      6.1
       Severance costs                                       6.3                5.5                  --                .8
                                                    ---------------------------------------------------------------------
                                                     $      13.1         $      9.6          $     3.4         $      6.9
                                                    =====================================================================
</TABLE>

Historical financial data for the closing of the 29 stores is as follows for the
for the fiscal years presented:
<TABLE>
<CAPTION>
       In thousands                                      1997                      1996                      1995
                                                    ----------------------------------------------------------------
       <S>                                          <C>                       <C>                       <C>
       Net sales                                    $  209,898                $   328,541               $   319,354
       Net operating income (loss)                  $   (9,153)               $     5,990               $     8,990
</TABLE>

A special  charge of $8.2 million  ($5.0  million  after tax),  primarily a cash
charge,  was recorded in the third quarter of fiscal 1996 in connection with the
closing of nine underperforming  stores. Eight of the nine stores were closed at
November  30,  1996,  and the  remaining  store was closed in fiscal  1997.  The
Company also  recorded an inventory  write-down  of $5.8 million  ($3.5  million
after tax),  included in cost of merchandise  sold, in connection with the store
closings.

The fiscal 1996 special charge includes:
<TABLE>
<CAPTION>
                                                                                              Discharge of
                                       Amount           Amount               Reclass          Indebtedness
                                       Charged     Utilized Through       1996 Reserve       in Fresh-Start      Reserve at
       In millions                      1996         Nov. 29, 1997       to 1997 Reserve       Accounting     Nov. 29, 1997
                                    ---------------------------------------------------------------------------------------
       <S>                            <C>            <C>                  <C>                   <C>               <C> 
       Future store rentals           $     3.7      $       1.3          $         --          $      (2.4)      $      --
       Real estate disposal costs           4.5              3.3                  (1.2)                --                --
                                    ---------------------------------------------------------------------------------------
                                      $     8.2      $       4.6          $       (1.2)         $      (2.4)      $      --
                                    =======================================================================================
</TABLE>


Historical  financial  data for the closing of the nine stores is as follows for
the fiscal years presented:
<TABLE>
<CAPTION>
       In thousands                                      1996                      1995
                                                    --------------------------------------
       <S>                                          <C>                       <C>
       Net sales                                    $   63,088                $    70,284
       Net operating income (loss)                  $   (7,636)               $    (1,720)
</TABLE>

Costs of $153.7 million  associated with a restructuring plan which included the
closing of six stores on December 30, 1995, the sale of a distribution center on
December 22, 1995, and the reorientation of several stores to concentrate on the
professional  customer  during  the  first two  quarters  of  fiscal  1996,  are
contained in the accompanying statement of operations for fiscal 1995 as special
charges.


<PAGE>33


Payless Cashways, Inc.

NOTES TO FINANCIAL STATEMENTS (cont'd.)


The fiscal 1995 special charge includes:
<TABLE>
<CAPTION>
                                                         Amount         Amount                          Reclass
                                                         Charged   Utilized Through    Changes In    1995 Reserve       Reserve at
       In millions                                        1995       Nov. 29, 1997      Estimate    to 1997 Reserve    Nov. 29, 1997
                                                    --------------------------------------------------------------------------------
       <S>                                          <C>               <C>              <C>           <C>               <C>  
       Write-off of allocable cost in excess of
          assets acquired (goodwill)                $      101.5      $    101.5       $      --     $       --        $      --
       Real estate write-down and disposal costs            31.2            31.8             1.9           (1.3)              --
       Inventory liquidation and store closing costs        15.3            13.7            (1.6)            --               --
       Severance and other employment costs                  3.9             3.6             (.3)            --               --
       Other                                                 1.8              .9              --            (.9)              --
                                                    ----------------------------------------------------------------------------
                                                    $      153.7      $    151.5       $      --     $     (2.2)       $      --
                                                    ============================================================================
</TABLE>

Historical  financial  data for the six closed  stores is as follows  for fiscal
1995:

