|**Exhibit
99.****2**
|--------------------



|M A N A G E M E N T 
      S   D I S C U S S I O N   A N D  A N A LY S I
      S as at December 5, 2006
      THE MANAGEMENTS DISCUSSION
      AND ANALYSIS (MD&A) SECTION PROVIDES A REVIEW OF THE SIGNIFICANT
      DEVELOPMENTS AND ISSUES THAT INFLUENCED TEMBEC INC.S FINANCIAL PERFORMANCE DURING THE FISCAL YEAR
      ENDED SEPTEMBER 30, 2006 AS COMPARED TO THE FISCAL YEAR ENDED SEPTEMBER 24, 2005. THE MD&A SHOULD BE READ IN
      CONJUNCTION WITH THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS FOR THE
      FISCAL YEAR ENDED SEPTEMBER 30,
      2006. ALL REFERENCES TO QUARTERLY OR
      COMPANY INFORMATION RELATE TO TEMBEC INC.S FISCAL
      QUARTERS.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The MD&A includes
forward-looking statements within the meaning of securities laws. Such
statements relate to the Companys or managements objectives, projections,
estimates, expectations or predictions of the future and can be identified by
words such as anticipate, estimate, expect and project or variations of
such words. These statements are based on certain assumptions and analyses made
by the Company in light of its experience and its perception of future
developments. Such statements are subject to a number of risks and
uncertainties, including, but not limited to, changes in foreign exchange rates,
product selling prices, raw material and operating costs and other factors
identified in our periodic filings with securities regulatory authorities in
Canada and the United States. Many of these risks are beyond the control of the
Company and, therefore, may cause actual actions or results to materially differ
from those expressed or implied herein. The Company disclaims any intention or
obligation to update or revise any forward-looking statements, whether as a
result of new information, future events or otherwise.

Throughout the
MD&A, Tembec or Company means Tembec Inc. and its consolidated
subsidiaries and investments. AV Cell refers to the Companys 50%
participation in AV Cell Inc. which operates a dissolving pulp mill located in
Atholville, New Brunswick. Marathon refers to its 50% participation in
Marathon Pulp Inc., which operates a northern bleached softwood kraft (NBSK)
pulp mill in Marathon, Ontario. Temlam refers to the Companys 50%
participation in Temlam Inc., which operates laminated veneer lumber (LVL)
plants in Ville-Marie and Amos, Quebec and wood I-beam manufacturing plants in
Calgary, Alberta, Bolton, Ontario and Blainville, Quebec. Temrex refers to the
Companys 50% participation in Produits Forestiers Temrex Limited Partnership,
which operates two sawmills in the Gaspe region of Quebec. These investments are
accounted for by the proportionate consolidation method.

Tembecs operations
consists of four reportable business segments: Forest Products, Pulp, Paper, and
Chemicals. On September 30, 2006,Tembec had approximately 9,000 employees and
operated manufacturing facilities in New Brunswick, Quebec, Ontario, Manitoba,
Alberta, British Columbia, the states of Louisiana and Ohio as well as in
Southern France. Principal facilities are described in the subsequent sections
of the MD&A.

On February 27, 2006,
the Company completed the sale of its oriented strandboard (OSB) business
located in Saint-Georges-de-Champlain, Quebec. The financial results of the OSB
operation have been reclassified as discontinued operations. Comparative figures
have also been reclassified to exclude the OSB mills results from the
continuing operations. For certain non-GAAP financial measures, the amount
presented still reflect the actual reported results of prior periods. In those
circumstances, a footnote indicates that they include the results of the OSB
operations.

ACCOUNTING
CHANGESEffective January 2005, the Company adopted Canadian Institute of
Chartered Accountants (CICA) Accounting Guideline No. 15 (AcG-15),
Consolidation of Variable Interest Entities. AcG-15 addresses the
application of consolidation principles to entities that are subject to control
on a basis other than ownership voting interests. The implementation of this new
accounting guideline had no impact on the Companys consolidated financial
statements. The CICA Emerging Issues Committee issued Abstract 157 (EIC-157),
Implicit Variable Interest under AcG-15. The abstract clarifies that an
implicit variable interest is an implied pecuniary interest in an entity that
changes with the fair value of that entitys net assets exclusive of variable
interest. The CICA Emerging Issues Committee also issued Abstract 163 (EIC-163),
Determining the Variability to be Considered in Applying AcG-15.
EIC-163 provides guidance on the relevant risks and rewards that must be
identified and evaluated in order to apply AcG-15. The two abstracts had no
impact on the Companys consolidated financial statements.

The CICA Emerging
Issues Committee issued Abstract 161 (EIC-161), Discontinued
Operations. EIC-161 replaced EIC-45 Discontinued Operations and
provides guidance regarding the allocation of interest expense and of general
corporate overhead. The Company applied EIC-161 in fiscal 2006 as a result of
the sale of its OSB operation.

The CICA issued
Section 3831 Non-Monetary Transactions. This section requires that all
non-monetary transactions be measured at fair value unless certain specified
conditions where applicable. The Section became effective January 1, 2006, and
did not impact the Companys financial statements.

8

---

IMPACT OF
ACCOUNTING PRONOUNCEMENTS ON FUTURE REPORTING PERIODS

The CICA issued three
new Handbook Sections in relation with financial instruments: Section 3855
Financial Instruments  Recognition and Measurement, Section 3865
Hedges, and Section 1530 Comprehensive Income. These Sections
apply to the Company beginning October 1, 2006. Section 3855 expands on Handbook
Section 3860 Financial Instruments  Disclosure and Presentation, by
prescribing when a financial instrument is to be recognized on the balance sheet
and at what amount. It also specifies how financial instrument gains and losses
are to be presented. Section 3865 provides alternative accounting treatments to
Section 3855 for entities which choose to designate qualifying transactions as
hedges for accounting purposes. It replaces and expands on AcG-13 Hedging
Relationship and the hedging guidance in Section 1650 Foreign Currency Translation by specifying
how hedge accounting is applied and what disclosures are necessary when it is
applied. Section 1530 introduces a new requirement to present certain revenues,
expenses, gains and losses, that otherwise would not be immediately recorded in
income, in a comprehensive income statement with the same prominence as other
statements that constitute a complete set of financial statements. The
application of these new Handbook Sections for financial instruments is not
expected to have a significant effect on the Company, but will require Tembec to
present a new statement entitled Comprehensive
Income.

The CICA subsequently
amended Section 3865 Hedges by deleting paragraph 54. This paragraph
required the use of the same method to assess the effectiveness of the hedge and
to calculate the ineffective portion of the gain or loss on the hedging item.
The removal of this paragraph allows an entity to use a different method to
assess effectiveness and calculate ineffectiveness. As the Company does not use
hedge accounting, this amendment did not impact its consolidated financial
statements.

The CICA also
subsequently amended Section 3855 Financial Instruments  Recognition and
Measurement. The amendment provides guidance on accounting for fees and
costs incurred upon the exchange of debt instruments or modification of a
financial liability. Section 3855 applies to transactions occurring after
October 1, 2006.

The CICA has released
two new Handbook Sections in relation to financial instruments: Section 3862
Financial Instruments Disclosures and Section 3863 Financial
Instruments  Presentation. These standards enhance existing disclosures in
previously issued Section 3861 Financial Instruments  Disclosures and
Presentation. Section 3862 places greater emphasis on disclosures about
risks related to recognized and unrecognized financial instruments and how those
risks are managed. Section 3863 carries forward the same presentation standards
as Section 3861. Both Sections will become effective October 1, 2007 and will
require the Company to increase disclosure in the financial instruments
note.

The CICA has released
Section 1535 Capital Disclosures. The Section requires additional
disclosure about capital management. The Section will become effective October
1, 2007 and will require the Company to expand its disclosure in that
area.

The CICA issued a
revised version of Section 1506 Accounting Changes. The revised Section
provides additional guidance in determining when it is impractible to give
retrospective application to a change in accounting policy. The Section will
become effective on January 1, 2007. Although the Company does not currently
foresee the requirement to initiate accounting changes, it will comply with
Section 1506 should the need arise.

The CICA Emerging
Issues Committee issued Abstract 162 (EIC-162), Stock-Based Compensation for
Employees Eligible to Retire Before the Vesting Date. EIC-162 provides
guidance to determine compensation costs attributable to a stock-based award
under a compensation plan that contains a provision that allows an employee to
continue vesting after the employee has retired. The Abstract became effective
October 1, 2006. The application EIC-162 will not have an impact on the
financial statements of the Company.

The CICA issued
Section 3251 Equity. The Section replaces Section 3250 Surplus. The Section incorporates
consequential amendments resulting from the issuance of Section 1530
Comprehensive Income. The Section became effective on October 1, 2006.
As noted previously, the Company will be required to present a new statement
entitled Comprehensive Income beginning in October
2006.

9

---

2006
    MANAGEMENT'S DISCUSSION AND ANALYSIS

CRITICAL
ACCOUNTING POLICIES AND ESTIMATESFixed asset depreciationThe Company records its fixed assets,
primarily production buildings and equipment, at cost. Interest costs are
capitalized for projects in excess of $1 million that have a duration in excess
of one year. Investment tax credits or capital assistance received reduce the
cost of the related assets. Fixed assets acquired as a result of a business
acquisition are recorded at their estimated fair value. Depreciation of fixed
assets is provided over their estimated useful lives, generally on a
straight-line basis. Forest access roads are depreciated on the basis of
harvested volumes and certain equipment is depreciated using the unit of
production method. The estimated useful lives of fixed assets are based on
judgement and the best currently available information. Changes in circumstances
can result in the actual useful lives differing from our estimates. Revisions to
the estimated useful lives of fixed assets constitute a change in accounting
estimate and are dealt with prospectively by amending the amount of depreciation
expense. There were no significant adjustments to depreciation rates in fiscal
2005 and 2006. In fiscal 2005, the Company recorded an impairment charge of $4
million relating to a specialty wood sawmill that was included in depreciation
expense.

Impairment of
goodwillAccounting standards require that goodwill no longer be amortized to
earnings, but be periodically tested for impairment. The Company uses certain
operating and financial assumptions to conduct its impairment test, principally
those contained in its most recent multi-year operating plan. This ensures that
assumptions are supported, where available, by relevant independent information.
The fiscal 2005 impairment test did find impairment of goodwill in relation to
the hardwood flooring and newsprint operations. The carrying value of goodwill
was reduced by $26 million. The charge to income was included in unusual items.
There was no goodwill impairment in fiscal 2006.

