---





Consolidated Financial Statements of

TEMBEC INDUSTRIES INC.

Years ended September 30, 2006 and September 24, 2005







---

AUDITORS' REPORTTo the Shareholders of Tembec Industries Inc.
We have audited the consolidated balance sheets of Tembec
Industries Inc. as at September 30, 2006 and September 24, 2005, and the
consolidated statements of operations, retained earnings (deficit) and cash
flows for the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with Canadian generally
accepted auditing standards. Those standards require that we plan and perform an
audit to obtain reasonable assurance 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.
In our opinion, these consolidated financial statements
present fairly, in all material respects, the financial position of the Company
as at September 30, 2006 and September 24, 2005, and the results of its
operations and its cash flows for the years then ended in accordance with
Canadian generally accepted accounting principles.
Chartered Accountants
Montréal, Canada 
November 15, 2006, except as to note 22 (b), which is as of December 5, 2006



---

TEMBEC INDUSTRIES INC.Consolidated Financial
Statements

Years ended September 30, 2006 and September 24, 2005

|Financial
    Statements                                   |  
|---------------------------------------------------------- | -
|                                                           |  
|Consolidated Balance Sheets                                | 1
|Consolidated Statements of Operations                      | 2
|Consolidated Statements of Retained Earnings
    (Deficit) | 2
|Consolidated Statements of Cash Flows                      | 3
|Consolidated Business Segment Information                  | 4
|Consolidated Geographic Segment Information                | 5
|Notes to Consolidated Financial Statements                 | 6



---



|TEMBEC INDUSTRIES
    INC.                                       |                                                                              |       |       |      
|---------------------------------------------------------------- | ---------------------------------------------------------------------------- | ----- | ----- | -----
|Consolidated Balance
    Sheets                                  |                                                                              |       |       |      
|                                                                 |                                                                              |       |       |      
|September 30, 2006 and
    September 24, 2005                    |                                                                              |       |       |      
|(in millions of
    dollars)                                     |                                                                              |       |       |      
|                                                                 |                                                                              |       |       |      
|                                                                 |                                                                              | 2006  |       | 2005 
|Assets                                                           |                                                                              |       |       |      
|                                                                 |                                                                              |       |       |      
|Current assets:                                                  |                                                                              |       |       |      
|                                                                 | Cash and cash equivalents                                                    | $     | 26    | $    
|                                                                 | Temporary investments                                                        |       | -     |      
|                                                                 | Derivative financial instruments (note 21)                                   |       | -     |      
|                                                                 | Accounts receivable (note 8)                                                 |       | 405   |      
|                                                                 | Due from parent company, Tembec Inc.                                         |       | 14    |      
|                                                                 | Inventories (notes 3 and 8)                                                  |       | 483   |      
|                                                                 | Prepaid expenses                                                             |       | 20    |      
|                                                                 | Current assets of discontinued operations (note
    2)                       |       | -     |      
|                                                                 |                                                                              | 948   |       | 1,088
|                                                                 |                                                                              |       |       |      
|Investments                                                      |                                                                              | 15    |       | 5    
|Fixed assets (note 5)                                            |                                                                              | 1,796 |       | 2,092
|Other assets (note 6)                                            |                                                                              | 173   |       | 188  
|Future income taxes
    (note 18)                                |                                                                              | 62    |       | 36   
|Goodwill (notes 7 and
    16)                                    |                                                                              | 3     |       | 3    
|Non-current assets of discontinued
    operations (note 2)       |                                                                              | -     |       | 29   
|                                                                 | $                                                                            | 2,997 | $     | 3,441
|                                                                 |                                                                              |       |       |      
|Liabilities and
    Shareholders' Equity                         |                                                                              |       |       |      
|                                                                 |                                                                              |       |       |      
|Current liabilities:                                             |                                                                              |       |       |      
|                                                                 | Bank indebtedness                                                            | $     | 5     | $    
|                                                                 | Operating bank loans (note 8)                                                |       | 235   |      
|                                                                 | Accounts payable and accrued charges                                         |       | 426   |      
|                                                                 | Due to parent company, Tembec Inc.                                           |       | -     |      
|                                                                 | Current portion of deferred gain on foreign
    exchange contracts (note 21) |       | -     |      
|                                                                 | Current portion of long-term debt (note 9)                                   |       | 21    |      
|                                                                 | Current liabilities related to discontinued
    operations (note 2)          |       | -     |      
|                                                                 |                                                                              | 687   |       | 772  
|                                                                 |                                                                              |       |       |      
|Long-term debt (note
    9)                                      |                                                                              | 1,482 |       | 1,536
|Other long-term
    liabilities and credits (note 10)            |                                                                              | 150   |       | 140  
|Future income taxes
    (note 18)                                |                                                                              | 121   |       | 136  
|Minority interests
    (note 11)                                 |                                                                              | 5     |       | 5    
|Redeemable preferred
    shares (notes 12 and 13)                |                                                                              | 26    |       | 26   
|                                                                 |                                                                              |       |       |      
|Shareholders' equity:                                            |                                                                              |       |       |      
|                                                                 | Share capital (note 13)                                                      |       | 732   |      
|                                                                 | Contributed surplus                                                          |       | 3     |      
|                                                                 | Cumulative exchange translation of foreign
    subsidiaries                  |       | (3)   |      
|                                                                 | Retained earnings (deficit)                                                  |       | (206) |      
|                                                                 |                                                                              |       |       | 826  
|                                                                 |                                                                              | 526   |       |      
|                                                                 | $                                                                            | 2,997 | $     | 3,441
|Guarantees,
    commitments and contingencies (note 14)          |                                                                              |       |       |      
|Subsequent events
    (note 22)                                  |                                                                              |       |       |      
|                                                                 |                                                                              |       |       |      
|See
    accompanying notes to consolidated financial statements.

|                        |                                      
|----------------------- | -------------------------------------
|On behalf of the Board: |                                      
|                        |                                      
|Gordon S. Lackenbauer   | Chairman                             
|                        |                                      
|James Lopez             | President and Chief Executive Officer

- 1 -

---



|TEMBEC INDUSTRIES
    INC.                                             |   |       |   |      
|---------------------------------------------------------------------- | - | ----- | - | -----
|Consolidated
    Statements of Operations                              |   |       |   |      
|                                                                       |   |       |   |      
|Years ended September
    30, 2006 and September 24, 2005              |   |       |   |      
|(in millions of
    dollars, unless otherwise noted)                   |   |       |   |      
|                                                                       |   |       |   |      
|                                                                       |   | 2006  |   | 2005 
|                                                                       |   |       |   |      
|Sales                                                                  | $ | 3,332 | $ | 3,507
|Freight and sales
    deductions                                       |   | 399   |   | 406  
|Countervailing and
    antidumping duties (note 14)                    |   | 35    |   | 89   
|Cost of sales                                                          |   | 2,722 |   | 2,838
|Selling, general and
    administrative                                |   | 151   |   | 168  
|Depreciation and
    amortization (note 15)                            |   | 206   |   | 236  
|Unusual items (note
    16)                                            |   | 188   |   | 255  
|                                                                       |   |       |   |      
|Operating loss from continuing
    operations                          |   | (369) |   | (485)
|                                                                       |   |       |   |      
|Interest, foreign
    exchange and other (note 17)                     |   | 111   |   | 20   
|Exchange gain on
    long-term debt                                    |   | (64)  |   | (125)
|                                                                       |   |       |   |      
|Loss before income taxes from
    continuing operations                |   | (416) |   | (380)
|                                                                       |   |       |   |      
|Income taxes recovery
    (note 18)                                    |   | (65)  |   | (60) 
|                                                                       |   |       |   |      
|Net loss from continuing operations                                    |   | (351) |   | (320)
|Earnings from
    discontinued operations                              |   | 51    |   | 11   
|                                                                       |   |       |   |      
|Net loss                                                               | $ | (300) | $ | (309)
|                                                                       |   |       |   |      
|Consolidated
    Statements of Retained Earnings (Deficit)             |   |       |   |      
|                                                                       |   |       |   |      
|Years ended September
    30, 2006 and September 24, 2005              |   |       |   |      
|(in millions of
    dollars)                                           |   |       |   |      
|                                                                       |   |       |   |      
|                                                                       |   | 2006  |   | 2005 
|                                                                       |   |       |   |      
|Retained earnings,
    beginning of year                               | $ | 94    | $ | 404  
|Adjustment resulting
    from a change in accounting policies (note 1) |   | -     |   | (1)  
|                                                                       |   |       |   |      
|Restated retained earnings, beginning
    of year                      |   | 94    |   | 403  
|                                                                       |   |       |   |      
|Net loss                                                               |   | (300) |   | (309)
|                                                                       |   |       |   |      
|Retained earnings (deficit), end of
    year                           | $ | (206) | $ | 94   
|                                                                       |   |       |   |      
|See accompanying notes
    to consolidated financial statements.       |   |       |   |      