       In thousands

       Net sales                $    61,969
       Net operating loss       $    (4,023)



Note M--Litigation

The Company is a defendant in a lawsuit  brought in connection  with a reduction
in force pursuant to a January 1994  restructuring.  The suit asserted a variety
of  claims  including  federal  and  state  securities  fraud  claims,   alleged
violations of the Racketeer  Influenced and Corrupt  Organizations Act ("RICO"),
federal  and  state  claims of age  discrimination,  alleged  violations  of the
Employment  Retirement Income Security Act of 1974, and various state law claims
including,  but not  limited to,  fraudulent  misrepresentation  allegations.  A
ruling has been  entered on the  Company's  motion to dismiss  the  majority  of
pending claims,  substantially  narrowing plaintiff's legal claims by dismissing
some age  discrimination  counts,  all federal securities counts and RICO counts
except one each, and all state law counts related to an alleged partnership. The
plaintiff's motion for class  certification has been denied on all claims except
the age  discrimination  claims.  The court has recently granted the plaintiff's
motion for class certification of certain age discrimination claims. As a result
of  this  ruling,   approximately  20  additional   individuals  may  choose  to
participate  in the age claims  asserted  in this suit.  Each of the parties has
conducted discovery pursuant to the court's scheduling order and discovery plan.
The lawsuit was formally  stayed  pursuant to the  automatic  stay issued by the
Bankruptcy  Court following the voluntary  Chapter 11  reorganization  filing on
July 21, 1997.  During the Chapter 11  reorganization,  plaintiffs  timely filed
proofs of claim,  including a  purported  claim on behalf of the  potential  Age
Discrimination  in Employment Act opt-in class, for an aggregate of $37 million.
The case has been returned to the United States  District Court for the Southern
District of Iowa for  resolution.  Any recovery for the  plaintiffs  against the
Company would be treated as a general  unsecured  claim entitling the plaintiffs
to their pro rata share of  8,269,329  shares of New Common  Stock  reserved for
such claims.

The Company  denies any and all claimed  liability and is  vigorously  defending
this  litigation,  but is unable  to  estimate  a  potential  range of  monetary
exposure,  if any,  to the  Company  or to predict  the  likely  outcome of this
matter.


<PAGE>34


Payless Cashways, Inc.

INDEPENDENT AUDITORS' REPORT


The Board of Directors
Payless Cashways, Inc.:

We have audited the accompanying balance sheets of Payless Cashways,  Inc. as of
November  29,  1997,  and  November  30,  1996,  and the related  statements  of
operations,  stockholders' equity and cash flows for each of the fiscal years in
the three-year  period ended November 29, 1997.  These financial  statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material respects,  the financial  position of Payless Cashways,  Inc. as of
November 29, 1997 and November 30, 1996,  and the results of its  operations and
its cash  flows for each of the  fiscal  years in the  three-year  period  ended
November 29, 1997 in conformity with generally accepted accounting principles.

As  discussed  in Note A to the  financial  statements,  the  November  29, 1997
balance sheet reflects the application of fresh-start  reporting as of that date
and,  therefore,  is not comparable in all respects to the balance sheets of the
Company  prior to November  29, 1997.  As  discussed in Note H to the  financial
statements,  the Company adopted Statement of Financial Accounting Standards No.
121,  "Accounting  for the  Impairment of Long-Lived  Assets and for  Long-Lived
Assets to Be Disposed Of," in fiscal 1996.




/S/ KPMG Peat Marwick LLP

Kansas City, Missouri
January 19, 1998



<PAGE>35


Payless Cashways, Inc.