Impairment of
long-lived assetsThe Company must review the carrying value of long-lived assets when
events or changes in circumstances indicate that the value may have been
impaired and is not recoverable through future operations and cash flows. To
estimate future cash flows, the Company uses operating and financial
assumptions, primarily those contained in its most recent multi-year operating
plan. This ensures that the assumptions are supported, where available, by
relevant independent information. The work conducted in fiscal 2005 indicated an
impairment of $4 million relating to a specialty wood sawmill. The charge to
income is included in depreciation and amortization expense.

Employee
future benefitsTembec contributes to several defined benefit pension plans,
primarily related to employees covered by collective bargaining agreements. The
Company also provides post-retirement benefits to certain retirees, primarily
health-care related. For post-retirement benefits, funding of disbursements is
done on a pay as you go basis. The Company uses independent actuarial firms to
quantify the amount of pension and post-retirement obligations. The Company,
based on its own experience and recommendations from its actuarial firms,
evaluates the underlying assumptions on an annual basis. Changes in estimates or
assumptions can have a substantial impact on the amount of pension and
post-retirement benefit expense, the carrying values on the balance sheet, and,
in the case of defined benefit plans, the amount of plan surplus or deficit. At
June 30, 2006, (the measurement date), the fair value of defined benefit plan
assets was $677 million, an amount equal to 80% of the estimated accrued benefit
obligation of $849 million, generating a deficit of $172 million. The plan
deficit was $274 million at the prior measurement date, June 30, 2005. The
deficit decrease of $102 million that occurred over the 12-month period was
caused primarily by two items. The deficit was reduced by $14 million as
contributions of $36 million exceeded the current service cost of $22 million.
An actuarial gain of $88 million decreased the accrued benefit obligation at the
measurement date. This item was caused primarily by an increase from 4.98% to
5.59% of the weighted average discount rate applied to the accrued benefit
obligation. The discount rate is tied to the rates applicable to high-quality
corporate bonds (AA or higher) in effect as at the measurement date. Pension
expense in fiscal 2006 was $42 million, as compared to $28 million in the prior
year. Based on current assumptions, employer contributions and pension expense
in fiscal 2007 are expected to be approximately $50 million and $21 million
respectively. A description of the Companys defined benefit pension plans and
assumptions used in the calculations are presented in note 19 of the audited
consolidated financial statements.

With regard to other
employee future benefit plans, the accrued benefit obligation at the measurement
date was $59 million, a decrease from $75 million in the prior year. The
decrease was also due to an increase in the discount rate, from 4.99% to 5.80% .
Employer contributions were $3 million, unchanged from the prior year. The
expense recognized for other employee benefit plans was $9 million, up from $8
million in the prior year. Based on current assumptions, the amount of employer
contributions and the amount of expense to be recognized in fiscal 2007 are
expected to be approximately $3 million and $5 million respectively. A
description of the Companys other employee future benefit plans and assumptions
used in the calculations are presented in note 20 of the audited consolidated
financial statements.

10

---

MANAGEMENT'S DISCUSSION AND
      ANALYSIS
    2006



Future income
taxesFuture
income tax is provided for using the asset and liability method and recognizes
temporary differences between the tax values and the financial statement values
of balance sheet items as well as certain carry-forward items. The Company only
recognizes a future income tax asset to the extent that, in its opinion, it is
more likely than not that the future income tax asset will be realized. This
opinion is based on estimates and assumptions as to the future financial
performance of the various taxable legal entities in the various tax
jurisdictions. The Company periodically reviews the carrying value of its future
income tax assets. Additional details are provided in note 18 of the audited
consolidated financial statements.

USE OF
NON-GAAP FINANCIAL MEASURESThe following summarizes non-GAAP financial measures
utilized in the MD&A. As there is no generally accepted method of
calculating these financial measures, they may not be comparable to similar
measures reported by other companies.

EBITDA refers to earnings before unusual items, interest, income
taxes, depreciation, amortization and other non-operating expenses and revenues.
The Company considers EBITDA to be a useful indicator of the financial
performance of the Company, the business segments and the individual business
units.

Free cash
flow refers to cash provided by operating
activities before changes in non-cash working capital balances less net fixed
asset additions. Working capital changes are excluded as they are often seasonal
and temporary in nature. The Company considers free cash flow to be a useful
indicator of its ability to generate discretionary cash flow, thereby improving
its overall liquidity position.

Net
debt refers to debt less cash and cash equivalents such as marketable
securities or temporary investments.

Total
capitalization
refers to net debt plus future income taxes, other long-term liabilities and
shareholders equity. Net debt to total capitalization is used by the Company to
measure its financial leverage.

Cash return on
capital employed (CROCE) refers to EBITDA for a
given period divided by the average gross capital employed for the period. Gross
capital employed is the sum of working capital (accounts receivable, inventories
and prepaid expenses less accounts payable), undepreciated fixed assets and
other assets. The Company considers this to be a useful indicator of financial
returns being generated by the Company.

Return on capital
employed (ROCE) refers to net earnings (or loss)
for a given period, adjusted for the after-tax impact of interest expense,
divided by the average of total assets less non-interest bearing current
liabilities for the period. The Company utilizes this measure to compare its
performance to other competitors in its industry. The long-term incentive plan
for senior management is based on ROCE performance.

Return on equity
(ROE) refers to net earnings or loss for a given
period divided by the average shareholders equity for the
period.



11

---

|     |                                     
|---- | ------------------------------------
|2006 | MANAGEMENT'S DISCUSSION AND ANALYSIS
|     |                                     

|2006 vs 2005                                           |  |       |  |       |  |       |  |       |  |      
|------------------------------------------------------ |  | ----- |  | ----- |  | ----- |  | ----- |  | -----
|                                                      
|FINANCIAL
      SUMMARY                                |  |       |  |       |  |       |  |       |  |      
|(in millions of dollars, unless otherwise
      noted) |  |       |  |       |  |       |  |       |  |      
|                                                       |  | 2002  |  | 2003  |  | 2004  |  | 2005  |  | 2006 
|                                                      
|Sales                                                  |  | 3,337 |  | 3,282 |  | 3,556 |  | 3,507 |  | 3,332
|Freight and sales
    deductions                       |  | 390   |  | 386   |  | 414   |  | 406   |  | 399  
|Lumber duties                                          |  | 18    |  | 81    |  | 112   |  | 89    |  | 35   
|Cost of sales                                          |  | 2,498 |  | 2,598 |  | 2,738 |  | 2,838 |  | 2,722
|SG&A                                                   |  | 165   |  | 162   |  | 178   |  | 171   |  | 153  
|                                                      
|EBITDA                                                 |  | 266   |  | 55    |  | 114   |  | 3     |  | 23   
|                                                      
|Depreciation &
      amortization                      |  | 225   |  | 227   |  | 231   |  | 238   |  | 208  
|Unusual items                                          |  | 24    |  | 18    |  | 47    |  | 255   |  | 189  
|                                                      
|Operating earnings (loss)                              |  | 17    |  | (190) |  | (164) |  | (490) |  | (374)
|                                                      
|Interest, foreign exchange &
      other               |  | 210   |  | 119   |  | (99)  |  | 11    |  | 111  
|Gain on translation of foreign
      debt              |  | (4)   |  | (264) |  | (94)  |  | (125) |  | (64) 
|                                                      
|Pre-tax earnings (loss)                                |  | (189) |  | (45)  |  | 29    |  | (376) |  | (421)
|Income taxes (recovery)                                |  | (69)  |  | (43)  |  | 26    |  | (61)  |  | (66) 
|Minority interests                                     |  |      |  | (2)   |  |      |  |      |  |     
|                                                      
|Net earnings (loss) from continuing
      operations   |  | (120) |  |      |  | 3     |  | (315) |  | (355)
|                                                      
|Earnings from discontinued
      operations            |  | 4     |  | 11    |  | 34    |  | 11    |  | 51   
|                                                      
|Net earnings (loss)                                    |  | (116) |  | 11    |  | 37    |  | (304) |  | (304)
|                                                      
|Total assets (at end of
    year)                      |  | 3,991 |  | 3,819 |  | 3,922 |  | 3,457 |  | 3,017
|                                                      
|Total long-term debt(1) (at end of
      year)         |  | 1,927 |  | 1,728 |  | 1,617 |  | 1,515 |  | 1,461
|                                                      
|(1) Includes current
      portion                     |  |       |  |       |  |       |  |       |  |      





12

---

MANAGEMENT'S
      DISCUSSION AND ANALYSIS
    2006



|SALES                          |  |       |  |       |  |          |  |          |  |         
|------------------------------ |  | ----- |  | ----- |  | -------- |  | -------- |  | --------
|(in millions of
      dollars) |  |       |  |       |  |          |  |          |  |         
|                               |  |       |  |       |  |          |  |          |  | Volume  
|                               |  |       |  |       |  | Total    |  | Price    |  | & Mix   
|                               |  | 2005  |  | 2006  |  | Variance |  | Variance |  | Variance
|                              
|Forest Products                |  | 1,267 |  | 1,088 |  | (179)    |  | (101)    |  | (78)    
|Pulp                           |  | 1,373 |  | 1,451 |  | 78       |  | (24)     |  | 102     
|Paper                          |  | 943   |  | 874   |  | (69)     |  | (16)     |  | (53)    
|Chemical &
    other           |  | 209   |  | 199   |  | (10)     |  | (17)     |  | 7       
|                              
|                               |  | 3,792 |  | 3,612 |  | (180)    |  | (158)    |  | (22)    
|Less: internal
    sales       |  | (285) |  | (280) |  | 5        |  |          |  |         
|                              
|Sales                          |  | 3,507 |  | 3,332 |  | (175)    |  |          |  |         
|                              

Sales declined by
$175 million as compared to the prior year. The Forest Products segment sales
declined by $179 million as a result of lower prices and volumes. Pricing was
impacted by lower US $ reference prices and a stronger Canadian $, which
averaged 7% higher versus the US $. A portion of the volume reduction was the
result of the permanent shutdown of several manufacturing facilities. The Pulp
segment sales increased by $78 million with higher volumes more than offsetting
lower selling prices. The Paper segment sales declined by $69 million, primarily
as a result of lower volumes. The decline in shipments was caused by the
permanent closures of the Saint-Raymond, Quebec paper mill and of an uncoated
bleached board machine at the St. Francisville, Louisiana paper mill. In terms
of geographical distribution the U.S. remained the Companys principal market
with 45% of sales in fiscal 2006, as compared to 47% in the prior year. Canadian
sales represented 20% of sales, the same percentage as the prior year. Sales
outside of the U.S. and Canada represented the remaining 35% in fiscal 2006, as
compared to 33% a year ago.