- 2 -

---



|TEMBEC INDUSTRIES
    INC.                                                        |                                        |                                                                                   |       |      
|--------------------------------------------------------------------------------- | -------------------------------------- | --------------------------------------------------------------------------------- | ----- | -----
|Consolidated
    Statements of Cash Flows                                         |                                        |                                                                                   |       |      
|                                                                                  |                                        |                                                                                   |       |      
|Years ended September
    30, 2006 and September 24, 2005                         |                                        |                                                                                   |       |      
|(in millions of
    dollars)                                                      |                                        |                                                                                   |       |      
|                                                                                  |                                        |                                                                                   |       |      
|                                                                                  |                                        | 2006                                                                              |       | 2005 
|                                                                                  |                                        |                                                                                   |       |      
|Cash flows from
    operating activities:                                         |                                        |                                                                                   |       |      
|                                                                                  | Net loss                               | $                                                                                 | (300) | $    
|                                                                                  | Adjustments for:                       |                                                                                   |       |      
|                                                                                  |                                        | Earnings from discontinued
    operations                                         |       | (51) 
|                                                                                  |                                        | Depreciation and amortization
    (note 15)                                       |       | 206  
|                                                                                  |                                        | Amortization of deferred
    financing costs (note 17)                            |       | 6    
|                                                                                  |                                        | Exchange gain on long-term debt                                                   |       | (64) 
|                                                                                  |                                        | Amortization of deferred gain
    on foreign exchange contracts (notes 17 and 21) |       | (38) 
|                                                                                  |                                        | Derivative financial
    instruments gain (note 21)                               |       | -    
|                                                                                  |                                        | Proceeds from sale of
    derivative financial instruments (note 21)              |       | 6    
|                                                                                  |                                        | Loss on consolidation of
    foreign integrated subsidiaries                      |       | 1    
|                                                                                  |                                        | Future income taxes (note 18)                                                     |       | (63) 
|                                                                                  |                                        | Unusual items (note 16)                                                           |       | 185  
|                                                                                  |                                        | Other                                                                             |       | 8    
|                                                                                  |                                        | (104)                                                                             |       | (39) 
|                                                                                  | Changes in non-cash working capital:   |                                                                                   |       |      
|                                                                                  |                                        | Temporary investments                                                             |       | 16   
|                                                                                  |                                        | Accounts receivable                                                               |       | 7    
|                                                                                  |                                        | Inventories                                                                       |       | 82   
|                                                                                  |                                        | Prepaid expenses                                                                  |       | 5    
|                                                                                  |                                        | Accounts payable and accrued charges                                              |       |      
|                                                                                  |                                        | 42                                                                                |       | (20) 
|                                                                                  |                                        | (62)                                                                              |       | (59) 
|Cash flows from
    investing activities:                                         |                                        |                                                                                   |       |      
|                                                                                  | Additions to fixed assets              |                                                                                   | (80)  |      
|                                                                                  | Proceeds from disposal of fixed assets |                                                                                   | 5     |      
|                                                                                  | Proceeds from disposal of operations   |                                                                                   | 12    |      
|                                                                                  | Other                                  |                                                                                   | (9)   |      
|                                                                                  |                                        | (72)                                                                              |       | (163)
|Cash flows from financing activities:                                             |                                        |                                                                                   |       |      
|                                                                                  | Change in operating bank loans         |                                                                                   | 47    |      
|                                                                                  | Increase in long-term debt             |                                                                                   | 19    |      
|                                                                                  | Repayments of long-term debt           |                                                                                   | (9)   |      
|                                                                                  | Change in other long-term liabilities  |                                                                                   | (2)   |      
|                                                                                  | Other                                  |                                                                                   | 9     |      
|                                                                                  |                                        | 64                                                                                |       | 132  
|Cash used by continuing operations                                                |                                        | (70)                                                                              |       | (90) 
|Cash generated by discontinued
    operations (note 2)                            |                                        | 91                                                                                |       | 21   
|                                                                                  |                                        | 21                                                                                |       | (69) 
|Foreign exchange gain on cash and cash
    equivalents held in foreign currencies | -                                      |                                                                                   | (1)  
|Net increase
    (decrease) in cash and cash equivalents                          |                                        | 21                                                                                |       | (70) 
|                                                                                  |                                        |                                                                                   |       |      
|Cash and cash
    equivalents, net of bank indebtedness, beginning of year        |                                        | -                                                                                 |       | 70   
|                                                                                  |                                        |                                                                                   |       |      
|Cash and cash equivalents, net of bank
    indebtedness, end of year              | $                                      | 21                                                                                | $     | -    

Interest paid in 2006 totalled $135 million (2005 - $136
million) and income taxes paid amounted to $2 million (2005 - $8 million).

See accompanying notes to consolidated financial statements.

- 3 -

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|TEMBEC
    INDUSTRIES INC.                                   
|-------------------------------------------------------------
|Consolidated Business Segment Information                    
|                                                             
|Years
    ended September 30, 2006 and September 24, 2005    
|(in millions of
    dollars)                                 
|                                                             
|                                                             
|                                                             
|                                                             
|                                                             
|                                                             
|Sales:                                                       
|                                                             
|                                                             
|                                                             
|Earnings (loss) before
    the following                     
|Depreciation and
    amortization (note 15)                  
|Unusual items (note
    16)                                  
|Operating loss from
    continuing operations                
|Net fixed asset
    additions:                               
|                                                             
|                                                             
|                                                             
|Goodwill                                                     
|Identifiable assets -
    excluding cash and cash equivalents
|Cash and cash
    equivalents                                
|Total assets                                                 
|                                                             
|                                                             
|                                                             
|                                                             
|                                                             
|                                                             
|                                                             
|Sales:                                                       
|                                                             
|                                                             
|                                                             
|Earnings (loss) before
    the following                     
|Depreciation and
    amortization (note 15)                  
|Unusual items (note
    16)                                  
|Operating earnings
    (loss) from continuing
    operations 
|Net fixed asset
    additions:                               
|                                                             
|                                                             
|                                                             
|Goodwill                                                     
|Identifiable assets -
    excluding cash and cash equivalents
|Cash and cash
    equivalents                                
|Total assets                                                 

- 4 -

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|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Consolidated Geographic Segment
    Information          
|                                                         
|Years ended September 30, 2006
    and September 24, 2005
|(in millions of dollars)                                 
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|Sales (by final destination):                            
|Canada                                                   
|United States                                            
|Pacific Rim and India                                    
|United Kingdom, Europe and other                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|Sales (by final destination):                            
|Canada                                                   
|United States                                            
|Pacific Rim and India                                    
|United Kingdom, Europe and other                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|Fixed assets and goodwill:                               
|Canada                                                   
|United States                                            
|United Kingdom, Europe and other                         
|                                                         
|                                                         

- 5 -

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|TEMBEC INDUSTRIES INC.                               
|-----------------------------------------------------
|Notes to Consolidated Financial Statements           
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

1. Significant accounting policies:

Changes in accounting policies

Effective September 26, 2004, the
Company adopted retroactively with restatement the new recommendations of the
Canadian Institute of Chartered Accountants (CICA) under CICA Handbook Section
3110 with respect to asset retirement obligations. These recommendations require
entities to record a liability at fair value, in the period in which a legal
obligation associated with the retirement of an asset is incurred. The
associated costs are capitalized as part of the carrying value of the related
asset and depreciated over its remaining useful life. The liability is accreted
using a credit adjusted risk free interest rate. For such assets, a liability
will be initially recognized in the period in which sufficient information
exists to estimate a range of possible settlement dates. For the Company, asset
retirement obligations in connection with the adoption of CICA Handbook Section
3110 were primarily related to landfill capping obligations. The adoption of
CICA Handbook Section 3110 has decreased the September 25, 2004 retained
earnings by $1 million, increased net fixed assets by $1 million, decreased
future income taxes by $1 million and increased liabilities by $3 million.

Basis of consolidation

The consolidated financial statements
include the accounts of Tembec Industries Inc. (the ''Corporation'') and all its
subsidiaries and joint ventures (collectively ''Tembec'' or the ''Company'').
Investments over which the Corporation has effective control are fully
consolidated. Investments over which the Corporation exercises significant
influence are accounted for by the equity method. The Corporation's interest in
joint ventures is accounted for by the proportionate consolidation method.

Business of the Company

The Company operates an integrated
forest products business. The performance of each segment is evaluated by the
management of the Company against short-term and long-term financial objectives
as well as environmental and other key criteria. The Forest Products segment
consists primarily of forest and sawmill operations, which produce lumber and
building materials. The Pulp segment includes the manufacturing and marketing
activities of a number of different types of pulps. The Paper segment consists
primarily of production and sales of newsprint, coated papers and bleached
board. The Chemical and other products segment consists primarily of the
transformation and sale of resins and pulp by-products. Intersegment transfers
of wood chips, pulp and other services are recorded at transfer prices agreed to
by the parties, which are intended to approximate fair market value. The
accounting policies used in these business segments are the same as those
described in the annual audited consolidated financial statements.

- 6 -

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|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

1. Significant accounting policies (continued):

Use of estimates

The preparation of financial
statements in conformity with generally accepted accounting principles (GAAP)
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the period. Significant areas requiring the use of
management estimates are: useful lives of plant and equipment, value of
investments, impairment of long-lived assets and goodwill, employee future
benefits, income taxes, asset retirement obligations and environmental accruals.
Actual results could differ from those estimates.

Revenue

The Company recognizes revenue when
persuasive evidence of an arrangement exists, goods have been delivered, there
are no uncertainties surrounding product acceptance, the related revenue is
fixed and determinable and collection is reasonably assured. Revenues are
recorded using the gross method.

Cash and cash equivalents

Cash and cash equivalents include
cash on hand, demand deposits, banker's acceptances and commercial paper with
maturities of three months or less from date of purchase are recorded at cost,
which approximates market value.

Inventories

Finished goods are valued at the
lower of cost, determined on an average cost basis, and net realizable value.
Other inventories are valued at the lower of cost, determined on an average cost
basis, and replacement cost.

Investments

Investments in affiliated companies
in which Tembec has no significant influence are carried at cost. Investments
over which the Company exercises significant influence are accounted for by the
equity method.

- 7 -

---



|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

1. Significant accounting policies (continued):

Fixed assets and government
assistance

Fixed assets are recorded at cost
after deducting investment tax credits and government assistance. Depreciation
and amortization are provided over their estimated useful lives, generally on a
straight-line basis, as follows:

| | Asset                                                             | Period        | 
| | ----------------------------------------------------------------- | ------------- | 
| |                                                                   |               | 
| | Buildings, Pulp, Newsprint
    and Papermill production equipment | 20 - 30 years | 
| | Sawmill production equipment                                      | 10 - 15 years | 
| | Boardmill production
    equipment                                | 25 - 30 years | 
| |                                                                   |               | 

Certain forest access roads and
timber holdings are depreciated in relation to the volume of wood cut and
certain machinery and equipment are depreciated using units of production.
Repairs and maintenance as well as planned shutdown maintenance are charged to
expense as incurred.

Capitalized interest is based on the
average cost of construction of major projects in progress during the year,
using interest rates actually paid on long-term debt.

Impairment of long-lived assets

Long-lived assets are reviewed for
impairment upon the occurrence of events or changes in circumstances indicating
that the carrying value of the assets may not be recoverable, as measured by
comparing their net book value to the estimated undiscounted future cash flows
generated by their use. Impaired assets are recorded at fair value, determined
principally by using discounted future cash flows expected from their use and
eventual disposition.

Goodwill

Goodwill is subject to an annual
impairment test or more frequently if events or changes in circumstances
indicate that goodwill might be impaired. Testing for impairment is accomplished
mainly by determining whether the fair value of a reporting unit, based on
discounted cash flows, exceeds the net carrying amount of the net assets of that
reporting unit as at the assessment date. If the fair value is greater than the
carrying amount, no impairment is necessary. In the event that the carrying
amount exceeds the fair value, a second test must be performed whereby the fair
value of the reporting unit's goodwill must be estimated to determine if it is
less than its carrying amount. Fair value of goodwill is estimated in the same
manner as goodwill is determined in an acquisition, that is, the excess of the
fair value of the reporting unit's over the fair value of the identifiable net
assets of the reporting unit. In the case where the carrying value of the
reporting unit exceeds its fair value, the carrying value of goodwill will be
reduced and an impairment loss recognized and charged to operating results.

- 8 -

---



|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

1.Significant accounting policies (continued):

Other assets

(i)      Development and pre-operating expenses are amortized on a straight-line basis
over a period not exceeding 5 years.

(ii)    
Financing costs are amortized on a straight-line basis over the expected term of
the related debt.

(iii)    Timber rights are amortized on a straight-line basis
over a period not exceeding 40 years.

(iv)   
Assets held for resale are valued at the lower of cost and net realizable value.