FIVE-YEAR FINANCIAL SUMMARY

<TABLE>
<CAPTION>
                                            Reorganized |
In thousands, except per share                Company   |                              Predecessor Company
                                            ----------- | ------------------------------------------------------------------------
amounts, percentages and ratios                1997     |     1997          1996            1995           1994             1993
----------------------------------------------------------------------------------------------------------------------------------
<S>                                      <C>              <C>            <C>           <C>             <C>             <C>
Net sales and other income (a)                     N/A  | $ 2,290,215    $2,650,905    $ 2,685,670     $ 2,733,182     $ 2,605,978
Cost of merchandise sold                           N/A  |   1,676,658     1,906,734      1,912,620       1,918,674       1,824,663
Selling, general and administrative                N/A  |     558,817       615,466        619,589         594,024         570,016
Reorganization items (b)                           N/A  |      25,455            --             --              --              --
Fresh-start revaluation (b)                        N/A  |     355,559            --             --              --              --
Special charges (c)                                N/A  |      13,056         8,184        153,667              --           4,000
Asset impairment charges (d)                       N/A  |      60,483        59,967             --              --              --
Depreciation and amortization                      N/A  |      51,110        55,016         60,356          58,692          56,213
Interest expense                                   N/A  |      61,251        60,488         61,067          65,571         125,247
Interest income (e)                                N/A  |          --         4,900             --              --              --
                                         -----------------------------------------------------------------------------------------
Income (loss) before income taxes                  N/A  |    (512,174)      (49,780)      (121,629)         96,221          25,839
Federal and state income taxes (e)                 N/A  |     (90,406)      (30,702)        (4,911)         41,808          16,170
                                         -----------------------------------------------------------------------------------------
Income (loss) before equity in loss of                  |
   joint venture and extraordinary item            N/A  |    (421,768)      (19,078)      (116,718)         54,413           9,669
Equity in loss of joint venture (f)                N/A  |          --            --        (11,831)         (2,281)             --
Extraordinary item (g)                             N/A  |     133,176            --             --          (7,243)       (45,828)
                                         -----------------------------------------------------------------------------------------
Net income (loss)                                  N/A  | $  (288,592)   $  (19,078)   $  (128,549)    $    44,889     $  (36,159)
                                         =========================================================================================
                                                        |
Current ratio                                      2.15 |         N/A           1.41           1.29           1.45            1.25
Working capital                          $     258,405  |         N/A    $  131,004    $    98,400     $   139,128     $    85,142
Total assets                             $     911,341  |         N/A    $1,293,118    $ 1,344,436     $ 1,495,882     $ 1,458,481
Long-term debt                           $     424,031  |         N/A    $  618,667    $   608,627     $   654,131     $   640,127
Stockholders' equity                     $     183,800  |         N/A    $  289,731    $   308,163     $   435,865     $   387,311
Capital expenditures                               N/A  | $    62,940    $   41,670    $    67,281     $    81,906     $    49,982
Income from operations before                           |
   depreciation and amortization (h)               N/A  | $    65,433    $  134,552    $   153,461     $   220,484     $   211,299
<FN>
(a)  Net sales and other income include gains of $2.3 million in 1996 related to
     settlements  of 1995 fire losses and  gains of $5.9 million in 1994 related
     to settlements of 1993 flood losses.

(b)  In  connection  with its Chapter 11 filing on July 21,  1997,  discussed at
     Note A, the Company recorded reorganization items in 1997. The Company also
     adopted  fresh-start  accounting,  discussed  at Note B, as of November 29,
     1997,  as a result  of its  emergence  from  bankruptcy  under  its plan of
     reorganization effective date, December 2, 1997.

(c)  Special  charges for 1997 and 1996 consisted of costs  associated  with the
     closing of 29 stores and nine  stores,  respectively.  Special  charges for
     1995  consisted of  restructure  costs  associated  with the closing of six
     stores, the sale of a distribution  center and the reorientation of several
     stores to concentrate on the  professional  customer.  Special  charges for
     1993 consisted of costs associated with the elimination of a layer from the
     Company's field management organization.

(d)  Asset  impairment  charges  for 1997 and 1996  consist  of a  reduction  of
     goodwill and certain real estate carrying values,  net of amounts estimated
     to be  recoverable,  and the  recording of a  liabilities  for future store
     lease payments. The Company adopted of SFAS 121 in 1996.