13

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|     |                                     
|---- | ------------------------------------
|2006 | MANAGEMENT'S DISCUSSION AND ANALYSIS
|     |                                     

|EBITDA                         |  |      |  |      |  |          |  |          |  |         
|------------------------------ |  | ---- |  | ---- |  | -------- |  | -------- |  | --------
|(in millions of
      dollars) |  |      |  |      |  |          |  |          |  |         
|                               |  |      |  |      |  |          |  |          |  | Cost &  
|                               |  |      |  |      |  | Total    |  | Price    |  | Volume  
|                               |  | 2005 |  | 2006 |  | Variance |  | Variance |  | Variance
|                              
|Forest Products                |  | 32   |  | 22   |  | (10)     |  | (101)    |  | 91      
|Pulp                           |  | (25) |  | 6    |  | 31       |  | (24)     |  | 55      
|Paper                          |  | (12) |  | (11) |  | 1        |  | (16)     |  | 17      
|Chemical &
    other           |  | 8    |  | 6    |  | (2)      |  | (17)     |  | 15      
|                              
|                               |  | 3    |  | 23   |  | 20       |  | (158)    |  | 178     
|                              

EBITDA increased by
$20 million as compared to the prior year period. The Forest Products segment
EBITDA declined by $10 million with lower prices being partially offset by lower
costs. Lumber export duties on shipments to the U.S. declined by $54 million due
to reduced deposit rates that came into effect in December 2005. The Pulp
segment EBITDA improved by $31 million as lower manufacturing costs more than
offset the decline in selling prices. The cost improvement was driven by a more
favourable exchange rate on the French pulp mills Euro costs. The Paper segment
EBITDA was relatively unchanged with lower manufacturing costs negating the
impact of lower selling prices. Chemical segment prices and costs decreased by
similar amounts and profitability remained relatively unchanged. This is to be
expected for this segment as raw material prices are linked to product selling
prices.

|OPERATING EARNINGS
    (LOSS)  |  |       |  |       |  |          |  |                    |  |              |  |         
|------------------------------ |  | ----- |  | ----- |  | -------- |  | ------------------ |  | ------------ |  | --------
|(in millions of
      dollars) |  |       |  |       |  |          |  |                    |  |              |  |         
|                               |  |       |  |       |  |          |  | Depreciation
    & |  | Unusual     
|                               |  |       |  |       |  | Total    |  | EBITDA             |  | Amortization |  | Items   
|                               |  | 2005  |  | 2006  |  | Variance |  | Variance           |  | Variance     |  | Variance
|                              
|Forest Products                |  | (81)  |  | (31)  |  | 50       |  | (10)               |  | 2            |  | 58      
|Pulp                           |  | (143) |  | (269) |  | (126)    |  | 31                 |  | 22           |  | (179)   
|Paper                          |  | (267) |  | (72)  |  | 195      |  | 1                  |  | 7            |  | 187     
|Chemical &
    other           |  | 1     |  | (2)   |  | (3)      |  | (2)                |  | (1)          |  |        
|                              
|                               |  | (490) |  | (374) |  | 116      |  | 20                 |  | 30           |  | 66      
|                              

The operating loss
decreased by $116 million as compared to the prior year period. The Forest
Products segment operating loss declined by $50 million due to a positive
variance on unusual items. In the prior year period, the Company recorded
unusual charges totalling $57 million related to the permanent closure of
several facilities. The Pulp segment operating loss increased by $126 million.
The current year loss includes unusual charges of $183 million relating
primarily to asset impairment at the Smooth Rock Falls, Ontario pulp mill. The
impairment charge was the principal reason depreciation and amortization expense
declined by $22 million. The Paper segment operating loss declined by $195
million. The prior year results included an unusual charge of $101 million
relating to the permanent closure of the Saint-Raymond, Quebec paper mill as
well as a charge of $93 million relating to three items; a charge of $45 million
for the closure of a pulp line and a paper machine; a charge of $26 million to
reduce the carrying value of a dismantled paper machine; and a charge of $22
million to reduce the carrying value of previously recorded goodwill in the
newsprint operations.

A more detailed
review of items having impacted sales, EBITDA and operating results of each
business segment is outlined in a subsequent section of the MD&A. The
following sections review the impact of non-operating items on the financial
performance of the Company.



14

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|                                           |     
|------------------------------------------ | ----
|MANAGEMENT'S DISCUSSION AND
      ANALYSIS | 2006
|                                           |     

|INTEREST, FOREIGN EXCHANGE
      AND OTHER                        |  |       |  |     
|----------------------------------------------------------------- |  | ----- |  | ----
|(in millions of dollars)                                          |  |       |  |     
|                                                                  |  | 2005  |  | 2006
|                                                                 
|Interest on indebtedness                                          |  | 130   |  | 135 
|Amortization of deferred gain on foreign
      exchange contracts |  | (118) |  | (38)
|Derivative financial instruments
      gain                       |  | (30)  |  |    
|Other foreign exchange
    items                                  |  | 17    |  | 11  
|Loss on consolidation of foreign integrated
      subsidiaries    |  | 6     |  | 1   
|Other items                                                       |  | 6     |  | 2   
|                                                                 
|                                                                  |  | 11    |  | 111 
|                                                                 

Interest on long-term
debt declined by $5 million primarily as a result of the stronger Canadian $.
Approximately 92% of the Companys long-term debt relates to US $ senior notes
with fixed rates of interest. As such, the only item affecting interest on
long-term debt is a change in the relative value of the Canadian $ versus the US
$. Interest on short-term debt increased by $10 million as the Company made
greater use of its short-term operating lines.

Effective September
28, 2003, the Company applied the accounting treatment prescribed by EIC-128 of
the CICA with respect to the accounting treatment for derivative financial
instruments that do not qualify for hedge accounting. Prior to the
implementation of this guideline, gains and losses related to financial
instruments, primarily foreign exchange contracts, were recognized on the
maturity dates of the instruments. If derivative financial instruments were sold
or traded prior to their stated maturity dates, the gains or losses were
deferred and recognized on the statement of operations as per the original
maturity dates. The old rules required disclosure of outstanding derivative
financial instruments and their mark to market value in the notes to the
financial statements, but the positions were not shown on the Companys balance
sheet. The Company applied EIC-128 and the accounting guideline for
discontinuing hedge accounting at the beginning of fiscal
2004.

The following table
summarizes the change in the unamortized deferred gain on foreign exchange
contracts during the years ended September 2005 and 2006:

|                                |  |         |  | (in millions of
  dollars)
|------------------------------- |  | ------- |  | --------------------------
|                               
|                                |  | Opening |  |                           
|                                |  | Balance |  | Amortization              
|                               
|Year ended September 2005       |  | 156     |  | (118)                     
|                               
|Year ended September
      2006 |  | 38      |  | (38)                      
|                               

Since the beginning
of fiscal 2004, the Company has shown the market value of its derivative
financial instruments on its balance sheet and the resulting gain or loss for
the period has been reflected in its statement of operations. Derivative
financial instruments relate primarily to foreign exchange contracts but also
include commodity related instruments such as lumber futures and hedges for
purchased waste fibre and energy.



15

---



|     |                                     
|---- | ------------------------------------
|2006 | MANAGEMENT'S DISCUSSION AND ANALYSIS
|     |                                     

|                                                                         |  |         |  |        |  | (in millions of
      dollars)
|------------------------------------------------------------------------ |  | ------- |  | ------ |  | ------------------------------
|                                                                        
|                                                                         |  | Opening |  | Gain   |  | Disbursements                 
|Year ended September
      2005                                          |  | Balance |  | (Loss) |  | (Proceeds)                    
|                                                                        
|Market value of outstanding foreign
      exchange contracts             |  | 105     |  | 23     |  | (128)                         
|Market value of commodity related
      derivative financial instruments |  | 10      |  | 7      |  | (11)                          
|                                                                        
|                                                                         |  | 115     |  | 30     |  | (139)                         
|                                                                        
|                                                                        
|                                                                         |  |         |  |        |  | (in millions of
      dollars)
|                                                                        
|                                                                         |  | Opening |  | Gain   |  | Disbursements                 
|Year ended September
      2006                                          |  | Balance |  | (Loss) |  | (Proceeds)                    
|                                                                        
|Market value of outstanding foreign
      exchange contracts             |  |        |  | 3      |  | (3)                           
|Market value of commodity related
      derivative financial instruments |  | 6       |  | (3)    |  | (3)                           
|                                                                        
|                                                                         |  | 6       |  |       |  | (6)                           
|                                                                        

During fiscal 2005,
the Company recorded a gain of $23 million on its outstanding foreign exchange
contracts as the relative value of the Canadian $ increased from US $0.784 to US
$0.854. The Company received proceeds of $128 million relating to foreign
exchange contracts during fiscal 2005. There was limited foreign exchange
activity in fiscal 2006. The Company had sold the bulk of its remaining
positions in the prior year.

At September 30,
2006, the Company did not hold any lumber futures. At the September 24, 2005,
the Company held lumber futures equal to approximately 0.5% of its annual SPF
lumber capacity. The fair value of these instruments was nil. At the end of
fiscal 2006, the Company did not hold any old newspapers (ONP) hedges. At the
end of the prior year, the Company held hedges relating to purchased ONP
representing approximately 3% of its annual recycled fibre purchases. The fair
value of these instruments was nil. At September 30, 2006, the Company did not
hold any natural gas hedges. At September 24, 2005, the Company held natural gas
hedges covering approximately 7% of its anticipated requirements for the next
year. The fair value of these instruments was $6 million.



16

---



|                                           |     
|------------------------------------------ | ----
|MANAGEMENT'S DISCUSSION AND
      ANALYSIS | 2006
|                                           |     

GAIN ON
TRANSLATION OF FOREIGN DEBTDuring fiscal 2006, the Company recorded a gain of $64
million on the translation of its US $ denominated debt as the relative value of
the Canadian $ increased from US $0.854 to US $0.895. In the prior year, the
Canadian $ had increased from US $0.784 to US $0.854, and the Company had
recorded a gain of $125 million. The after-tax impact of the gain on translation
of foreign denominated debt was $54 million or $0.62 per share as compared to
the prior year after-tax gain of $104 million or $1.22 per
share.