Environmental costs

The Company is subject
to environmental laws and regulations enacted by federal, provincial, state and
local authorities. Environmental expenditures that will benefit the Company in
future years are recorded at cost and capitalized as part of fixed assets.
Depreciation is charged to income over the estimated future benefit period of
the assets. Environmental expenditures, that are not expected to provide a
benefit to the Company in future periods, are accrued and expensed to earnings,
on a site-by-site basis, when a requirement to remedy an environmental exposure
is probable and a cost can be reasonably estimated.

Asset retirement
obligations

Asset retirement
obligations are recognized, at fair value, in the period in which the Company
incurs a legal obligation associated to the retirement of an asset. The
associated costs are capitalized as part of the carrying value of the related
asset and depreciated over its remaining useful life. The liability is accreted
using a credit adjusted risk-free interest rate.

Employee future
benefits

Pension benefit plans

The Company accrues
the cost of defined benefit plans as determined by independent actuaries based
on assumptions determined by the Company. The net periodic benefit cost
includes:

| | - | the cost of pension
    benefits provided in exchange for employees' services rendered during the
    year;                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                        
| | - | the interest cost of
    pension obligations;                                                                                                                                                                                          
| |   |                                                                                                                                                                                                                                        
| | - | the expected return on
    pension fund assets based on the fair value of plan assets;                                                                                                                                                 
| |   |                                                                                                                                                                                                                                        
| | - | gains or losses on
    settlements or curtailments, where, when the restructuring of a benefit plan
    gives rise to both a curtailment and a settlement of obligations, the
    curtailment is accounted for prior to the settlement;
| |   |                                                                                                                                                                                                                                        
| | - | the straight-line
    amortization of past service costs and plan amendments over the average
    remaining service period of the active employee group covered by the plans;
    and                                                  

- 9 -

---



|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

1.Significant accounting policies (continued):

Employee future benefits (continued)

Pension benefit plans (continued)

| | - | the amortization of
    cumulative unrecognized net actuarial gains and losses in excess of 10% of
    the greater of the accrued benefit obligation or fair value of plan assets
    at the beginning of year over the average remaining service period of the
    active employee group covered by the plans.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The pension plan obligations are
determined in accordance with the projected benefit method prorated on services.

Other employee future benefit plans

The Company accrues the cost of
post-retirement benefits other than pensions as determined by independent
actuaries based on assumptions determined by the Company. These benefits, which
are funded by the Company as they become due, include life insurance programs as
well as medical and dental benefits. The Company amortizes the cumulative
unrecognized net actuarial gains and losses in excess of 10% of the accrued
benefit obligation at the beginning of the year, over the average remaining
service period of the active employee group covered by the plans.

Translation of foreign currencies

Monetary assets and liabilities of
domestic and integrated foreign operations denominated in foreign currencies are
translated at year-end exchange rates. Non-monetary assets and liabilities of
integrated foreign operations are translated at the historical rate relevant for
the particular asset or liability. The exchange gains or losses resulting from
the translations are included in "Interest, foreign exchange and other"
expenses. Revenues and expenses are translated at prevailing market rates in the
recognition year.

Income taxes

The Company accounts for income taxes
using the asset and liability method. Under this method, future income tax
assets and liabilities are determined based on the temporary differences between
the accounting basis and the tax basis of assets and liabilities. These
temporary differences are measured using the current tax rates and laws expected
to apply when these differences reverse. Future tax benefits are recognized to
the extent that realization of such benefits is considered more likely than not.
The effect on future tax assets and liabilities of a change in income tax rates
is recognized in earnings in the period that includes the substantive enactment
date.

Investment tax credits related to
research and development are recognized in earnings as a reduction of such
expenses when the Company has made the qualifying expenditures and there is
reasonable assurance that the credits will be realized.

- 10 -

---



|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

1.Significant accounting policies (continued):



The Company manages its foreign
exchange exposure on anticipated net cash inflows, principally U.S. dollars and
Euros, through the use of options and forward contracts.

The Company may, from time to time,
manage its exposure to commodity price risk associated with sales of lumber,
pulp and newsprint through the use of cash-settled hedge (swap) contracts. The
Company does not hold or issue derivative financial instruments for trading or
speculative purposes.

The Company does not currently apply
hedge accounting for these derivative financial instruments. These are measured
at fair value, with changes in fair value after September 27, 2003, recognized
in income. The unrealized gain as of September 27, 2003 was amortized into
earnings based on the original maturity date of the contracts.

2.

On February 27, 2006, the Company
completed the sale of its oriented strandboard (OSB) business, part of the
Forest Products segment, located in Saint-Georges-de-Champlain, Quebec to Jolina
Capital Inc. ("Jolina") for total consideration of $98 million, representing
fair value, including net working capital of $7 million. An amount of $88
million was paid on the closing and the balance is payable in the form of a $10
million interest-bearing note, repayable in equal annual instalments over a
five-year period. Jolina is a Company controlled by Mr. Emanuele (Lino) Saputo,
a significant shareholder of Tembec Inc. and a director of the Company. As a
result of this transaction, the Company recorded a gain of $63 million. The
after-tax effect was $47 million.

The financial results of the OSB
operation, as well as the gain on disposition have been reclassified as
discontinued operations. Comparative figures have also been reclassified to
exclude the OSB mill's results from the continuing operations.

Condensed
earnings from discontinued operations related to the OSB are as follows:

| |                                           |   | 2006 |   | 2005
| | ----------------------------------------- | - | ---- | - | ----
| |                                           |   |      |   |     
| | Sales                                     | $ | 38   | $ | 86  
| | Operating profit                          | $ | 7    | $ | 17  
| | Earnings from discontinued
    operations | $ | 51   | $ | 11  
| |                                           |   |      |   |     

- 11 -

---



|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

2. Discontinued operations (continued):

Condensed cash flows from discontinued operations are
as follows:

| |                                                 |   | 2006 |   | 2005
| | ----------------------------------------------- | - | ---- | - | ----
| |                                                 |   |      |   |     
| | Cash flows from operating activities            | $ | 10   | $ | 22  
| | Cash flows from investing activities            |   | 81   |   | (1) 
| |                                                 |   |      |   |     
| | Cash flows generated by discontinued operations | $ | 91   | $ | 21  

3. Inventories:

| |                        |   | 2006 |   | 2005
| | ---------------------- | - | ---- | - | ----
| |                        |   |      |   |     
| | Finished goods         | $ | 197  | $ | 279 
| | Logs and wood chips    |   | 152  |   | 151 
| | Supplies and materials |   | 134  |   | 141 
| |                        |   |      |   |     
| |                        | $ | 483  | $ | 571 

- 12 -

---



|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

4. Investments in joint ventures:

The consolidated financial statements
include the Company's proportionate share of the revenues, expenses, assets and
liabilities of AV Cell Inc., 1387332 Ontario Limited (Marathon Pulp joint
venture), Temlam Inc., and Temrex Forest Products Limited Partnership at 50%, as
follows:

| |                                                            |   | 2006 |   | 2005
| | ---------------------------------------------------------- | - | ---- | - | ----
| |                                                            |   |      |   |     
| | Assets:                                                    |   |      |   |     
| | Current assets                                             | $ | 71   | $ | 76  
| | Fixed assets and other                                     |   | 159  |   | 162 
| |                                                            |   |      |   |     
| |                                                            | $ | 230  | $ | 238 
| |                                                            |   |      |   |     
| | Liabilities and equity:                                    |   |      |   |     
| | Current liabilities                                        | $ | 59   | $ | 61  
| | Long-term debt                                             |   | 59   |   | 51  
| | Other long-term liabilities                                |   | 8    |   | 9   
| | Equity                                                     |   | 104  |   | 117 
| |                                                            |   |      |   |     
| |                                                            | $ | 230  | $ | 238 
| |                                                            |   |      |   |     
| | Sales                                                      | $ | 232  | $ | 226 
| | Expenses                                                   |   | 238  |   | 227 
| |                                                            |   |      |   |     
| | Loss before income taxes, interest, and minority interests | $ | (6)  | $ | (1) 
| |                                                            |   |      |   |     
| | Net loss                                                   | $ | (9)  | $ | (3) 
| |                                                            |   |      |   |     
| | Cash provided by (used in):                                |   |      |   |     
| | Operating                                                  | $ | (1)  | $ | 2   
| | Investing                                                  |   |     |   | 34  
| | Financing                                                  |   | (4)  |   | (33)
| |                                                            |   |      |   |     
| |                                                            | $ | (5)  | $ | 3   

- 13 -

---



|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

5. Fixed assets:

| |                                         |   |       |              |       |       | 2006  |      |              |   |       |   | 2005 
| | --------------------------------------- | - | ----- | ------------ | ----- | ----- | ----- | ---- | ------------ | - | ----- | - | -----
| |                                         |   |       |              |       |       |       |      |              |   |       |   |      
| |                                         |   |       |              |       |       | Net   |      |              |   |       |   | Net  
| |                                         |   |       | Accumulated  |       | book  |       |      | Accumulated  |   | book 
| |                                         |   | Cost  | depreciation |       | value |       | Cost | depreciation |   | value
| |                                         |   |       |              |       |       |       |      |              |   |       |   |      
| | Land                                    | $ | 19    | $            | -     | $     | 19    | $    | 19           | $ |      | $ | 19   
| | Production buildings and
    equipment: |   |       |              |       |       |       |      |              |   |       |   |      
| | Pulp mills                              |   | 1,814 |              | 1,100 |       | 714   |      | 1,780        |   | 844   |   | 936  
| | Newsprint and Paper mills               |   | 863   |              | 406   |       | 457   |      | 861          |   | 368   |   | 493  
| | Sawmills                                |   | 480   |              | 281   |       | 199   |      | 488          |   | 249   |   | 239  
| | Boardmill                               |   | 294   |              | 137   |       | 157   |      | 294          |   | 126   |   | 168  
| | Roads and timber holdings               |   | 151   |              | 72    |       | 79    |      | 144          |   | 62    |   | 82   
| | Other buildings and equipment           |   | 100   |              | 49    |       | 51    |      | 89           |   | 43    |   | 46   
| | Assets under construction               |   | 120   |              | -     |       | 120   |      | 109          |   |      |   | 109  
| |                                         |   |       |              |       |       |       |      |              |   |       |   |      
| |                                         | $ | 3,841 | $            | 2,045 | $     | 1,796 | $    | 3,784        | $ | 1,692 | $ | 2,092

6. Other assets:

| |                                                       |   | 2006 |   | 2005
| | ----------------------------------------------------- | - | ---- | - | ----
| |                                                       |   |      |   |     
| | Deferred costs, at amortized
    value:               |   |      |   |     
| | Development, pre-operating costs and other            | $ | 7    | $ | 10  
| | Financing costs                                       |   | 7    |   | 11  
| | Assets held for sale                                  |   | 5    |   | 1   
| | Long-term loans to employees                          |   | 4    |   | 8   
| | Timber rights                                         |   | 29   |   | 31  
| | Deferred pension costs                                |   | 62   |   | 66  
| | Investment tax credit and
    income taxes receivable |   | 59   |   | 61  
| |                                                       |   |      |   |     
| |                                                       | $ | 173  | $ | 188 

Long-term loans to employees:

Included in long-term loans to
employees is $3 million (2005 - $6 million) of share purchase loans with respect
to shares of Tembec Inc., the ultimate parent company. At September 30, 2006,
there were 467,875 (2005 - 489,575) shares held in trust in respect of the
employee loans for which the market value was $1.39 (2005 - $2.38) per share.
These shares are held in trust as security for the loans, which are non-interest
bearing, and with defined repayment terms not exceeding 10 years.