(e)  During  1996,  the Company  recorded a federal  income tax benefit of $23.7
     million and related interest income of $4.9 million pursuant to legislation
     and a settlement with the Internal Revenue Service.

(f)  During  1995, the Company  recorded an $8.0 million loss on the sale of its
     Mexican joint venture investment.

(g)  During 1997, the Company recorded a $5.0 million charge, after tax, related
     to the  early  extinguishment  of debt and a $138.2  million  extraordinary
     gain,   after  tax,   related  to  debts   discharged  in  its  Chapter  11
     reorganization.   During  1993  and  1994,  the  extraordinary  items  also
     represent losses on early extinguishment of debt.

(h)  Income from operations before  depreciation and amortization is utilized by
     the  Company  as a  measure  for  managing  cash  flow  in  its  day-to-day
     operations.  The amounts are before the reorganization  items,  fresh-start
     revaluation,  special  charges  and  asset  impairment  charges.  Inventory
     write-downs   in  1997  and  1996  of  $10.7   million  and  $5.8  million,
     respectively, related to the closing of 29 and nine underperforming stores,
     respectively, are also excluded.
</FN>
</TABLE>


<PAGE>36


Payless Cashways, Inc.

FIVE-YEAR OPERATIONAL SUMMARY

<TABLE>
<CAPTION>
Average sales per facility, number                                             Predecessor Company
of customers, gross square feet and             --------------------------------------------------------------------------------
retail square feet are in thousands                 1997           1996 (a)         1995 (b)            1994             1993
--------------------------------------------------------------------------------------------------------------------------------
<S>                                             <C>              <C>               <C>              <C>               <C>  
Number of retail facilities                            164              192               206              202               196
Average same-store sales per facility           $   12,600       $   13,107        $   13,114       $   13,716        $   13,284
Number of customers                                 50,743           56,736            59,685           60,812            60,678
Average sales per customer                      $    45.04       $    45.81        $    44.91       $    44.77        $    42.87
Number of employees                                 12,782           16,664            18,122           18,406            18,093
Average sales per employee                      $  162,099       $  152,228        $  147,894       $  147,778        $  143,757
Gross square feet (total)                           15,550           17,578            19,453           18,730            18,095
Retail square feet (inside)                          5,334            6,209             6,740            6,468             6,200
Sales per retail square foot                    $   388.44       $   408.56        $   397.65       $   420.53        $   419.52
Percent increase (decrease) in same-
  store sales                                       (6.6)%           (2.5)%            (4.5)%             3.3%              4.1%
<FN>
 (a)  Fiscal  1996 was a  53-week  year.  All 1996 data has been  computed  on a
 52-week basis. (b) Includes six retail stores closed in December 1995.
</FN>
</TABLE>

--------------------------------------------------------------------------------

Payless Cashways, Inc.

RESPONSIBILITY FOR FINANCIAL STATEMENTS


The  financial  statements  of Payless  Cashways,  Inc.  have been  prepared  by
management in accordance  with  generally  accepted  accounting  principles  and
necessarily  include amounts based on management's  judgment and best estimates.
The presentation,  integrity and consistency of the financial statements are the
responsibility of management.

The financial statements have been audited by KPMG Peat Marwick LLP, independent
auditors. Their responsibility is to audit the Company's financial statements in
accordance  with  generally  accepted  auditing  standards  and to express their
opinion on these  statements  with  respect to fairness of  presentation  of the
Company's financial position, results of operations and cash flows.

To fulfill its  responsibilities,  management has developed a system of internal
controls designed to provide  reasonable  assurance that assets are safeguarded,
transactions  are executed in accordance with  management's  authorizations  and
financial  records provide a reliable basis for preparing  financial  statements
and other data.  Management  believes  the controls in place are  sufficient  to
provide this reasonable  assurance.  The controls include careful  selection and
training of  qualified  personnel,  appropriate  division  of  responsibilities,
communication  of written  policies and procedures  throughout the Company and a
program of internal audits.