INCOME
TAXESIn
fiscal 2005, the Company recorded an income tax recovery of $61 million on a
pre-tax loss of $376 million. The income tax recovery was $64 million lower than
the projected recovery of $125 million based on the Companys combined Canadian
federal and provincial income tax rate of 33.3% . There was a favourable item
which increased the recovery by $20 million relating to the non-taxable portion
of the exchange gain on US $ denominated debt, which currently receives capital
gains treatment in Canada and is taxed at 50% of regular business income. Lower
corporate income tax rates in the Companys non-Canadian operations increased
the recovery by $9 million. The above favourable items were more than offset by
several items which reduced the income tax recovery by $93 million. The
non-recognition of period losses, primarily related to our U.S. operations in
St. Francisville, Louisiana reduced the recovery by $33 million. As well, the
reduction in carrying value of a previously recognized income tax asset relating
to the St. Francisville operations further reduced the income tax recovery by
$32 million. Non-deductible expenses, primarily related to goodwill impairment,
decreased the recovery by $21 million. The non-deductible loss on consolidation
of foreign subsidiaries decreased the recovery by $4 million. Finally, the
Canadian large corporation tax reduced the recovery by $3
million.

During fiscal 2006,
the Company recorded an income tax recovery of $66 million on a pre-tax loss
from continuing operations of $421 million. The income tax recovery was $74
million lower than the projected recovery of $140 million based on the Companys
effective tax rate of 33.3% . There were several favourable items which
increased the recovery by $21 million. Lower corporate income taxes in the
Companys non-Canadian operations increased the recovery by $9 million. There
was a favourable item of $9 million relating to the non-taxable portion of the
exchange gain on US $ denominated debt, which currently receives capital gains
treatment in Canada and is taxed at 50% of regular business income. Other
permanent differences increased the recovery by $3 million. The aforementioned
favourable items were more than offset by several unfavourable items which
reduced the income tax recovery by $95 million. The non-recognition of period
losses, primarily related to the Companys Canadian and U.S. operations, reduced
the recovery by $88 million. The change in valuation allowance at a joint
venture reduced the recovery by $3 million. The income tax recovery was further
reduced by $3 million due to the net effect of announced future rate enactments,
with favourable Canadian federal corporate tax rate changes being more than
offset by increased rates in the Province of Quebec. Finally, the non-deductible
loss on consolidation of foreign subsidiaries decreased the recovery by $1
million.

Details regarding the
Companys tax position are outlined in note 18 of the audited consolidated
financial statements.

EARNINGS
FROM DISCONTINUED OPERATIONSIn February 2006, the Company sold its OSB mill located
in Saint-Georges-de-Champlain, Quebec for total consideration of $98 million.
The sale generated an after-tax gain of $47 million or $0.55 per share. As well,
the OSB mill generated net earnings of $4 million or $0.05 per share during the
five months it was owned by the Company. This compares to net earnings of $11
million or $0.13 per share in the prior year.



17

---



|     |                                     
|---- | ------------------------------------
|2006 | MANAGEMENT'S DISCUSSION AND ANALYSIS
|     |                                     

NET
LOSSThe
Company generated a net loss of $304 million or $3.55 per share compared to a
net loss of $304 million or $3.55 per share in the same period a year ago. As
noted previously, the Companys financial results were impacted by certain
specific items. The following table summarizes the impact of these items on the
reported financial results. The Company believes it is useful supplemental
information as it provides an indication of results excluding the specific
items. This supplemental information is not intended as an alternative measure
for net loss as determined by Canadian GAAP. The table below contains one
recurring item, namely the gain or loss on translation of foreign debt. Because
the Company has a substantial amount of US $ denominated debt, relatively minor
changes in the value of the Canadian $ versus the US $ can lead to large
unrealized periodic gains or losses. As well, the item receives capital
gains/loss tax treatment and is not tax-affected at regular business income
rates.

|                                                                      |  |       |  |                                                      |  | Year ended         |  | Year ended       
|--------------------------------------------------------------------- |  | ----- |  | ---------------------------------------------------- |  | ------------------ |  | -----------------
|                                                                      |  |       |  |                                                      |  | September 2005     |  | September
2006   
|                                                                      |  |       |  |                                                      |  | ($
      millions) |  | ($
      / share)
|                                                                     
|Net loss as reported  in accordance
      with GAAP                  |  | (304) |  | (3.55)                                               |  | (304)              |  | (3.55)           
|Specific items
      (after-tax):                                     |  |       |  |                                                      |  |                    |  |                  
|Gain on translation of
      foreign debt                             |  | (104) |  | (1.22)                                               |  | (53)               |  | (0.62)           
|Derivative financial
      instruments gain                           |  | (20)  |  | (0.24)                                               |  |                   |  |                 
|Amortization of deferred
      gain on foreign exchange contracts     |  | (80)  |  | (0.93)                                               |  | (26)               |  | (0.30)           
|Unusual
      item                                                    |  |      |  | Sawmills                                             |  | 38                 |  | 0.44             
|Unusual
      item                                                    |  |      |  | Saint-Raymond paper
      mill                       |  | 68                 |  | 0.80             
|Unusual
      item                                                    |  |      |  | Dismantled
    machines                              |  | 20                 |  | 0.23             
|Unusual
      item                                                    |  |      |  | Asset impairment                                     |  | 3                  |  | 0.03             
|Unusual
      item                                                    |  |      |  | Goodwill
    impairment                              |  | 23                 |  | 0.26             
|Unusual
      item                                                    |  |      |  | Smooth Rock Falls pulp
      mill                    |  |                   |  |                 
|Unusual
      item                                                    |  |      |  | St. Francisville paper
      mill                    |  | 45                 |  | 0.53             
|Unusual
      item                                                    |  |      |  | Gain on sale of metal plate and web
      operations |  |                   |  |                 
|Unusual
      item                                                    |  |      |  | International pine
      operations                  |  |                   |  |                 
|Unusual
      item                                                    |  |      |  | Gain on sale of land and
      building              |  |                   |  |                 
|Earnings from discontinued
      operations  OSB mill                |  | (11)  |  | (0.13)                                               |  | (51)               |  | (0.60)           
|                                                                     
|Net loss excluding specific items  not
      in accordance with GAAP |  | (324) |  | (3.78)                                               |  | (306)              |  | (3.57)           
|                                                                     





18

---





|                                           |     
|------------------------------------------ | ----
|MANAGEMENT'S DISCUSSION AND
      ANALYSIS | 2006
|                                           |     

|QUARTERLY FINANCIAL
      INFORMATION                      |  |         |  |         |  |         |  |          |  |         |  |        
|---------------------------------------------------------- |  | ------- |  | ------- |  | ------- |  | -------- |  | ------- |  | -------
|(in millions of dollars, except per share
      amounts)   |  |         |  |         |  |         |  |          |  |        
|                                                           |  | 2005    |  | 2006   
|                                                           |  | Dec. 26 |  | Mar. 26 |  | June 25 |  | Sept. 24 |  | Dec. 25 |  | Mar. 25
|                                                          
|Sales                                                      |  | 872     |  | 880     |  | 938     |  | 817      |  | 789     |  | 818    
|EBITDA                                                     |  | (17)    |  | 6       |  | 21      |  | (7)      |  | (33)    |  | 5      
|Depreciation and                                           |  |         |  |         |  |         |  |          |  |         |  |        
|amortization                                               |  | 59      |  | 61      |  | 57      |  | 61       |  | 56      |  | 56     
|Unusual items                                              |  | 21      |  |        |  | 136     |  | 98       |  |        |  | 176    
|Operating loss                                             |  | (97)    |  | (55)    |  | (172)   |  | (166)    |  | (89)    |  | (227)  
|                                                          
|Net loss from                                              |  |         |  |         |  |         |  |          |  |         |  |        
|continuing                                                 |  |         |  |         |  |         |  |          |  |         |  |        
|operations                                                 |  | (2)     |  | (31)    |  | (146)   |  | (136)    |  | (79)    |  | (216)  
|Net loss                                                   |  | (1)     |  | (26)    |  | (142)   |  | (135)    |  | (75)    |  | (169)  
|Net loss per share:                                        |  |         |  |         |  |         |  |          |  |         |  |        
|From
      continuing                                      |  |         |  |         |  |         |  |          |  |         |  |        
|operations                                                 |  | (0.03)  |  | (0.36)  |  | (1.72)  |  | (1.59)   |  | (0.92)  |  | (2.52) 
|Basic                                                      |  | (0.01)  |  | (0.31)  |  | (1.66)  |  | (1.58)   |  | (0.88)  |  | (1.96) 
|Fully
    diluted                                          |  | (0.01)  |  | (0.31)  |  | (1.66)  |  | (1.58)   |  | (0.88)  |  | (1.96) 
|                                                          
|Cash flow                                                  |  |         |  |         |  |         |  |          |  |         |  |        
|per share(1)                                               |  | (0.35)  |  | 0.11    |  | (0.20)  |  | 0.04     |  | (0.72)  |  | (0.33) 
|                                                          
|(1) Before changes in non-cash
      working capital items |  |         |  |         |  |         |  |          |  |         |  |        

FOURTH
QUARTER ANALYSISThe Company reported a net loss of $54 million or $0.64 per share in
the fourth quarter ended September 30, 2006 compared to net loss of $135 million
or $1.58 per share in the same quarter of fiscal 2005. The weighted average
number of common shares outstanding was 85.6 million, unchanged from the prior
year.

Sales increased by
$46 million as compared to the same quarter a year ago. The Forest Products
segment sales declined by $28 million as a result of lower prices US $ reference
prices. Pricing also was impacted by a stronger Canadian $, which averaged 7%
higher versus the US $. The Pulp segment sales increased by $71 million on the
strength of improved prices and higher shipments. The Paper segment sales
increased by $5 million as lower selling prices were more than offset by
increased shipments for all grades of paper.