- 14 -

---



|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

7. Goodwill:

| |                                 |          |       |          |              | Chemicals |   |  
| | ------------------------------- | -------- | ----- | -------- | ------------ | --------- | - | -
| |                                 | Forest   |       |          | & other      |           |  
| |                                 | products | Paper | products | Consolidated
| |                                 |          |       |          |              |           |   |  
| | 2006                            |          |       |          |              |           |   |  
| |                                 |          |       |          |              |           |   |  
| | Goodwill, beginning of
    year | $        | 2     | $        | -            | $         | 1 | $
| | Goodwill impairment             |          | -     |          | -            |           | - |  
| |                                 |          |       |          |              |           |   |  
| | Goodwill, end of year           | $        | 2     | $        | -            | $         | 1 | $
| |                                 |          |       |          |              |           |   |  
| | 2005                            |          |       |          |              |           |   |  
| |                                 |          |       |          |              |           |   |  
| | Goodwill, beginning of
    year | $        | 6     | $        | 22           | $         | 1 | $
| | Goodwill impairment             |          | (4)   |          | (22)         |           | - |  
| |                                 |          |       |          |              |           |   |  
| | Goodwill, end of year           | $        | 2     | $        | -            | $         | 1 | $

8. Operating bank loans:

The Company had approximately $317
million (2005 - $428 million) of revolving operating credit facilities for which
accounts receivable and inventories are pledged as collateral. Interest rates
range between prime and prime plus 2.25%. At September 30, 2006, $235 million
(2005 - $188 million) were drawn on the above facilities and $48 million (2005 -
$29 million) were reserved for letters of credit.

- 15 -

---



|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

9. Long-term debt:

| |                                                              |   | 2006  |   | 2005 
| | ------------------------------------------------------------ | - | ----- | - | -----
| |                                                              |   |       |   |      
| | Tembec Industries
    Inc.:                                  |   |       |   |      
| |                                                              |   |       |   |      
| | 8.625% Unsecured Senior Notes (US$350 million)               |   |       |   |      
| | redeemable at the option of the Company on or
    after      |   |       |   |      
| | June 30, 2004 at specified redemption prices, due            |   |       |   |      
| | June 30, 2009 with semi-annual interest payments
    due     |   |       |   |      
| | June 30 and December 30 of each year                         | $ | 391   | $ | 410  
| |                                                              |   |       |   |      
| | 8.50% Unsecured Senior Notes (US$500 million)                |   |       |   |      
| | redeemable at any time at the option of the
    Company,     |   |       |   |      
| | at a price that includes a make-whole payment,
    due       |   |       |   |      
| | February 1, 2011 with semi-annual interest
    payments      |   |       |   |      
| | due February 1 and August 1 of each year                     |   | 559   |   | 586  
| |                                                              |   |       |   |      
| | 7.75% Unsecured Senior Notes (US$350 million)                |   |       |   |      
| | redeemable at any time at the option of the
    Company,     |   |       |   |      
| | at a price that includes a make-whole payment,
    due       |   |       |   |      
| | March 15, 2012 with semi-annual interest payments            |   |       |   |      
| | due March 15 and September 15 of each year                   |   | 391   |   | 410  
| |                                                              |   |       |   |      
| | Advances from the ultimate parent company, Tembec            |   |       |   |      
| | Inc., with interest at cost to Tembec Inc., with
    no      |   |       |   |      
| | specific terms of repayment                                  |   | 67    |   | 67   
| |                                                              |   |       |   |      
| | Tembec SAS:                                                  |   |       |   |      
| |                                                              |   |       |   |      
| | Unsecured term loans (Euro 2 million in 2006;                |   |       |   |      
| | Euro 3 million in 2005), bearing interest at
    rates up to |   |       |   |      
| | 1.5%, repayable and maturing at various dates to             |   |       |   |      
| | December 2013                                                |   | 3     |   | 4    
| |                                                              |   |       |   |      
| | Advances from related Company, Tembec
    Envirofinance      |   |       |   |      
| | SAS, non-interest bearing, repayable and maturing
    at     |   |       |   |      
| | various dates from June 2014 to June 2017                    |   | 21    |   | 12   
| |                                                              |   |       |   |      
| | Other Tembec SAS obligations                                 |   | 7     |   | 7    
| |                                                              |   |       |   |      
| | Balance carried forward                                      |   | 1,439 |   | 1,496

- 16 -

---



|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

9. Long-term debt (continued):

| |                                                            |   | 2006  |   | 2005 
| | ---------------------------------------------------------- | - | ----- | - | -----
| |                                                            |   |       |   |      
| | Balance brought
    forward                                | $ | 1,439 | $ | 1,496
| |                                                            |   |       |   |      
| | 1387332 Ontario
    Limited (Marathon Pulp joint venture)  |   |       |   |      
| | (50% proportionate consolidation):                         |   |       |   |      
| |                                                            |   |       |   |      
| | Term loan bearing interest at prime rate plus
    2.75%,   |   |       |   |      
| | maturing March 31, 2006                                    |   | 10    |   | 13   
| |                                                            |   |       |   |      
| | Temlam Inc. (50%
    proportionate consolidation):         |   |       |   |      
| | Term loans bearing interest at 6.75% and between
    prime |   |       |   |      
| | rate plus 3⁄4% and 11⁄2%, maturing on various dates
    to     |   |       |   |      
| | June 2015, repayable in monthly instalments of             |   |       |   |      
| | varying amounts                                            |   | 40    |   | 32   
| |                                                            |   |       |   |      
| | Other long-term obligations                                |   | 14    |   | 16   
| |                                                            |   | 1,503 |   | 1,557
| |                                                            |   |       |   |      
| | Less current portion                                       |   | 21    |   | 21   
| |                                                            |   |       |   |      
| |                                                            | $ | 1,482 | $ | 1,536

Certain covenants:

The indentures of agreements for
Tembec's borrowings contain restrictive covenants, including restrictions on the
incurrence of additional indebtedness, the investments in other persons, the
creation of liens, sale and leaseback transactions, certain amalgamations,
mergers, consolidations and sales of assets and certain transactions with
affiliates.

The Marathon joint venture does not meet certain financial covenants
on its revolving operating line and its term loan with a syndicate of banks. As
a result, the operating line, which expired in March 2005, has not been renewed
pending the outcome of ongoing discussions with the syndicate. The term loan has
been reclassified as short term. There is no recourse to the shareholders on
either of these loan facilities.

Instalments on consolidated long-term debt for
the four years following September 29, 2007 are as follows:

| |      |   |    
| | ---- | - | ---
| | 2008 | $ | 13 
| | 2009 |   | 405
| | 2010 |   | 24 
| | 2011 |   | 572
| |      |   |    

- 17 -

---



|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

10.    Other long-term liabilities and credits:

| |                                                                   |   | 2006 |   | 2005
| | ----------------------------------------------------------------- | - | ---- | - | ----
| |                                                                   |   |      |   |     
| | Accrued benefit liability -
    pension benefit plans             | $ | 59   | $ | 54  
| | Accrued benefit liability -
    other benefit plans               |   | 61   |   | 57  
| | Balance payable on
    acquisition of Jager Building Systems Inc. |   | 4    |   | 7   
| | Reforestation - BC operations                                     |   | 7    |   | 6   
| | Environment and other asset
    retirement obligations            |   | 8    |   | 8   
| | Deferred government
    assistance                                |   | 4    |   | -   
| | Deferred gain on sale of
    assets                               |   | 5    |   | 5   
| | Other                                                             |   | 2    |   | 3   
| |                                                                   |   |      |   |     
| |                                                                   | $ | 150  | $ | 140 

11.    Minority interests:

| |              |   | 2006 |   | 2005
| | ------------ | - | ---- | - | ----
| |              |   |      |   |     
| | AV Cell Inc. | $ | 5    | $ | 5   

12.    Redeemable preferred shares:

| |                                                  |   | 2006 |   | 2005
| | ------------------------------------------------ | - | ---- | - | ----
| |                                                  |   |      |   |     
| | 16,627,500 Series 2 Class B
    preferred shares | $ | 17   | $ | 17  
| | 9,103,710 Series 4 Class B
    preferred shares  |   | 9    |   | 9   
| |                                                  |   |      |   |     
| |                                                  | $ | 26   | $ | 26  

- 18 -

---



|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

13.   Share capital:

Authorized:

Unlimited number of common voting
shares, without par value.

Unlimited number of non-voting Class
B preferred shares issuable in series without par value, with other attributes
to be determined at time of issuance:

Unlimited number of Series 2 Class B
shares redeemable at any time by the Company and, commencing on June 26, 2011,
at the option of the holder, the redemption price being equal to the issue price
plus declared and unpaid dividends. The Series 2 Class B shares are entitled to
a preferential and non-cumulative dividend equal to the dividend yield
percentage paid on the common shares.

9,103,710 0.5% per month
non-cumulative Series 4 Class B shares redeemable at any time by the Company and
after September 30, 2009, at the option of the holder, the redemption price
being equal to the issue price plus declared and unpaid dividends. The Series 4
Class B shares can be redeemed in cash or in a variable number of common shares
at the option of the Company.

Unlimited number of Class C shares,
non-voting, participating and redeemable at the issue price plus the increase in
the book value per share since the issue date.

Unlimited number of non-voting Class
D shares, redeemable at the option of the Company and the holders at the fair
market value of the consideration received by the Company upon issue of such
share; entitled to a preferential and non-cumulative annual dividend at the rate
of 6% of the redemption price.

Unlimited number of non-voting Class
E shares, redeemable at the option of the Company and the holders at the fair
market value of the consideration received by the Company upon issue of such
share; entitled to a preferential and non-cumulative annual dividend at the rate
of 6% of the redemption price.

| |                                             |   | 2006 |   | 2005
| | ------------------------------------------- | - | ---- | - | ----
| |                                             |   |      |   |     
| | Issued and fully paid:                      |   |      |   |     
| | 536,807,704 Class A shares                  | $ | 732  | $ | 732 
| | Series 2 Class B preferred shares (note 12) |   | -    |   | -   
| | Series 4 Class B preferred shares (note 12) |   | -    |   | -   
| |                                             |   |      |   |     
| |                                             | $ | 732  | $ | 732 

- 19 -

---



|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

14.   Guarantees, commitments and contingencies:

Guarantees:

Under the terms of the three
indentures governing the Unsecured Senior Notes, the Company has agreed to
indemnify its American lenders against the application of withholding taxes.
These indemnifications extend for the term of the indebtedness and do not
provide any limit on the maximum potential liability. At September 30, 2006 and
September 24, 2005, there were no outstanding liabilities relating to these
indemnifications.