The Board of Directors,  through its Audit  Committee  composed of Directors who
are neither  officers  nor  employees  of the Company,  is  responsible  for the
maintenance of a strong control environment and quality financial reporting. The
Board, on the  recommendation  of the Audit  Committee,  selects and engages the
independent  auditors.  The Audit Committee meets  periodically with management,
the  independent  auditors and internal  auditors to discuss the results of both
independent and internal audits, the adequacy of internal controls and financial
reporting  matters.  The  independent  auditors and the internal  auditors  have
direct access to the Audit  Committee  without the presence of management,  when
deemed appropriate.


/S/ Donald E. Roller                           /S/ Richard G. Luse

Donald E. Roller                               Richard G. Luse
Acting Chief Executive Officer                 Senior Vice President-Finance
                                                and Chief Financial Officer


<PAGE>37


Payless Cashways, Inc.

Board of Directors

Peter G. Danis +
Non-executive Chairman of the Board
Payless Cashways, Inc.
Chief Executive Officer
Boise Cascade Office Products Corporation

Donald E. Roller #
Acting Chief Executive Officer
Payless Cashways, Inc.

David M. Chamberlain * +
Chairman
Genesco, Inc.

Harold D. Cleberg * @
President and Chief Executive Officer
Farmland Industries, Inc.

David G. Gundling + #
President and Chief Executive Officer
Hagemeyer Foods N.A., Inc.

Max D. Hopper @ #
Principal
Max D. Hopper Associates, Inc.

Peter M. Wood * @
Former Managing Director
J. P. Morgan & Co., Incorporated


*    Member of Audit Committee
+    Member of Compensation Committee
@    Member of Corporate Governance and
         Nominating Committee
#    Member of Finance Committee




Officers

Donald E. Roller
Acting Chief Executive Officer
Payless Cashways, Inc.

Stanley K. Boyd
Senior Vice President - Store Operations

Robert S. Islinger
Senior Vice President - Marketing and Merchandising

Richard G. Luse
Senior Vice President - Finance and
Chief Financial Officer

Donald R. Bowman
Regional Vice President

Kenneth G. Frank, Jr.
Regional Vice President

David J. Krumbholz
Regional Vice President

David L. Wenman
Regional Vice President

Kelly R. Abney
Vice President - Distribution and Transportation

Louise R. Iennaccaro
Vice President - Human Resources

Ronald D. Long
Vice President - Merchandising/Building Materials

John W. Zalonis
Vice President - Merchandising/Finishing Products



<PAGE>38


Payless Cashways, Inc.