EBITDA improved by
$37 million over the prior year quarter. The Forest Products segment negative
EBITDA declined by $7 million with lower prices being more than offset by lower
costs. Lumber export duties on shipments to the U.S. declined by $10 million due
to reduced deposit rates that came into effect in December 2005. The Pulp
segment EBITDA improved by $23 million as prices improved substantially. The
Paper segment EBITDA improved by $9 million. This segment benefited from lower
manufacturing costs which more than offset weaker revenues. Energy costs were
lower and the segment also benefited from a more favourable exchange rate on the
St. Francisville paper mills US $ costs.

The operating loss
decreased by $131 million as compared to the year ago quarter. The Forest
Products segment operating loss declined by $7 million. The aforementioned
improvement in EBITDA was the most significant contributor. The Pulp segment
operating loss of $10 million represented a $24 million improvement over the
prior year quarter. The gain was driven by the higher EBITDA and reduced
depreciation expense resulting from the asset impairment charge on the Smooth
Rock Falls pulp mill taken in the March 2006 quarter. The Paper segment
operating loss declined by $102 million as the year ago quarter included an
unusual charge of $93 million relating to three items: a charge of $45 million
for the closure of a pulp line and of a paper machine; a charge of $26 million
to reduce the carrying value of a dismantled paper machine; and a charge of $22
million to reduce the carrying value of previously recorded goodwill in the
newsprint operations.

During the September
2006 quarter, the Company recorded a gain of $7 million on the translation of
its US $ denominated debt as the relative value of the Canadian $ increased from
US $0.890 to US $0.895. In the comparable period a year ago, the Canadian $ had
increased from US $0.811 to US $0.854, and the Company had recorded a gain of
$74 million. The after-tax impact of the gain on translation of foreign
denominated debt was $6 million or $0.07 per share as compared to the prior year
after-tax gain of $61 million or $0.72 per share.

The fourth quarter
2006 interim MD&A issued on November 22, 2006 provides a more extensive
analysis of items having impacted the Companys quarterly financial
results.



19

---

2006
    MANAGEMENT'S DISCUSSION AND ANALYSISSUMMARY OF QUARTERLY
RESULTSOn a
quarterly basis, sales have benefited from improvements in US $ reference prices
for lumber, pulp and paper over the last two years. However, much of the benefit
was offset by a strengthening Canadian $ compared to the US $, increasing from
an average of US $0.818 in the first quarter of fiscal 2005 to US $0.892 in the
fourth quarter of fiscal 2006, a 9% increase. As a result, the Company has
continued to generate low levels of EBITDA.

The Companys
financial performance and that of its Forest Products segment for the last eight
quarters were negatively impacted by substantial export duties on lumber shipped
to the US. Total amount incurred over the last two years was $124 million, an
amount greater than the total reported EBITDA of $26 million.

The Company has
generated losses from continuing operations of $656 million in the last eight
quarters. In addition to marginal levels of EBITDA previously noted, the Company
has recorded unusual charges totalling $444 million over the last eight
quarters. The following summarizes major unusual items
recorded.

|(in millions of dollars)                                      |  |      |  |     
|------------------------------------------------------------- |  | ---- |  | ----
|                                                              |  | 2005 |  | 2006
|                                                             
|Ontario Sawmills  December
      2004                        |  | 21   |  |    
|Quebec/Specialty sawmills  March
      2005                  |  | 35   |  |    
|St. Raymond paper mill  March
      2005                     |  | 101  |  |    
|St. Francisville paper mill  September
      2005/March 2006 |  | 45   |  | 7   
|Dismantled machines  September
      2005                    |  | 30   |  |    
|Goodwill impairment  September
      2005                    |  | 23   |  |    
|Smooth Rock Falls pulp mill  March
      2006/September 2006 |  |     |  | 183 
|Sale of metal plate and web operations  June
      2006      |  |     |  | (5) 
|International pine operations  September
      2006          |  |     |  | 5   
|Sale of land and building  September
      2006              |  |     |  | (1) 
|                                                             
|                                                              |  | 255  |  | 189 
|                                                             

Details are outlined
in note 16 of the audited consolidated financial statements.

While the stronger
Canadian $ reduced EBITDA, the Company realized significant gains on its
derivative financial instruments, primarily US $ foreign exchange contracts.
During the four quarters of fiscal 2005 and the first two quarters of fiscal
2006, the Company has recorded $186 million of realized and amortized gains on
derivative financial instruments. However, the impact of foreign exchange
derivatives on our financial results declined considerably in March 2006. As a
result, gains in the last two quarters of fiscal 2006 were
negligible.

The Company also
recorded a gain of $189 million on the translation of its US $ denominated debt
over the last two years. However, the impact of the quarterly translation gains
and losses added considerable volatility to the results, with the impact ranging
from a gain of $74 million in the September 2005 quarter to a loss of $20
million in the June 2005 quarter.





20

---





|                                           |     
|------------------------------------------ | ----
|MANAGEMENT'S DISCUSSION AND
      ANALYSIS | 2006
|                                           |     

|Segment
      review                       |  |       |   |       |   |       |   |       |   |       |      
|------------------------------------------ |  | ----- | - | ----- | - | ----- | - | ----- | - | ----- | -----
|                                           | 
|FOREST PRODUCTS                            |  |       |   |       |   |       |   |       |   |       |      
|(in millions of
      dollars)             |  |       |   |       |   |       |   |       |   |       |      
|                                           |  | 2002  |   | 2003  |   | 2004  |   | 2005  |   | 2006  |      
|                                           | 
|Total sales                                |  | 1,079 |   | 1,012 |   | 1,308 |   | 1,267 |   | 1,088 |      
|Consolidated
    sales                     |  | 907   |   | 838   |   | 1,095 |   | 1,072 |   | 905   |      
|Lumber duties                              |  | 18    |   | 81    |   | 111   |   | 89    |   | 35    |      
|                                           | 
|EBITDA                                     |  | 61    |   | (57)  |   | 75    |   | 32    |   | 22    |      
|EBITDA margin on consolidated
      sales  |  | 6.7   | % | (6.8) | % | 6.8   | % | 3.0   | % | 2.4   | **%**
|                                           | 
|Depreciation and
      amortization        |  | 42    |   | 43    |   | 48    |   | 56    |   | 54    |      
|Unusual items                              |  | 6     |   | 16    |   |      |   | 57    |   | (1)   |      
|                                           | 
|Operating earnings
      (loss)            |  | 13    |   | (116) |   | 27    |   | (81)  |   | (31)  |      
|                                           | 
|Identifiable assets (excluding
      cash) |  | 752   |   | 717   |   | 846   |   | 813   |   | 759   |      
|                                           | 

The Forest Products
segment is divided into two main areas of activity: forest resource management
and manufacturing operations.

The Forest Resource
Management group is responsible for managing all of the Companys Canadian
forestry operations. This includes the harvesting of timber, either directly or
by contractual agreements, and all silviculture and regeneration work required
to ensure a sustainable supply for the manufacturing units. The group is also
responsible for third party timber purchases, which are needed to supplement
total requirements. The groups main objective is the optimization of the flow
of timber into various manufacturing units. As the Companys forest activity in
Canada is conducted primarily on Crown lands, the Forest Resource Management
group works closely with provincial governments to ensure harvesting plans and
operations comply with established regulations and that stumpage charged by the
provinces is reasonable and reflects the fair value of the timber being
harvested. During fiscal 2006, the Companys operations harvested and delivered
7.2 million cubic metres of timber versus 8.0 million cubic metres in 2005.
Additional supply of approximately 1.2 million cubic metres was secured mainly
through purchases and exchanges with third parties, down from 1.3 million cubic
metres in the prior year.

The Forest Products
group includes operations located in Quebec, Ontario, Alberta, British Columbia
and France. The group also has a minority ownership position in a Chilean pine
sawmill. As equity accounting is used for this operation, its sales, margins and
volumes are not included in the Companys consolidated results. The group
focuses on three main product areas: SPF Lumber, Specialty Wood and Engineered
Wood. The SPF Lumber operations can produce approximately 1.7 billion board feet
of lumber. The Specialty Wood operations can annually produce 125 million board
feet of pine lumber, hardwood lumber and hardwood flooring, after allowing for
the permanent shutdown of the Davidson, Quebec pine and hardwood sawmills. The
Engineered Wood operations produce laminated veneer lumber (LVL), finger joint
lumber, wood I-beams, rim joists, metal plates and webs. On February 27, 2006,
the Company completed the sale of its oriented strandboard (OSB) business
located in Saint-Georges-de-Champlain, Quebec. The financial results of the OSB
operation have been reclassified as discontinued operations. Comparative figures
have also been reclassified to exclude the OSB mills results from the
continuing operations.





21

---





|     |                                     
|---- | ------------------------------------
|2006 | MANAGEMENT'S DISCUSSION AND ANALYSIS
|     |                                     

|The
      following summarizes the annual operating levels of each facility by
      product group:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  |                          
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|SPF
      LUMBER                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | MFBM                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Stud Lumber  Taschereau/La Sarre,
      QC(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  | 200,000                  
|Stud Lumber  Senneterre,
      QC                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |  | 150,000                  
|Stud Lumber  Cochrane,
      ON                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | 170,000                  
|Stud Lumber  Kapuskasing,
      ON                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  | 105,000                  
|Random Lumber  Nouvelle /
      Saint-Alphonse, QC(2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |  | 75,000                   
|Random Lumber  Béarn,
      QC                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  | 110,000                  
|Random Lumber  Chapleau,
      ON                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |  | 135,000                  
|Random Lumber  Timmins,
      ON                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |  | 100,000                  
|Random Lumber  Hearst,
      ON                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | 160,000                  
|Random Lumber  Canal Flats,
      BC(3)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  | 180,000                  
|Random Lumber  Elko,
      BC(3)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |  | 270,000                  
|Finger Joint Lumber  Cranbrook,
      BC                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  | 25,000                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | 1,680,000                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|SPECIALTY
      WOOD                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  | MFBM                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Pine & Hardwood Lumber  Davidson,
      QC(4)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  | 55,000                   
|Pine & Hardwood Lumber  Mattawa,
      ON                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |  | 30,000                   
|Hardwood Lumber  Huntsville,
      ON                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |  | 30,000                   
|Hardwood Flooring  Huntsville,
      ON                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  | 18,000                   
|Pre-Finished Hardwood Flooring 
      Toronto, ON                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |  | 10,000                   
|Pine Lumber  Brassac,
      France                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  | 15,000                   
|Radiata Pine Lumber  Curanilahue,
      Chile(5)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |  | 22,000                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | 180,000                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|ENGINEERED WOOD                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  | Thousand
      ft.3      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Laminated Veneer Lumber  Ville-Marie,
      QC(6)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |  | 475                      
|Laminated Veneer Lumber  Amos,
      QC(6)(7)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  | 2,300                    
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | 2,775                    
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | MFBM                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Engineered Finger Joint Lumber  La
      Sarre, QC                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  | 60,000                   
|Engineered Finger Joint Lumber 
      Kirkland Lake, ON(7)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  | 60,000                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | 120,000                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | Thousand linear
      ft.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Wood I-Beams  Bolton,
      ON(6)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |  | 40,000                   
|Wood I-Beams  Calgary,
      AB(6)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  | 18,000                   
|Wood I-Beams  Blainville,
      QC(6)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |  | 5,000                    
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | 63,000                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | Millions
      lbs       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Metal Plates and Webs  Bolton,
      ON(6)(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  | 10.0                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|(1) Sites are operated as a combined
      entity.(2)
      Volumes reflect 50% of the
      actual capacity as the units are part of the Temrex joint
      venture.(3)
      The Elko and Canal Flats
      sawmills rely on Cranbrook Planing Mill to dry and dress 80,000 mfbm of
      lumber.(4)
      The Davidson facility was shut
      down temporarily for an indefinite period in the September 2005
      quarter.(5)
      Volume reflects 34.31% of the
      actual plant capacity as the unit is part of the Foraction joint venture
      whose financial results are not consolidated with those of the
      Company.(6)
      Volumes reflect 50% of the
      actual plant capacity as the units are part of the Temlam joint
      venture.(7)
      Projected capacity as mill is in
      start-up phase.(8) The Temlam joint venture sold its metal plate and
      web business in the June 2006 quarter.