The Company and certain of its
subsidiaries have granted irrevocable letters of credit, issued by high rated
financial institutions, to third parties to indemnify them in the event the
Company does not perform its contractual obligations. The Company has not
recorded any additional liability with respect to these guarantees, as the
Company does not expect to make any payments in excess of what is recorded in
the Company's financial statements. The letters of credit mature at various
dates in fiscal 2007.

Countervailing and antidumping
duties:

In response to the expiration of the
Softwood Lumber Agreement on April 1, 2001, a number of industry groups in the
United States filed petitions with the U.S. Department of Commerce ("USDOC") and
the U.S. International Trade Commission ("USITC) alleging unfair trade practices
by the Canadian softwood lumber industry. These petitions proposed that certain
softwood lumber exports from Canada to the United States be charged with
countervailing and antidumping duties.

Countervailing duty

Effective May 22, 2002, the Company
was subject to an initial countervailing duty of 18.79%. A charge of $18 million
was incurred during Fiscal 2002 relating to lumber shipments to the U.S. between
May 22 and September 28, 2002. A charge of $50 million was incurred relating to
lumber shipments to the U.S. between September 29, 2002 and September 27, 2003.
A charge of $68 million was incurred relating to lumber shipments to the U.S.
between September 28, 2003 and September 25, 2004. On December 20, 2004, the
USDOC reduced the countervailing duty deposit rate to 17.18%. On February 17,
2005, the rate was further modified to 16.37%. A charge of $57 million was
incurred relating to lumber shipments to the U.S. between September 26, 2004 and
September 24, 2005. On December 12, 2005, the USDOC reduced the countervailing
duty deposit rate to 8.7%. A charge of $30 million was incurred relating to
lumber shipments to the U.S. between September 25, 2005 and September 30, 2006.

- 20 -

---



|TEMBEC INDUSTRIES INC.                                   
|---------------------------------------------------------
|Notes to Consolidated Financial
    Statements, Continued
|                                                         
|Years ended September 30, 2006 and September 24, 2005    
|(in millions of dollars, unless otherwise noted)         

14.   Guarantees, commitments and contingencies (continued):

Antidumping duty

Effective May 22, 2002, the Company
was subject to an initial average antidumping duty of 10.21%. While all cash
payments since that date were made at the required deposit rates, the Company
has, and continues to, regularly review its estimate of the antidumping duty
expense by applying the USDOC's methodology to updated sales and cost data as it
becomes available. The Company records a charge equal to the greater of the
calculated amount or the actual duties deposited. A charge of $10 million was
incurred during Fiscal 2002 relating to lumber shipments to the U.S. between May
22 and September 28, 2002. A charge of $31 million was incurred relating to
lumber shipments to the U.S. between September 29, 2002 and September 27, 2003.
A charge of $44 million was incurred relating to lumber shipments to the U.S.
between September 28, 2003 and September 25, 2004. On December 20, 2004, the
USDOC increased the antidumping duty deposit to 10.59%. On February 17, 2005,
the rate was further modified to 9.1%. A charge of $32 million was incurred
relating to lumber shipments to the U.S. between September 26, 2004 and
September 24, 2005. On December 12, 2005, the USDOC reduced the antidumping duty
deposit rate to 4.02%. As a result, the Company also recorded a favourable
adjustment of $10 million relating to previously accrued antidumping duty
charges in excess of actual cash deposits. A charge of $15 million was incurred
relating to lumber shipments to the U.S. between September 25, 2005 and
September 30, 2006.

On October 12, 2006, Canada and the
United States entered into an agreement to govern the shipment of Canadian
softwood lumber into the United States. The agreement also provided for the
return of a portion of the monies deposited by Canadian exporters since May
2002. See note on Subsequent events.

Commitments:

The Company has entered into
operating leases for property, plant and equipment for expected cash out flows
of $25 million, of which $8 million is due in fiscal 2007.

Contingencies:

Tembec is party to claims and
lawsuits, which are being contested. Management believes that the resolution of
these claims and lawsuits will not have a material adverse effect on Tembec's
financial condition, earnings or liquidity.

- 21 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

15.  Depreciation and amortization:

| |                                                         |   | 2006 |   | 2005
| | ------------------------------------------------------- | - | ---- | - | ----
| |                                                         |   |      |   |     
| | Fixed assets                                            | $ | 199  | $ | 228 
| | Deferred development, pre-operating costs and
    other |   | 7    |   | 4   
| | Impairment charge                                       |   | -    |   | 4   
| |                                                         |   |      |   |     
| |                                                         | $ | 206  | $ | 236 

During 2005, the Company recognized
an impairment charge of $4 million ($2 million after-tax) related to an Eastern
Ontario sawmill. These assets are included in the Forest products segment.

16.  Unusual items:

2006

During the March 2006 quarter, the
Company recognized an impairment charge of $169 million related to the property,
plant and equipment of the Smooth Rock Falls, Ontario pulpmill. As a result of
the announced indefinite idling of the pulpmill, the Company undertook an
impairment review and found that the majority of its long-lived assets were no
longer recoverable and exceeded their fair value. The after-tax effect of this
charge was $111 million. Also during the quarter, as a result of the ongoing
restructuring of the St. Francisville, Louisiana papermill, the Company recorded
an unusual charge of $7 million relating to additional severance and other
related costs. As no tax recovery was recorded, the after-tax effect of the
charge was $7 million.

During the June 2006 quarter, the Company's joint
venture, Temlam Inc., completed the sale of its metal plates and webs operations
located in Bolton, Ontario. Based on the Company's 50% ownership, consideration
received amounted to $11 million including net working capital of $2 million. As
a result of this transaction, the Company recorded a gain of $5 million. The
after-tax effect of this gain was $3 million.

- 22 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

16.  Unusual items (continued):

2006 (continued)

During the September 2006 quarter,
the Company commenced a process to dispose of a small pine lumber operation
located in Brassac, France, and two international sales offices located in
Ireland and in the United States. Net assets of $8 million have been
reclassified in other assets as held for sale. An impairment charge of $4
million was recorded to adjust the net assets to their fair value. The Company
completed the sale of the remaining assets of the remanufacturing facility which
had been permanently closed during the June 2005 quarter. The Company recorded a
gain of $1 million in respect to this transaction. The Company incurred a charge
of $9 million relating to the reduction in carrying value of the spare parts
inventory at the Smooth Rock Falls pulpmill. The mill was idled indefinitely at
the end of July 2006. The curtailment also resulted in a further charge of $5
million relating to the reduction of the unamortized past-service pension costs.
The after-tax effect of these charges was $14 million.

2005

During the December 2004 quarter, as
a result of a major restructuring of its sawmills in North Eastern Ontario, the
Company recorded a non-cash charge of $16 million including $3 million for
goodwill relating to the reduction of the carrying value of the fixed and other
assets of two sawmills that were permanently closed. Employee severance and
other closure costs amounting to $5 million were also recorded. The after-tax
effect of theses charges was $14 million.

During the June 2005 quarter, the
Company recorded a non-cash charge of $115 million relating to the reduction of
the carrying value of the fixed and other assets of three sawmills, a papermill
and a remanufacturing facility that were permanently or indefinitely closed.
Employee severance and other closure costs amounting to $21 million were also
recorded. The after-tax effect of these charges was $92 million.

- 23 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

16.  Unusual items (continued):

2005 (continued)

During the September 2005 quarter, as
a result of the permanent closure of the pressurized groundwood pulping line and
one of the four paper machines at the St. Francisville, Louisiana papermill, the
Company recorded a non-cash charge of $40 million relating to the reduction of
the carrying value of the fixed and other related assets. Employee severance and
other closure costs amounting to $5 million were also recorded. Also during the
September 2005 quarter, the Company recorded a non-cash charge of $30 million
relating to the reduction of the carrying value of a dismantled pulp machine and
a dismantled paper machine. During the September 2005 quarter, the Company
performed the required annual impairment test of goodwill and found that
impairment did exist in relation to its hardwood flooring and its newsprint
business. As a result, goodwill impairment charges of $1 million and $22
million, respectively were recorded. The after-tax effect of these charges was
$87 million.

The following table provides the
components of the unusual items by reportable segment:

| |                            |   |          |   |      |   |       |              | 2006
| | -------------------------- | - | -------- | - | ---- | - | ----- | ------------ | ----
| |                            |   |          |   |      |   |       |              |     
| |                            |   | Forest   |   |      |   |       |              |     
| |                            |   | products |   | Pulp |   | Paper | Consolidated
| |                            |   |          |   |      |   |       |              |     
| | Fixed assets write-down    | $ | 2        | $ | 169  | $ | -     | $            | 171 
| | Other assets               |   | 2        |   | 14   |   | 4     |              | 20  
| | Gain on sale of assets     |   | (6)      |   | -    |   | -     |              | (6) 
| | Severance and other labour |   |          |   |      |   |       |              |     
| | related costs              |   | -        |   | -    |   | 3     |              | 3   
| |                            |   |          |   |      |   |       |              |     
| |                            | $ | (2)      | $ | 183  | $ | 7     | $            | 188 

- 24 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

16.  Unusual items (continued):

| |                               |   |          |   |      |   |       |              | 2005
| | ----------------------------- | - | -------- | - | ---- | - | ----- | ------------ | ----
| |                               |   |          |   |      |   |       |              |     
| |                               |   | Forest   |   |      |   |       |              |     
| |                               |   | products |   | Pulp |   | Paper | Consolidated
| |                               |   |          |   |      |   |       |              |     
| | Fixed assets write-down       | $ | 34       | $ | -    | $ | 110   | $            | 144 
| | Fixed assets depreciation     |   | -        |   | -    |   | 38    |              | 38  
| | Goodwill impairment           |   | 4        |   | -    |   | 22    |              | 26  
| | Other assets                  |   | -        |   | 4    |   | 3     |              | 7   
| | Obsolescence of inventory and |   |          |   |      |   |       |              |     
| | other current assets          |   | 3        |   | -    |   | 6     |              | 9   
| | Severance and other labour    |   |          |   |      |   |       |              |     
| | related costs                 |   | 13       |   | -    |   | 10    |              | 23  
| | Idling and other costs        |   | 3        |   | -    |   | 5     |              | 8   
| |                               |   |          |   |      |   |       |              |     
| |                               | $ | 57       | $ | 4    | $ | 194   | $            | 255 

During the year, as a result of its restructuring
activities, the Company reduced its salaried and hourly workforce at the St.
Francisville, Louisiana papermill and recorded approximately $3 million for
termination costs including severance and other labour-related costs. In 2005,
the Company had recorded approximately $23 million for similar costs relating to
a number of locations. Idling and other costs of $8 million were also recorded.