1997 STORE LOCATIONS


ARIZONA
PHOENIX 5, TUCSON 3

CALIFORNIA
BAKERSFIELD 2, FRESNO 2,
MODESTO 1, REDDING 1,
SACRAMENTO 6, VISALIA 1

COLORADO
BOULDER 1,
COLORADO SPRINGS 3,
DENVER 13, GREELEY 1

ILLINOIS
QUINCY 1, SILVIS 1,
SPRINGFIELD 1

INDIANA
ANDERSON 1, BLOOMINGTON 1,
CLARKSVILLE 1, INDIANAPOLIS 5,
KOKOMO 1, LAFAYETTE 1,
MUNCIE 1

IOWA
ALTOONA 1, CEDAR RAPIDS 1,
CORALVILLE 1, DAVENPORT 2,
DES MOINES 2, FORT DODGE 1,
SIOUX CITY 1, WATERLOO 1

KANSAS
ELWOOD 1, KANSAS CITY 5,
LAWRENCE 1, SALINA 1, TOPEKA 1, WICHITA 2

KENTUCKY
FLORENCE 1, LEXINGTON 1,
LOUISVILLE 3

LOUISIANA
BATON ROUGE 1

MINNESOTA
MINNEAPOLIS/ST. PAUL 8

MISSOURI
COLUMBIA 1, KANSAS CITY 5,
SPRINGFIELD 1,
ST. JOSEPH 1

MONTANA
BILLINGS 1

NEBRASKA
LINCOLN 2, OMAHA 3

NEVADA
LAS VEGAS 4,
RENO 1, SPARKS 1

NEW MEXICO
ALBUQUERQUE 1,
SANTA FE 1

OHIO
DAYTON 2, CINCINNATI 7,
FINDLAY 1, HUBER HEIGHTS 1,
LIMA 1, SPRINGFIELD 1

OKLAHOMA
NORMAN 1,
OKLAHOMA CITY 3, TULSA 2

OREGON
EUGENE 1, SALEM 1

TENNESSEE
MEMPHIS 3

TEXAS
ABILENE 1, AMARILLO 1, AUSTIN 3, COLLEGE STATION 1, CONROE 1, DALLAS/FT. WORTH 
16, LONGVIEW 1, LUBBOCK 2, SHERMAN 1, TEXARKANA 1, TYLER 1, WACO 1








1997 DISTRIBUTION CENTERS

CHANDLER, ARIZONA

SACRAMENTO, CALIFORNIA

DENVER, COLORADO

INDIANAPOLIS, INDIANA

KANSAS CITY, MISSOURI

SEDALIA, MISSOURI

LAKE DALLAS, TEXAS



<PAGE>39


Payless Cashways, Inc.

STOCKHOLDER INFORMATION


As of the July 21, 1997, the Chapter 11 filing date, Payless Cashways Old Common
Stock ceased  trading on the New York Stock  Exchange  (ticker  symbol PCS), was
subsequently delisted and began trading  over-the-counter (ticker symbol PYLSQ).
On  December  2,  1997,   the  Effective   Date  for  the   Company's   Plan  of
Reorganization,  the Company  canceled Old Common Stock and Old Preferred  Stock
and began  issuing  shares of New Common  Stock  (ticker  symbol  PCSH) which is
trading  on  the  over-the-counter   bulletin  board.  Therefore,  the  required
information presented below with respect to the Old Common Stock for fiscal 1997
and 1996 is not  meaningful  and has not been  converted to the current  trading
price of the New Common Stock. The number of registered holders of the Company's
Old Common Stock at November 29, 1997,  was 1,797.  No cash  dividends have been
declared on either Old or New Common Stock since 1988.  Certain of the Company's
debt  instruments  contain  restrictions  on  the  declaration  and  payment  of
dividends  on,  or the  making of any  distribution  to the  holders  of, or the
acquisition of, any shares of Common Stock.

<TABLE>
<CAPTION>
                                                                    1997                      1996
                 --------------------------------------- -------------------------- ------------------------
                   Price range of Old Common Stock            High          Low         High         Low
                 --------------------------------------- ------------- ------------ ------------ -----------
                        <S>                                  <C>           <C>          <C>         <C>   
                        First quarter                        2.500         1.125        4.750       3.625

                        Second quarter                       2.125         1.375        5.125       3.750

                        Third quarter                        1.750         0.130        5.000       1.375

                        Fourth quarter                       0.360         0.053        2.250       1.500
</TABLE>






Copies of the Payless  Cashways,  Inc. Form 10-K for fiscal 1997, filed with the
Securities and Exchange  Commission,  are available  without charge. To obtain a
copy, please write to:

                             Payless Cashways, Inc.
                               Investor Relations
                                 P.O. Box 419466
                           Kansas City, MO 64141-0466
                        (Web site: payless.cashways.com)


Annual Meeting - April 15, 1998, 10:00 a.m.         Independent Auditors
Two Pershing Square, 2300 Main Street               KPMG Peat Marwick LLP
Kansas City, MO  64108                              Kansas City, MO

Registrar and Transfer Agent                        Telephone Number of
UMB Bank, n.a.                                      Payless Cashways, Inc. is
Kansas City, MO                                     (816) 234-6000
(816) 860-7786