22

---

MANAGEMENT'S
      DISCUSSION AND ANALYSIS
    2006



The segment is
dominated by SPF lumber, which represented 75% of building material sales in
fiscal 2006, the same as in the prior year. The average selling price of SPF
lumber was $62 per mfbm (thousand foot board measure) lower than in the prior
year. The lower prices were the result of lower US $ reference prices for lumber
and a Canadian $ that averaged 7% higher versus the US $. Specialty and
Engineered Wood prices and revenues were also negatively impacted by the
stronger Canadian $. Overall, Specialty Wood represented 14% of building
material sales in fiscal 2006, down from 16% in fiscal 2005. Engineered Wood
sales in the year were at 11%, up from 9% in the prior year.

In addition to the
above, the Forest Products group produced and shipped approximately 1.9 million
tonnes of wood chips in fiscal 2006, 86% of which were directed to the Companys
pulp and paper operations. In 2005, the group produced 2.0 million tonnes and
shipped 85% of this volume to the pulp and paper mills. The internal transfer
price of woodchips is based on current and expected market transaction
prices.

Total sales for this
segment reached $1,088 million, a decrease of $179 million over the prior year.
Lower selling prices and volumes of SPF lumber accounted for $96 million of the
decrease. The shutdown of the Marks Lumber reman operations, located in
Brantford, Ontario, and the previously noted Davidson hardwood and pine
operations reduced sales by a further $42 million. Wood chip sales declined by
$25 million as a result of lower volumes and prices. Overall, the Forest
Products segment generated 27% of Company consolidated sales, down from 31% in
the prior year. The groups main market is North America, which represented 95%
of consolidated sales in fiscal 2006, as compared to 94% in the prior
year.

|                                             |  |                                                                                                                                                                |  | Sales        |  | Shipments   |  | Selling
Prices
|-------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ |  | ----------- |  | --------------
|                                             |  |                                                                                                                                                                |  | ($ millions) |  | (000 units) |  | ($ / unit)    
|                                             |  |                                                                                                                                                                |  | 2005         |  | 2006        |  | 2005          
|                                            
|                                            
|SPF
      LUMBER                             |  |                                                                                                                                                                |  |              |  |             |  |               
|SPF Lumber
(mfbm)                            |  | 681                                                                                                                                                            |  | 585          |  | 1,464.0     |  | 1,451.7       
|Remanufactured Lumber
      (mfbm)(1)        |  | 15                                                                                                                                                             |  |             |  | 36.6        |  |              
|                                            
|                                             |  |                                                                                                                                                                |  | 696          |  | 585         |  |               
|                                             |  |                                                                                                                                                                |  |              |  |             |  |               
|                                            
|SPECIALTY WOOD                               |  |                                                                                                                                                                |  |              |  |             |  |               
|Pine & Hardwood
      (mfbm)                 |  | 86                                                                                                                                                             |  | 47           |  | 107.3       |  | 67.6          
|Hardwood Flooring
      (mfbm)               |  | 68                                                                                                                                                             |  | 63           |  | 15.3        |  | 14.0          
|                                            
|                                             |  |                                                                                                                                                                |  | 154          |  | 110         |  |               
|                                             |  |                                                                                                                                                                |  |              |  |             |  |               
|                                            
|ENGINEERED WOOD                              |  |                                                                                                                                                                |  |              |  |             |  |               
|LVL (cubic feet)                             |  | 17                                                                                                                                                             |  | 21           |  | 633.8       |  | 875.1         
|Eng. Finger Joint Lumber
      (mfbm)        |  | 2                                                                                                                                                              |  | 12           |  | 4.9         |  | 20.9          
|Wood I-Beams & Rim Joists (linear
      ft.) |  | 50                                                                                                                                                             |  | 46           |  | 31,274      |  | 28,921        
|Metal Plates & Webs (000
      lbs)(2)       |  | 10                                                                                                                                                             |  | 6            |  | 10,062      |  | 5,832         
|                                            
|                                             |  |                                                                                                                                                                |  | 79           |  | 85          |  |               
|                                             |  |                                                                                                                                                                |  |              |  |             |  |               
|TOTAL BUILDING
MATERIALS                     |  | 929                                                                                                                                                            |  | 780          |  |             |  |               
|                                             |  |                                                                                                                                                                |  |              |  |             |  |               
|Wood Chips & other
      sales               |  | 338                                                                                                                                                            |  | 308          |  |             |  |               
|                                             |  |                                                                                                                                                                |  |              |  |             |  |               
|TOTAL SALES                                  |  | 1,267                                                                                                                                                          |  | 1,088        |  |             |  |               
|                                             |  |                                                                                                                                                                |  |              |  |             |  |               
|Internal Wood Chips & other
      sales      |  | (195)                                                                                                                                                          |  | (183)        |  |             |  |               
|                                             |  |                                                                                                                                                                |  |              |  |             |  |               
|CONSOLIDATED SALES                           |  | 1,072                                                                                                                                                          |  | 905          |  |             |  |               
|                                             |  |                                                                                                                                                                |  |              |  |             |  |               
|(1)                                          |  | The lumber remanufacturing operations located in
      Brantford, Ontario were permanently closed in the June 2005
      quarter.                              |  |              |  |            
|(2)                                          |  | The Companys proportionately
      consolidated joint venture, Temlam Inc., sold all of its metal plate and
      web operations, located in Bolton, Ontario,
|                                             |  | in
      the June 2006 quarter.                                                                                                                                |  |              |  |             |  |               

23

---



|     |                                     
|---- | ------------------------------------
|2006 | MANAGEMENT'S DISCUSSION AND ANALYSIS
|     |                                     

MARKETSThe benchmark random length Western SPF lumber net price averaged US
$311 per mfbm in 2006, a decrease from US $348 per mfbm in 2005. In the East,
the random length Eastern SPF average lumber price (delivered Great Lakes)
decreased from US $422 per mfbm to US $384 per mfbm in 2006. The Company
considers these to be relatively low levels, approximately US $20 to US $30
below normal trendline prices for random lumber. The reference price for stud
lumber decreased as well with the Eastern average lumber price (delivered Great
Lakes) down from US $421 per mfbm to US $363 per mfbm, a level approximately US
$20 to US $30 per mfbm below trendline prices. While U.S. annual housing starts
were in excess of two million units in fiscal 2006, a reduction in the latter
part of year, combined with uncertainty surrounding the then proposed lumber
agreement between Canada and the United States, led to excess shipments and
significantly lower selling prices.

It has now been
approximately five and a half years since the five-year Canada / U.S. Softwood
Lumber Agreement (SLA) expired on April 1, 2001. On April 2, 2001, petitions for
the imposition of antidumping and countervailing duties on softwood lumber to
the U.S. were filed with the U.S. Department of Commerce (USDOC) and the U.S.
International Trade Commission (USITC) by certain U.S. industry and trade
groups. In August 2001, the USDOC made a preliminary countervailing duty
determination, imposing a bonding rate of 19.31% on Canadian softwood lumber
shipped to the U.S. after August 16, 2001.

The preliminary
countervailing duty continued in fiscal 2002 as the Company accrued $11 million
on lumber shipments to the U.S. from September 30 to December 15, 2001.
Preliminary countervailing duty effectively expired on the latter date. In
addition, on October 31, 2001, the USDOC made a preliminary antidumping
determination imposing a bonding requirement at the rate of 10.76% on the
Companys shipments of Canadian softwood lumber to the U.S. The aforementioned
average rate was assigned specifically to the Company based on the USDOC review
of our actual historical shipments to the U.S. During the first half of fiscal
2002, the Company accrued a total of $10 million relating to shipments to the
U.S. between November 6, 2001 and March 30, 2002.

On May 16, 2002, the
USITC announced it had found no current injury, but a threat of injury, to the
U.S. lumber industry, effectively removing the requirement to remit the $22
million of accrued preliminary countervailing duty and the $10 million of
accrued preliminary antidumping duty. The finding of threat of injury by USITC
resulted in the USDOC issuing an order to collect cash deposits of estimated
countervailing and antidumping duties on a going forward basis. Effective May
22, 2002, the Companys softwood lumber exports to the U.S. were subject to a
countervailing duty cash deposit rate of 18.79% and an antidumping cash deposit
rate of 10.21% . During fiscal 2003, the Company incurred a charge of $50
million relating to countervailing duty and a charge of $31 million for
antidumping duty for lumber shipped to the U.S.. During fiscal 2004, the Company
incurred a charge of $68 million relating to countervailing duty and a charge of
$44 million for antidumping duty. On December 20, 2004, the USDOC reduced the
countervailing duty deposit rate to 17.18% and increased the antidumping rate to
10.59% . On February 17, 2005, the countervailing duty rate was further
corrected to 16.37% and the antidumping rate to 9.1% . During fiscal 2005, the
Company incurred a charge of $57 million relating to countervailing duty and a
charge of $32 million for antidumping duty. On December 12, 2005, the USDOC
reduced the countervailing duty rate to 8.7% and the antidumping rate to 4.02% .
During fiscal 2006, the Company incurred a charge of $30 million relating to
countervailing duty and a charge of $5 million relating to antidumping
duty.