The following table provides the reconciliation
components of the mill closure provisions by reportable segment.

| |                                                         |          |        |       |              |   | 2006
| | ------------------------------------------------------- | -------- | ------ | ----- | ------------ | - | ----
| |                                                         |          |        |       |              |   |     
| |                                                         |          | Forest |       |              |   |     
| |                                                         | products |        | Paper | Consolidated
| |                                                         |          |        |       |              |   |     
| | Opening balance                                         | $        | 8      | $     | 11           | $ | 19  
| | Additions: Severance and other labour-related
    costs |          | -      |       | 3            |   | 3   
| | Payments: Severance and other labour-related
    costs  |          | (2)    |       | (8)          |   | (10)
| | Idling and other costs                                  |          | (2)    |       | (1)          |   | (3) 
| |                                                         |          |        |       |              |   |     
| | Ending balance                                          | $        | 4      | $     | 5            | $ | 9   
| |                                                         |          |        |       |              |   |     

- 25 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

16.   Unusual items (continued):

| |                                                         |          |        |       |              |   | 2005
| | ------------------------------------------------------- | -------- | ------ | ----- | ------------ | - | ----
| |                                                         |          |        |       |              |   |     
| |                                                         |          | Forest |       |              |   |     
| |                                                         | products |        | Paper | Consolidated
| |                                                         |          |        |       |              |   |     
| | Opening balance                                         | $        | -      | $     | -            | $ | -   
| | Additions: Severance and other labour-related
    costs |          | 13     |       | 10           |   | 23  
| | Idling and other costs                                  |          | 3      |       | 5            |   | 8   
| | Payments: Severance and other labour-related
    costs  |          | (7)    |       | (3)          |   | (10)
| | Idling and other costs                                  |          | (1)    |       | (1)          |   | (2) 
| |                                                         |          |        |       |              |   |     
| | Ending balance                                          | $        | 8      | $     | 11           | $ | 19  
| |                                                         |          |        |       |              |   |     

17.   Interest, foreign exchange and other:

| |                                                                 |   | 2006 |   | 2005 
| | --------------------------------------------------------------- | - | ---- | - | -----
| |                                                                 |   |      |   |      
| | Interest on long-term debt                                      | $ | 119  | $ | 128  
| | Interest on short-term debt                                     |   | 16   |   | 6    
| | Interest income                                                 |   | (4)  |   | (2)  
| | Investment loss (income)                                        |   | (2)  |   | 4    
| | Interest capitalized on construction projects                   |   | (3)  |   | (3)  
| |                                                                 |   | 126  |   | 133  
| |                                                                 |   |      |   |      
| | Amortization of deferred financing costs                        |   | 6    |   | 5    
| | Amortization of deferred gain on foreign
    exchange contracts |   | (38) |   | (118)
| | Derivative financial instruments gain                           |   | -    |   | (30) 
| | Other foreign exchange items                                    |   | 11   |   | 17   
| | Loss on consolidation of foreign                                |   |      |   |      
| | integrated
    subsidiaries                                     |   | 1    |   | 6    
| | Bank charges and other financing expenses                       |   | 5    |   | 7    
| |                                                                 |   | (15) |   | (113)
| |                                                                 |   |      |   |      
| |                                                                 | $ | 111  | $ | 20   

- 26 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

18.  Income taxes:

The tax effects of the significant components of
temporary differences that give rise to future income tax assets and liabilities
are as follows:

| |                                                    |                                                       | 2006  |       | 2005 
| | -------------------------------------------------- | ----------------------------------------------------- | ----- | ----- | -----
| |                                                    |                                                       |       |       |      
| | Future income tax assets:                          |                                                       |       |       |      
| |                                                    | Non-capital loss carryforwards and pool of deductible |       |       |      
| |                                                    | scientific
    research and development expenditures  | $     | 344   | $    
| |                                                    | Employee future benefits                              |       | 21    |      
| |                                                    | Capital loss carryforwards                            |       | 5     |      
| |                                                    | Other                                                 |       | 21    |      
| |                                                    | Valuation allowance                                   |       | (232) |      
| |                                                    |                                                       | 159   |       | 251  
| |                                                    |                                                       |       |       |      
| | Future income tax liabilities:                     |                                                       |       |       |      
| |                                                    | Fixed assets                                          |       | (115) |      
| |                                                    | Exchange gain on long-term debt                       |       | (83)  |      
| |                                                    | Timber rights                                         |       | (5)   |      
| |                                                    | Other                                                 |       | (15)  |      
| |                                                    |                                                       | (218) |       | (351)
| |                                                    |                                                       |       |       |      
| | Net future income tax liabilities                  | $                                                     | (59)  | $     | (100)
| |                                                    |                                                       |       |       |      
| | As reported in the consolidated balance
    sheet: |                                                       |       |       |      
| | Future income tax assets                           | $                                                     | 62    | $     | 36   
| | Future income tax liabilities                      |                                                       | (121) |       | (136)
| |                                                    |                                                       |       |       |      
| | Net future income tax liabilities                  | $                                                     | (59)  | $     | (100)
| |                                                    |                                                       |       |       |      

- 27 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

18.  Income taxes (continued):

Certain subsidiaries have accumulated
the following losses and deductions for income tax purposes, which may be
carried forward to reduce taxable income and taxes payable in future years.

| |                                                                                                                        |                                                           |         |                  | Expiring 
| | ---------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------- | ------- | ---------------- | ---------
| |                                                                                                                        |                                                           | Amounts |                  | dates    
| |                                                                                                                        |                                                           |         |                  |          
| | Non-capital loss carried forward
    for Canadian subsidiaries                                                         | $                                                         | 383     | 2007 to
    2026
| | Non-capital loss carried forward
    for foreign subsidiaries                                                          |                                                           | 294     | 2020 to
    2026
| |                                                                                                                        |                                                           |         |                  |          
| | Pool of deductible scientific
    research and experimental                                                            |                                                           |         |                  |          
| | development                                                                                                            |                                                           | 369     |                  | Unlimited
| |                                                                                                                        |                                                           |         |                  |          
| |                                                                                                                        |                                                           |         |                  |          
| |                                                                                                                        |                                                           |         |                  |          
| | The reconciliation of
    income taxes calculated at the statutory rate to the actual tax provision is
    as follows:
| |                                                                                                                        |                                                           |         |                  |          
| |                                                                                                                        |                                                           | 2006    |                  | 2005     
| |                                                                                                                        |                                                           |         |                  |          
| | Loss before income taxes and
    minority interest                                                                     |                                                           |         |                  |          
| | from continuing operations                                                                                             | $                                                         | (416)   | $                | (380)    
| |                                                                                                                        |                                                           |         |                  |          
| | Income taxes based on combined
    federal and provincial                                                              |                                                           |         |                  |          
| | income tax rates of 33.3%
    (2005 - 33.3%)                                                                           | $                                                         | (139)   | $                | (126)    
| |                                                                                                                        |                                                           |         |                  |          
| | Increase (decrease) resulting
    from:                                                                                |                                                           |         |                  |          
| |                                                                                                                        | Future income taxes adjustment due
    to rate enactments |         | 3                |          
| |                                                                                                                        | Net losses not recognized                                 |         | 88               |          
| |                                                                                                                        | Change in valuation allowance                             |         | 3                |          
| |                                                                                                                        | Rate differential between
    jurisdictions               |         | (9)              |          
| |                                                                                                                        | Permanent differences:                                    |         |                  |          
| |                                                                                                                        | Non-taxable portion of exchange gain on long-term debt    |         | (9)              |          
| |                                                                                                                        | Non-deductible loss on
    consolidation of foreign       |         |                  |          
| |                                                                                                                        | integrated subsidiaries                                   |         | 1                |          
| |                                                                                                                        | Other permanent differences                               |         | (3)              |          
| |                                                                                                                        | Large corporations tax                                    |         | -                |          
| |                                                                                                                        |                                                           | 74      |                  | 66       
| |                                                                                                                        |                                                           |         |                  |          
| | Income taxes recovery                                                                                                  | $                                                         | (65)    | $                | (60)     
| |                                                                                                                        |                                                           |         |                  |          
| | Income taxes:                                                                                                          |                                                           |         |                  |          
| | Current                                                                                                                | $                                                         | (2)     | $                | 5        
| | Future                                                                                                                 |                                                           | (63)    |                  | (65)     
| |                                                                                                                        |                                                           |         |                  |          
| | Income taxes recovery                                                                                                  | $                                                         | (65)    | $                | (60)     

- 28 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

19.  Pension plans:

Defined contribution plans

The Company contributes to defined
contribution plans, provincial and labour sponsored pension plans, group
registered retirement savings plans, deferred profit sharing plans, and 401(k)
plans. The pension expense under these plans is equal to the Company's
contribution. The 2006 pension expense was $13 million ($15 million in 2005.)

Defined benefit plans

The Company has several defined benefit pension
plans. Non-unionized employees in Canada joining the Company after January 1,
2000, participate in defined contribution plans. Some of the defined benefit
plans are contributory. The pension expense and the obligation related to the
defined benefit plans are actuarially determined using management's most
probable assumptions.

Components of net periodic benefit cost for defined
benefit plans:

| |                                                                            |   | 2006 |   | 2005 
| | -------------------------------------------------------------------------- | - | ---- | - | -----
| |                                                                            |   |      |   |      
| | Current service cost                                                       | $ | 22   | $ | 16   
| | Interest cost                                                              |   | 46   |   | 46   
| | Actual return on plan assets                                               |   | (48) |   | (63) 
| | Actuarial loss (gain)                                                      |   | (88) |   | 170  
| | Plan amendments and other                                                  |   | 16   |   | -    
| |                                                                            |   |      |   |      
| | Net expense (income) before adjustments to recognize the
    long-term     |   |      |   |      
| | nature on the plans                                                        |   | (52) |   | 169  
| |                                                                            |   |      |   |      
| | Difference between expected and actual return
    on plan assets           |   | -    |   | 19   
| | Difference between net actuarial loss (gain)
    and actuarial loss (gain) |   | 103  |   | (165)
| | Difference between amortization of past
    service costs for              |   |      |   |      
| | the year and actual plan amendment for
    the year                        |   | (9)  |   | -    
| | Other adjustments                                                          |   | -    |   | 5    
| |                                                                            |   |      |   |      
| | Net periodic benefit cost                                                  | $ | 42   | $ | 28   

The Company's funding policy is to
contribute annually the amount required to provide for benefits earned in the
year and to fund past service obligations over periods not exceeding those
permitted by the applicable regulatory authorities. Past service obligations
arise from improvements to plan benefits. The Company measures its accrued
benefit obligation and the fair value of plan assets for accounting purposes as
at June 30 of each year. Actuarial valuations for funding purposes are conducted
on a triennial basis, unless required earlier by pension legislation. The latest
actuarial valuations were conducted for 10 plans on December 31, 2005, 8 plans
on December 31, 2004 and 2 plans on December 31, 2003.