24

---

MANAGEMENT'S
      DISCUSSION AND ANALYSIS
    2006

Overall, the net
impact of duties in fiscal 2006 was a charge of $35 million, down from $89
million in the prior year. Lower prices combined with the lower rates for the
last three quarters of fiscal 2006 generated the decrease. To the end of
September 2006, the Company had expensed a total of $345 million in duties since
May 22, 2002. The following table summarizes duty expensed and remitted over
that period. Additional details are outlined in note 14 of the audited
consolidated financial statements.

|       |  |      |  |           |  | (in millions of
      dollars)
|------ |  | ---- |  | --------- |  | ------------------------------
|      
|       |  |      |  | Duties    |  | Duties                        
|       |  |      |  | Expensed  |  | remitted                      
|       |  |      |  | C
      $ |  | C
      $                     
|      
|Fiscal |  | 2002 |  | 28        |  | 25                            
|Fiscal |  | 2003 |  | 81        |  | 74                            
|Fiscal |  | 2004 |  | 112       |  | 106                           
|Fiscal |  | 2005 |  | 89        |  | 91                            
|Fiscal |  | 2006 |  | 35        |  | 48                            
|      
|       |  |      |  | 345       |  | 344                           
|      

On October 30, 2006,
the Company received a US $242 million payment pertaining to the recovery of
lumber export duties, including accrued interest. The funds received represented
approximately all of monies expected to be recovered as part of the new softwood
lumber agreement between Canada and the United States.

OPERATING
RESULTSThe
volume of SPF lumber sold in fiscal 2006 was similar to the shipments of the
prior year. In fiscal 2005, there were significant changes to the Companys
Eastern Canadian SPF operations. In response to lower allowable harvesting
levels of timber on Crown lands, the Company permanently idled three stud lumber
sawmills: Kirkland Lake, Ontario; Opasatika, Ontario; and La Sarre, Quebec. The
net impact was a reduction of production capacity of approximately 100 million
fbm. However, the remaining Eastern Canadian sawmills became approximately 21%
larger, in terms of normal production capacity.

Overall, lower
selling prices for SPF lumber were the primary cause of the EBITDA decrease of
$10 million. The lower prices were substantially offset by lower manufacturing
costs, primarily timber consumed in the SPF lumber operations. SPF costs were
also favourably impacted by lower lumber export duties. As noted previously,
countervailing and antidumping duties totalled $35 million in fiscal 2006, down
from $89 million in the prior year. The decline is due to the reduced rates that
came into effect in December 2005. The EBITDA margin was 2.4%, compared to a
five-year average of 2.4% . In fiscal 2006, the Forest Products segment
generated as much EBITDA as the consolidated EBITDA of the Company, as the Paper
segment generated negative EBITDA. In fiscal 2005, the segment generated more
EBITDA than the consolidated EBITDA of the Company, as both the Pulp and Paper
segments generated negative EBITDA.

The Forest Products
segment recorded several unusual items in fiscal 2005 and 2006. During the prior
year, the Company recorded unusual charges totalling $57 million related to the
permanent closure of several facilities. These included an SPF lumber sawmill in
Kirkland Lake, Ontario, an SPF lumber sawmill in Opasatika, Ontario, an SPF
lumber sawmill in La Sarre, Quebec, hardwood and pine sawmills in Davidson,
Quebec, a hardwood sawmill in Temiscaming, Quebec and a lumber remanufacturing
facility in Brantford, Ontario. A charge relating to the impairment of goodwill
for the hardwood flooring business was also recorded in the prior year. During
fiscal 2006, the Company recorded a gain of $4 million on the disposal of the
Temlam joint ventures metal plate and web operations as well as a gain of $1
million on the sale of land and building of a lumber remanufacturing facility
that had been permanently idled in the prior year. The Company also recorded
various charges totalling $4 million to reduce the carrying value of the net
assets of pine lumber operations in France and Chile as well as two
international sales offices to fair value.

The Forest Products
segment generated an operating loss of $31 million as compared to an operating
loss of $81 million in the prior year. The reduced loss was the result of the
lower unusual charges in the current year.



25

---





|     |                                     
|---- | ------------------------------------
|2006 | MANAGEMENT'S DISCUSSION AND ANALYSIS
|     |                                     

|PULP                                       |  |       |   |       |   |       |   |       |   |       |      
|------------------------------------------ |  | ----- | - | ----- | - | ----- | - | ----- | - | ----- | -----
|(in millions of dollars)                   |  |       |   |       |   |       |   |       |   |       |      
|                                           |  | 2002  |   | 2003  |   | 2004  |   | 2005  |   | 2006  |      
|                                           | 
|Total sales                                |  | 1,302 |   | 1,380 |   | 1,418 |   | 1,373 |   | 1,451 |      
|Consolidated sales                         |  | 1,228 |   | 1,291 |   | 1,334 |   | 1,290 |   | 1,360 |      
|EBITDA                                     |  | 96    |   | 73    |   | 61    |   | (25)  |   | 6     |      
|EBITDA margin on consolidated
      sales  |  | 7.8   | % | 5.7   | % | 4.6   | % | (1.9) | % | 0.4   | **%**
|                                           | 
|Depreciation and
    amortization          |  | 104   |   | 107   |   | 108   |   | 114   |   | 92    |      
|Unusual items                              |  | 2     |   |      |   |      |   | 4     |   | 183   |      
|Operating loss                             |  | (10)  |   | (34)  |   | (47)  |   | (143) |   | (269) |      
|                                           | 
|Identifiable assets (excluding
      cash) |  | 1,601 |   | 1,490 |   | 1,523 |   | 1,486 |   | 1,207 |      
|                                           | 

The Pulp group
consists of 11 market pulp manufacturing facilities operating at 10 sites. The
facilities are divided into two main types. Eight paper pulp mills produce
softwood kraft, hardwood kraft and high-yield pulps. Three specialty pulp mills
produce specialty cellulose, fluff and dissolving pulps. Nine of the pulp mills
are wholly owned and the Company has a 50% joint venture position in the
Marathon, Ontario softwood kraft pulp mill and in the Atholville, New Brunswick
dissolving pulp mill. All of the Companys financial and statistical data
include only its 50% proportionate share of these two mills. The Company does
however have responsibility for marketing the entire output of the two joint
ventures. The Companys partner in the AV Cell joint venture is the Aditya Birla
Group of India, which effectively purchases the entire output of the mill at
market prices. The paper pulp mills can produce approximately 1,860,000 tonnes
per year after adjusting for proportionate joint ventures. The specialty pulp
mills can produce approximately 380,000 tonnes per year.

The following summarizes
the annual operating levels of each facility by product group:

|PAPER
      PULP                                                                                                                                                                                                                                                                                                   |  | TONNES   
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ---------
|                                                                                                                                                                                                                                                                                                                  
|Softwood Kraft  Skookumchuck,
      BC                                                                                                                                                                                                                                                                            |  | 270,000  
|Softwood Kraft  Tarascon,
      France                                                                                                                                                                                                                                                                            |  | 260,000  
|Softwood Kraft  Smooth Rock Falls,
      ON(1)                                                                                                                                                                                                                                                                    |  | 200,000  
|Softwood Kraft  Marathon,
      ON(2)                                                                                                                                                                                                                                                                             |  | 95,000   
|                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                   |  | 825,000  
|                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                  
|Hardwood Kraft  Saint-Gaudens,
      France                                                                                                                                                                                                                                                                       |  | 305,000  
|                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                  
|Hardwood High-Yield  Temiscaming,
      QC                                                                                                                                                                                                                                                                        |  | 300,000  
|Hardwood High-Yield  Matane,
      QC                                                                                                                                                                                                                                                                             |  | 230,000  
|Hardwood High-Yield  Chetwynd,
      BC                                                                                                                                                                                                                                                                           |  | 200,000  
|                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                   |  | 730,000  
|                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                  
|SPECIALTY
      PULP                                                                                                                                                                                                                                                                                               |  |          
|                                                                                                                                                                                                                                                                                                                  
|Specialty Cellulose  Temiscaming,
      QC                                                                                                                                                                                                                                                                        |  | 165,000  
|Fluff  Tartas, France                                                                                                                                                                                                                                                                                             |  | 155,000  
|Dissolving  Atholville,
      NB(2)                                                                                                                                                                                                                                                                               |  | 60,000   
|                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                   |  | 380,000  
|                                                                                                                                                                                                                                                                                                                  
|TOTAL                                                                                                                                                                                                                                                                                                              |  | 2,240,000
|                                                                                                                                                                                                                                                                                                                  
|(1)     
      The pulp mill was indefinitely idled at the
      end of July 2006. On December 5, 2006, the Company announced the permanent
      closure of the pulp mill. See Subsequent events note 22(b) of the audited
      consolidated financial statements.(2)      50% of current annual
      capacity.



26

---

MANAGEMENT'S
      DISCUSSION AND ANALYSIS
    2006

Total sales for
the Pulp group reached a record $1,451 million, an increase of $78 million from
the prior year. Record shipment levels were partially offset by lower selling
prices. Strong market conditions allowed the Company to sell 156,700 more tonnes
in fiscal 2006, a 7.6% increase over the prior year. Shipments outpaced
production and the Company reduced its inventories by 128,800 tonnes, the
opposite of what had occurred in the prior year when inventories had increased
by 16,500 tonnes. While the segment benefited from higher US $ reference prices
on paper pulps, it was not sufficient to offset the impact of a stronger
Canadian $, which averaged 7% higher versus the US $. The net price effect was a
decrease in sales of $23 million or $10 per tonne. After eliminating internal
sales, the Pulp group generated 41% of consolidated sales, up from 37% in the
prior year.