- 29 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

19.   Pension plans (continued):

| | Change in accrued benefit obligation:                               |   |      |   |     
| | ------------------------------------------------------------------- | - | ---- | - | ----
| |                                                                     |   |      |   |     
| |                                                                     |   | 2006 |   | 2005
| |                                                                     |   |      |   |     
| | Accrued benefit obligation, at beginning of
    year                | $ | 912  | $ | 717 
| | Current service cost                                                |   | 22   |   | 16  
| | Interest cost                                                       |   | 46   |   | 46  
| | Employee contributions                                              |   | 5    |   | 5   
| | Benefits paid                                                       |   | (42) |   | (33)
| | Plan amendments                                                     |   | 10   |   | -   
| | Actuarial loss (gain)                                               |   | (88) |   | 170 
| | Foreign exchange rate changes and other
    adjustments             |   | (6)  |   | (9) 
| | Special termination benefit                                         |   | 1    |   | -   
| | Obligation being settled                                            |   | (3)  |   | -   
| | Decrease in obligation due to curtailment                           |   | (8)  |   | -   
| |                                                                     |   |      |   |     
| | Accrued benefit obligation, at end of year                          | $ | 849  | $ | 912 
| |                                                                     |   |      |   |     
| | Change in fair value of defined benefit plan
    assets:            |   |      |   |     
| |                                                                     |   |      |   |     
| |                                                                     |   | 2006 |   | 2005
| |                                                                     |   |      |   |     
| | Fair value of defined benefit plan assets, at
    beginning of year | $ | 638  | $ | 578 
| | Actual return on plan assets                                        |   | 48   |   | 63  
| | Employer contributions                                              |   | 36   |   | 34  
| | Employee contributions                                              |   | 5    |   | 5   
| | Benefits paid                                                       |   | (42) |   | (33)
| | Foreign exchange rate changes                                       |   | (5)  |   | (9) 
| | Settlement payments                                                 |   | (3)  |   | -   
| |                                                                     |   |      |   |     
| | Fair value of defined benefit plan assets, at end of year           | $ | 677  | $ | 638 
| |                                                                     |   |      |   |     

- 30 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

19.   Pension plans (continued):

The assets of the pension plans are
held by an independent trustee and accounted for separately in the Company's
pension funds. Based on the fair value of assets held at June 30, 2006, the plan
assets were comprised of 1% (1% in 2005) in cash and short-term investments, 4%
(4% in 2005) in real estate, 43% (44% in 2005) in bonds and 52% (51% in 2005) in
Canadian, U.S. and foreign equities.

No significant number of common
shares of Tembec Inc., the ultimate parent company, were held by the plans at
June 30, 2006 and June 30, 2005.

The following table presents the
difference between the fair value of the defined benefit pension plan assets and
the actuarially determined accrued benefit obligation as at September 30, 2006
and September 24, 2005. This difference is also referred to as either the
deficit or surplus, as the case may be, or the funded status of the plans.

The table further reconciles the
amount of the surplus or deficit (funded status) to the net amount recognized in
the Consolidated Balance Sheets. The difference between the funded status and
the net amount recognized in the Consolidated Balance Sheets, in accordance with
Canadian GAAP, represents the portion of the surplus or deficit not yet
recognized for accounting purposes. This approach allows for a gradual
recognition of changes in accrued benefit obligations and plan performance over
the expected average remaining life of the employee group covered by the plans.

Reconciliation of funded status:

| |                                                             |   | 2006  |   | 2005 
| | ----------------------------------------------------------- | - | ----- | - | -----
| |                                                             |   |       |   |      
| | Fair value of defined benefit plan assets                   | $ | 677   | $ | 638  
| | Accrued benefit obligation                                  |   | (849) |   | (912)
| |                                                             |   |       |   |      
| | Plan deficit                                                |   | (172) |   | (274)
| |                                                             |   |       |   |      
| | Employer contributions after measurement date
    (June 30) |   | 8     |   | 11   
| | Unamortized past service costs                              |   | 7     |   | 3    
| | Unamortized net actuarial loss                              |   | 160   |   | 272  
| |                                                             |   |       |   |      
| | Accrued benefit asset                                       | $ | 3     | $ | 12   
| |                                                             |   |       |   |      

- 31 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

19.   Pension plans (continued):

| | Amounts recognized in the Consolidated
    Balance Sheets:                                                                                                                 |   |       |   |      
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | - | ----- | - | -----
| |                                                                                                                                                                            |   |       |   |      
| |                                                                                                                                                                            |   | 2006  |   | 2005 
| |                                                                                                                                                                            |   |       |   |      
| | Deferred pension costs                                                                                                                                                     | $ | 62    | $ | 66   
| | Accrued benefit liability                                                                                                                                                  |   | (59)  |   | (54) 
| |                                                                                                                                                                            |   |       |   |      
| | Accrued benefit asset                                                                                                                                                      | $ | 3     | $ | 12   
| |                                                                                                                                                                            |   |       |   |      
| | The accrued benefit obligations
    in excess of fair value of plan assets at year-end with respect to pension benefit plans that are not fully
    funded are as follows:
| |                                                                                                                                                                            |   |       |   |      
| |                                                                                                                                                                            |   | 2006  |   | 2005 
| |                                                                                                                                                                            |   |       |   |      
| | Fair value of plan assets                                                                                                                                                  | $ | 662   | $ | 638  
| | Accrued benefit obligations                                                                                                                                                |   | (835) |   | (912)
| |                                                                                                                                                                            |   |       |   |      
| | Plan deficit                                                                                                                                                               | $ | (173) | $ | (274)
| |                                                                                                                                                                            |   |       |   |      
| | Weighted-average significant assumptions:                                                                                                                                  |   |       |   |      
| |                                                                                                                                                                            |   |       |   |      
| |                                                                                                                                                                            |   | 2006  |   | 2005 
| |                                                                                                                                                                            |   |       |   |      
| | Accrued benefit obligation at end of year:                                                                                                                                 |   |       |   |      
| | Discount rate                                                                                                                                                              |   | 5.59% |   | 4.98%
| | Rate of compensation increase                                                                                                                                              |   | 3.02% |   | 3.45%
| |                                                                                                                                                                            |   |       |   |      
| | Net periodic benefit cost for the year:                                                                                                                                    |   |       |   |      
| | Discount rate                                                                                                                                                              |   | 4.98% |   | 6.38%
| | Rate of compensation increase                                                                                                                                              |   | 3.45% |   | 3.39%
| | Expected long-term return on assets                                                                                                                                        |   | 7.48% |   | 7.48%
| |                                                                                                                                                                            |   |       |   |      

- 32 -

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|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

20.   Other employee future benefit plans:

The Company offers post-retirement life insurance,
health care and dental care plans to some of its retirees. The Company offers
post-employment health care and dental care plans to disabled employees. The
Company also assumes post-employment life insurance coverage of some of its
disabled employees.

The post-retirement and post-employment plans are
unfunded.

The Company measures its accrued benefit obligation
for accounting purposes as at June 30 of each year.

Components of net periodic benefit cost for other
employee future benefit plans:

| |                                                                            |   | 2006 |   | 2005
| | -------------------------------------------------------------------------- | - | ---- | - | ----
| |                                                                            |   |      |   |     
| | Current service cost                                                       | $ | 2    | $ | 1   
| | Interest cost                                                              |   | 4    |   | 4   
| | Post-employment                                                            |   | 1    |   | 1   
| | Actuarial loss (gain)                                                      |   | (18) |   | 9   
| | Past service costs                                                         |   | (1)  |   | -   
| | Difference between amortization
    of past service costs for the          |   |      |   |     
| | year and actual plan amendment
    for the year                            |   | 1    |   | -   
| | Difference between
    net actuarial loss (gain) and actuarial loss (gain) |   | 19   |   | (8) 
| | Other adjustments                                                          |   | 1    |   | 1   
| |                                                                            |   |      |   |     
| | Periodic benefit cost                                                      | $ | 9    | $ | 8   
| |                                                                            |   |      |   |     
| | Change in accrued benefit
    obligation:                                  |   |      |   |     
| |                                                                            |   |      |   |     
| |                                                                            |   | 2006 |   | 2005
| |                                                                            |   |      |   |     
| | Accrued benefit obligation, at
    beginning of year                       | $ | 75   | $ | 64  
| | Current service cost                                                       |   | 2    |   | 1   
| | Interest cost                                                              |   | 4    |   | 4   
| | Benefits paid                                                              |   | (3)  |   | (3) 
| | Actuarial loss (gain)                                                      |   | (18) |   | 9   
| | Foreign exchange rate changes                                              |   | (1)  |   | (1) 
| | Post-employment                                                            |   | 1    |   | 1   
| | Plan amendment                                                             |   | (1)  |   | -   
| | Decrease in obligation due to
    curtailment                              |   | (1)  |   | -   
| | Special termination benefit                                                |   | 2    |   | -   
| | Other                                                                      |   | (1)  |   | -   
| | Accrued benefit obligation, at
    end of year                             | $ | 59   | $ | 75  
| |                                                                            |   |      |   |     

- 33 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

20.   Other employee future benefit plans (continued):

Change in fair value of other employee future benefit
plan assets:

| |                                               |   | 2006 |   | 2005
| | --------------------------------------------- | - | ---- | - | ----
| |                                               |   |      |   |     
| | Fair value of assets of other employee future |   |      |   |     
| | benefit plans, at beginning of year           | $ |     | $ |    
| | Employer contributions                        |   | 3    |   | 3   
| | Benefits paid                                 |   | (3)  |   | (3) 
| |                                               |   |      |   |     
| | Fair value of assets of other employee future |   |      |   |     
| | benefit plans, at end of year                 | $ |     | $ |    

The table further reconciles the amount of the
surplus or deficit (funded status) to the net amount recognized in the
Consolidated Balance Sheets. The difference between the funded status and the
net amount recognized in the Consolidated Balance Sheets, in accordance with
Canadian GAAP, represents the portion of the surplus or deficit not yet
recognized for accounting purposes. This approach allows for a gradual
recognition of changes in accrued benefit obligations and plan performance over
the expected average remaining life of the employee group covered by the plans.

Reconciliation of funded status:

| |                                                             |   | 2006 |   | 2005
| | ----------------------------------------------------------- | - | ---- | - | ----
| |                                                             |   |      |   |     
| | Plan deficit                                                | $ | (59) | $ | (75)
| |                                                             |   |      |   |     
| | Employer contributions after measurement date
    (June 30) |   | 1    |   | -   
| | Unamortized past service costs                              |   | (1)  |   | 1   
| | Unamortized net actuarial loss                              |   | (2)  |   | 17  
| |                                                             |   |      |   |     
| | Accrued benefit liability                                   | $ | (61) | $ | (57)

- 34 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

20.   Other employee future benefit plans (continued):

Weighted-average significant assumptions:

| |                                                                    |             | 2006        |   | 2005  
| | ------------------------------------------------------------------ | ----------- | ----------- | - | ------
| |                                                                    |             |             |   |       
| | Accrued benefit obligation at end of year:                         |             |             |   |       
| | Discount rate (weighted)                                           |             | 5.80%       |   | 4.99% 
| | Rate of compensation
    increase                                  |             | 3.50%       |   | 3.50% 
| |                                                                    |             |             |   |       
| | Benefit cost for year:                                             |             |             |   |       
| | Discount rate (weighted)                                           |             | 4.99%       |   | 6.30% 
| | Rate of compensation
    increase                                  |             | 3.50%       |   | 3.50% 
| |                                                                    |             |             |   |       
| | Assumed health care cost trend rate at end of
    year (weighted): |             |             |   |       
| | Initial health care cost
    trend                                 |             | 10.00%      |   | 10.00%
| | Annual rate of decline in
    trend rate                           |             | 1.00%       |   | 1.00% 
| | Ultimate health care cost
    trend rate                           |             | 5.00%       |   | 5.00% 
| |                                                                    |             |             |   |       
| | Effect of change in health care cost trend
    rate                | 1% increase | 1% increase
| | Total of service cost and interest cost                            | $           | 1           | $ | 1     
| | Accrued benefit obligation                                         | $           | 4           | $ | 6     
| |                                                                    |             |             |   |       
| | Effect of change in health care cost trend
    rate                | 1% decrease | 1% decrease
| | Total of service cost and interest cost                            | $           | -           | $ | -     
| | Accrued benefit obligation                                         | $           | (4)         | $ | (5)   

- 35 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

21.   Financial instruments:

(a)    Derivative financial
instruments:

The following tables summarize the changes in the
market value of derivative financial instruments and in the deferred gain on
foreign exchange contracts:

(i)      Derivative financial instruments:

| |                              | Opening |     | Gain   | Disbursements | Ending 
| | ---------------------------- | ------- | --- | ------ | ------------- | -------
| | 2006                         | balance |     | (loss) | (proceeds)    | balance
| |                              |         |     |        |               |        
| | Market value of              |         |     |        |               |        
| | outstanding foreign          |         |     |        |               |        
| | exchange contracts           | $       | -   | $      | 3             | $      
| |                              |         |     |        |               |        
| | Market value of commodity-   |         |     |        |               |        
| | related derivative financial |         |     |        |               |        
| | instruments                  |         | 6   |        | (3)           |        
| |                              |         | 6   | $      | -             | $      
| |                              |         |     |        |               |        
| | Less current portion         |         | 6   |        |               |        
| |                              | $       | -   |        |               |        
| |                              |         |     |        |               |        
| |                              |         |     |        |               |        
| |                              | Opening |     | Gain   | Disbursements | Ending 
| | 2005                         | balance |     | (loss) | (proceeds)    | balance
| |                              |         |     |        |               |        
| | Market value of              |         |     |        |               |        
| | outstanding foreign          |         |     |        |               |        
| | exchange contracts           | $       | 105 | $      | 23            | $      
| |                              |         |     |        |               |        
| | Market value of commodity-   |         |     |        |               |        
| | related derivative financial |         |     |        |               |        
| | instruments                  |         | 10  |        | 7             |        
| |                              |         | 115 | $      | 30            | $      
| |                              |         |     |        |               |        
| | Less current portion         |         | 82  |        |               |        
| |                              |         |     |        |               |        
| |                              | $       | 33  |        |               |        

- 36 -

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|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

21.   Financial instruments (continued):

(a)   Derivative financial instruments
(continued):

(ii)     Unamortized deferred gain on foreign
exchange contracts:

| |                              |   | Opening |              |       |         | Ending
| | ---------------------------- | - | ------- | ------------ | ----- | ------- | ------
| | 2006                         |   | balance | Amortization |       | balance
| |                              |   |         |              |       |         |       
| | Foreign exchange contracts   |   |         |              |       |         |       
| | sold prior to fiscal 2004    | $ |        | $            |      | $       |      
| |                              |   |         |              |       |         |       
| | Foreign exchange contracts   |   |         |              |       |         |       
| | outstanding at the beginning |   |         |              |       |         |       
| | of fiscal 2004               |   | 38      |              | (38)  |         |      
| |                              |   | 38      | $            | (38)  |         |      
| |                              |   |         |              |       |         |       
| | Less current portion         |   | 38      |              |       |         |      
| |                              |   |         |              |       |         |       
| |                              | $ |        |              |       | $       |      
| |                              |   |         |              |       |         |       
| |                              |   |         |              |       |         |       
| |                              |   | Opening |              |       |         | Ending
| | 2005                         |   | balance | Amortization |       | balance
| |                              |   |         |              |       |         |       
| | Foreign exchange contracts   |   |         |              |       |         |       
| | sold prior to fiscal 2004    | $ | 26      | $            | (26)  | $       |      
| |                              |   |         |              |       |         |       
| | Foreign exchange contracts   |   |         |              |       |         |       
| | outstanding at the beginning |   |         |              |       |         |       
| | of fiscal 2004               |   | 130     |              | (92)  |         | 38    
| |                              |   | 156     | $            | (118) |         | 38    
| |                              |   |         |              |       |         |       
| | Less current portion         |   | 118     |              |       |         | 38    
| |                              |   |         |              |       |         |       
| |                              | $ | 38      |              |       | $       |      
| |                              |   |         |              |       |         |       

- 37 -

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|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

21.   Financial instruments (continued):

(b)   Foreign currency rate risk:

The Company realizes a significant
portion of its sales in foreign currencies, principally US $ and Euros, and
enters into various types of foreign exchange contracts in managing its foreign
exchange risk. In addition, this risk is partially covered by US $ purchases and
debt service. The Company does not hold or issue financial instruments for
trading purposes.

The Company had the following US $
foreign exchange contracts convertible into Canadian $ at September 30, 2006 and
September 24, 2005.

| |                                                                                                                                            |              | 2006          |              | 2005         
| | ------------------------------------------------------------------------------------------------------------------------------------------ | ------------ | ------------- | ------------ | -------------
| |                                                                                                                                            |              |               |              |              
| | Maturity per quarter                                                                                                                       | Average rate | US $ millions | Average rate | US $ millions
| |                                                                                                                                            |              |               |              |              
| | 2007 - December 2006                                                                                                                       | 1.1701       | 1             | -            | -            
| | - March 2007                                                                                                                               | 1.1189       | 1             | -            | -            
| | - June 2007                                                                                                                                | 1.1163       | 1             | -            | -            
| |                                                                                                                                            | 1.1299       | 3             | -            | -            
| |                                                                                                                                            |              |               |              |              
| | The Company had the following US
    $ foreign exchange contracts convertible into Euros at September 30, 2006
    and September 24, 2005:
| |                                                                                                                                            |              |               |              |              
| |                                                                                                                                            |              | 2006          |              | 2005         
| |                                                                                                                                            |              |               |              |              
| | Maturity per quarter                                                                                                                       | Average rate | US $ millions | Average rate | US $ millions
| |                                                                                                                                            |              |               |              |              
| | 2006 - December 2005                                                                                                                       | -            | -             | 1.2050       | 2            
| | - March 2006                                                                                                                               | -            | -             | 1.1671       | 2            
| | - June 2006                                                                                                                                | -            | -             | 1.1480       | 1            
| | - September 2006                                                                                                                           | -            | -             | 1.1479       | 2            
| |                                                                                                                                            |              |               |              |              
| | 2007 - December 2006                                                                                                                       | 1.2752       | 1             | 1.2752       | 1            
| | - March 2007                                                                                                                               | 1.2369       | 1             | 1.2280       | 1            
| | - June 2007                                                                                                                                | 1.2092       | 1             | 1.2092       | 1            
| | - September 2007                                                                                                                           | 1.3052       | 1             | 1.3052       | 1            
| |                                                                                                                                            |              |               |              |              
| | 2008 - December 2007                                                                                                                       | 1.3498       | -             | 1.3498       | -            
| |                                                                                                                                            |              |               |              |              
| |                                                                                                                                            | 1.2627       | 4             | 1.2033       | 11           
| |                                                                                                                                            |              |               |              |              

- 38 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

21.   Financial instruments (continued):

(c)   Commodity price risk:

Markets for the Company's principal
products are highly competitive and cyclical in nature. To mitigate the impact
of commodity price volatility of earnings, the Company may periodically purchase
commodity price hedges (lumber, pulp and newsprint). The Company does not hold
or acquire commodity price instruments for trading purposes. However, due to the
nature of lumber futures contracts, they are not normally held to maturity. At
September 30, 2006 and September 24, 2005, the Company did not hold any
significant commodity price hedges.

(d)   Credit risk:

The Company does not have a
significant exposure to any individual customer or counterparty. The Company
reviews a new customer's credit history before extending credit and conducts
regular reviews of its existing customers' credit performance. The Company may
require payment guarantees, such as letters of credit, or obtains credit
insurance coverage. The allowance for doubtful accounts as at September 30, 2006
and September 24, 2005 was $4 million and $6 million, respectively.

(e)   Fair value of
financial instruments:

The carrying amount of cash and cash
equivalents, accounts receivable, operating bank loans and accounts payable and
accrued charges approximates their fair values because of the near-term maturity
of those instruments.

The carrying value and the fair value
of long-term debt, balance payable on acquisition of companies and redeemable
preferred shares at September 30, 2006 were $1,532 million (2005 - $1,590
million) and $859 million (2005 - $1,115 million), respectively.

The fair value of long-term debt that
is actively traded is based on the closing trading value at the respective
year-end dates. The fair value of the long-term debt that is not actively
traded, balance payable on acquisition of companies and redeemable preferred
shares debt has been determined based on management's best estimate of the fair
value to renegotiate these financial instruments with similar terms at the
respective year-end dates.

- 39 -

---



|                                                     
|-----------------------------------------------------
|TEMBEC INDUSTRIES INC.                               
|Notes to Consolidated Financial Statements, Continued
|                                                     
|Years ended September 30, 2006 and September 24, 2005
|(in millions of dollars, unless otherwise noted)     

22.   Subsequent events:

(a)   On
October 12, 2006, Canada and the United States entered into an agreement to
govern the shipment of Canadian softwood lumber into the United States. As part
of the agreement, the Company received a US$242 million payment on October 30,
2006 pertaining to the recovery of lumber duties on deposit with the Department
of Commerce (DOC) that had accumulated since May 2002.

The amount received by the Company
corresponds to approximately 82% of the total amount on deposit at the DOC,
including accrued interest, and represents substantially all of the monies the
Company expects to receive as reimbursement of previously deposited duties. The
funds will be used by the Company to reduce its indebtedness and increase
overall liquidity levels. This item will be recorded in the Company's December
2006 quarterly financial statements.

As a result of the softwood lumber
agreement between Canada and the United States, the going concern note
disclosure as reported in the Company's second and third quarter is no longer
required.

(b)   On
December 5, 2006, the Company announced the permanent closure of the Smooth Rock
Falls, Ontario pulp mill. The facility had been idle since the end of July 2006.
As a result of this announcement, an unusual charge of $31 million relating to
pension, severance and other related costs will be recorded in the quarter
ending December 30, 2006.

23.   Comparative figures:

Certain 2005 comparative figures have been
reclassified to conform with the financial statement presentation adopted for
2006.

- 40 -

---