MARKETSThe Pulp segment is more global than the other business groups
within Tembec. In 2006, 81% of consolidated sales were generated outside of
Canada and the U.S., as compared to 80% in the prior year. The Company markets
its pulp on a world-wide basis, primarily through its own sales force. The Pulp
Group maintains sales or representative offices in Toronto, Canada, Signy/Nyon,
Switzerland, San Sebastian, Spain, Beijing, China. The Companys sales force
also periodically markets pulp and paperboard produced by third parties. In
fiscal 2006, agency pulp sales totalled 2,000 tonnes compared to 4,400 tonnes in
2005.

Year over year,
average selling prices of pulp decreased by $10 per tonne. In fiscal 2005, the
benchmark NBSK pulp price (delivered U.S.) began the year at US $610 per tonne.
It dropped to US $585 per tonne in October 2004 before gradually increasing to
US $680 per tonne by February 2005 and then falling back to US $620 per tonne by
September 2005. The average for fiscal 2005 was US $644 per tonne. In fiscal
2006, we experienced a continuous string of price increases, eventually closing
out the year at US $770 per tonne. The average selling price for the year was US
$688 per tonne, an increase of US $44 per tonne over the prior year. However,
the Canadian $, which averaged 7% higher versus the US $ effectively mitigated
the effect of higher US $ paper pulp prices. Specialty pulp markets were more
difficult with little change to US $ prices, therefore the business absorbed the
full effect of the stronger Canadian $. Average selling prices for specialty
pulps declined by $58 per tonne.

|                         |  | Sales        |  | Shipments    |  | Selling Prices
|------------------------ |  | ------------ |  | ------------ |  | --------------
|                         |  | ($ millions) |  | (000 tonnes) |  | ($ / tonne)   
|                         |  | 2005         |  | 2006         |  | 2005          
|                        
|PAPER
      PULPS        |  |              |  |              |  |               
|Softwood Kraft           |  | 496          |  | 521          |  | 749.7         
|Hardwood Kraft           |  | 173          |  | 172          |  | 286.3         
|Hardwood High-Yield      |  | 373          |  | 426          |  | 683.5         
|SPECIALTY
      PULPS    |  | 308          |  | 308          |  | 336.6         
|                        
|TOTAL PULP
      SALES   |  | 1,350        |  | 1,427        |  | 2,056.1       
|                         |  |              |  |             
|Other sales              |  | 23           |  | 24           |  |               
|                         |  |              |  |              |  |               
|TOTAL
      SALES        |  | 1,373        |  | 1,451        |  |               
|                         |  |              |  |              |  |               
|Internal sales           |  | (83)         |  | (91)         |  | (103.4)       
|                         |  |              |  |             
|CONSOLIDATED
      SALES |  | 1,290        |  | 1,360        |  | 1,952.7       
|                         |  |              |  |             

27

---

2006
    MANAGEMENT'S DISCUSSION AND ANALYSIS

OPERATING
RESULTSWhile
total shipments in fiscal 2006 increased by 156,700 tonnes over the prior year,
establishing a new record, the total amount of pulp produced increased by 11,600
tonnes. During fiscal 2006, the pulp group took 119,400 tonnes of total
downtime, including 35,000 tonnes of lost production at the Smooth Rock Falls
NBSK pulp mill in August and September. There was no market downtime taken in
fiscal 2006. In the prior fiscal year, the Company had taken 101,600 tonnes of
downtime, which included 46,800 tonnes of market related downtime, primarily in
high-yield pulp. The Company defines market downtime as temporary production
curtailments designed to reduce or control finished goods inventory
levels.

Despite the increased
production curtailments, year over year mill level manufacturing costs remained
relatively unchanged. A more favourable exchange rate on the French pulp mills
Euro costs improved operating results by $48 million.

As noted previously,
the Company remains mindful of allowing its inventories to increase beyond
normal levels. Total consolidated pulp inventories at September 30, 2006,
represented approximately 21 days of production. This was significantly lower
than in 2005 when we ended the year with 42 days of production in inventory. The
Company considers 25 days to be a normal level.

Total 2006 shipments
of 2,212,800 tonnes include 58,600 tonnes of high-yield pulp and 47,200 tonnes
of softwood kraft pulp consumed by the Companys paperboard operations as
compared to 56,500 tonnes and 34,900 tonnes respectively in the prior year. As
well, 8,900 tonnes of pulp were consumed internally by various other pulp and
paper operations, as compared to 12,000 tonnes in 2005. In all, internal pulp
consumption represented approximately 5% of total shipments, unchanged from the
prior year.

The eight North
American pulp mills purchased approximately 2.3 million bone dry tonnes (BDT) of
wood chips in fiscal 2006, unchanged from the prior year. Of this amount,
approximately 47% were supplied by the Forest Products group, compared to 49% in
the prior year. The remaining requirements were purchased from third parties
under contracts and agreements of various duration. The three pulp mills located
in Southern France purchased 1.5 million BDT of wood chips in fiscal 2006, as
compared to 1.4 million BDT in the prior year. The fibre is mainly sourced from
many private landowners.

Overall, lower
manufacturing costs and higher US $ reference prices more than offset the
stronger Canadian $ and the EBITDA margin improved from negative 1.9% to
positive 0.4% . This compares with a five-year positive average margin of 3.2% .
The Pulp group EBITDA represented 25% of total Company EBITDA in 2006. As
margins were negative in the prior year, the Pulp group did not contribute to
total Company EBITDA in fiscal 2005.

Depreciation and
amortization expense declined by $22 million, primarily due to the absence of
Smooth Rock Falls pulp mill depreciation expense for the last six months of
fiscal 2006. The carrying value of the mills fixed assets had been reduced in
the March 2006 quarter.

The Pulp segment
absorbed unusual item charges in fiscal 2005 and 2006. In the current year, the
Company recorded a charge of $183 million relating primarily to asset impairment
at the Smooth Rock Falls pulp mill. In the prior year, the Company recorded a
charge of $4 million relating to the reduction of the carrying value of a
dismantled pulp machine.

The Pulp segment
generated an operating loss of $269 million as compared to an operating loss of
$143 million in the prior year. The increased loss was the result of unusual
charges, with improved EBITDA and lower depreciation and amortization expense
providing a partial offset.



28

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|                                                 |     
|------------------------------------------------ | ----
|MANAGEMENT'S
      DISCUSSION AND
      ANALYSIS | 2006
|                                                 |     



|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|

The Paper segment
includes four paper manufacturing facilities with a total of nine paper
machines. The mills located in Kapuskasing, Ontario and Pine Falls, Manitoba
produce newsprint. The facility located in Temiscaming, Quebec produces
multi-ply bleached coated paperboard. The paperboard mill is partially
integrated with the high-yield pulp mill and also consumes pulp manufactured by
the Company at other sites. The St.Francisville, Louisiana mill produces coated
and specialty papers. In May 2005, the Company permanently shut down a 68,000
tonnes per year specialty paper mill located in Saint-Raymond, Quebec. The total
capacity of the Paper group is 1,085,000 tonnes.

The following summarizes
the products and operating levels of each facility by main
type:

|NEWSPRINT                                                                                                                                                                                                                            |  | TONNES(1)
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ---------
|                                                                                                                                                                                                                                    
|Kapuskasing, ON                                                                                                                                                                                                                      |  | 330,000  
|Pine Falls, MB                                                                                                                                                                                                                       |  | 185,000  
|                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                     |  | 515,000  
|                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                    
|COATED PAPER                                                                                                                                                                                                                         |  |          
|                                                                                                                                                                                                                                    
|St. Francisville, LA  Coated No 3
      & 4                                                                                                                                                                                         |  | 280,000  
|                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                    
|SPECIALTY PAPER                                                                                                                                                                                                                      |  |          
|                                                                                                                                                                                                                                    
|Uncoated Bleached Board  St.
      Francisville, LA(2)                                                                                                                                                                              |  | 80,000   
|Specialty Kraft Paper  St.
      Francisville, LA                                                                                                                                                                                   |  | 30,000   
|Coated Paperboard  Temiscaming,
      QC                                                                                                                                                                                            |  | 180,000  
|                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                     |  | 290,000  
|                                                                                                                                                                                                                                    
|TOTAL                                                                                                                                                                                                                                |  | 1,085,000
|                                                                                                                                                                                                                                    
|(1)     
      Although the above table shows all capacities
      in metric tonnes, coated papers and certain specialty papers are sold
      primarily in short tonnes.(2)      This machine was
      shut down in December 2005.

The $69 million
decline in sales resulted primarily from lower shipments and prices for
specialty and coated papers. Higher shipments and prices for newsprint provided
a partial offset. The decline in specialty paper shipments relates to the
permanent closure of the 68,000 tonnes per year Saint-Raymond, Quebec paper
mill, which occurred in May 2005, and the closure of the 80,000 tonnes per year
uncoated bleached board machine at the St. Francisville, Louisiana paper mill,
which occurred in December 2005. Overall, the Paper segment generated 26% of
consolidated sales in fiscal 2006, as compared to 27% in the prior
year.



29

---

2006
    MANAGEMENT'S DISCUSSION AND ANALYSIS

MARKETSThe focus of the Paper business is North America, which accounted for
98% of sales in 2006, unchanged from the prior year. The U.S. alone accounted
for 87% of sales. In fiscal 2005, the benchmark price for newsprint (48.8 gram)
increased from US $550 per tonne to US $615 per tonne, and averaged US $585 per
tonne. In fiscal 2006, price increases continued, ending the year at US $663 per
tonne. The average selling price for the year was US $648 per tonne, an increase
of US $63 per tonne over the prior year. After giving effect to the stronger
Canadian $, the Companys average selling price for newsprint increased by $33
per tonne.

In fiscal 2005, the
benchmark price for coated papers (No. 5  40 lb) increased from US $740 per
short ton to US $880 per short ton, and averaged US $821 per short ton. The
trend was reversed in fiscal 2006, as prices gradually declined to US $805 per
short ton. The average selling price for the year was US $856 per short ton, an
increase of US $35 per short ton over the prior year. After giving effect to the
stronger Canadian $, the Companys average selling price for coated papers
decreased by $56 per short ton.

The benchmark for
coated bleached boxboard (15 point) averaged US $804 per short ton in fiscal
2006, a US $40 per short ton increase over the prior year. Here again, the
improved US $ reference prices were not enough to offset the stronger Canadian $
and average prices for specialty papers remained relatively unchanged. Average
prices would have decreased if not for a higher value sales mix of products
resulting from the shutdown of the lower value uncoated bleached board
machine.

The 65,900 tonne
decline in specialty paper shipments relates primarily to the aforementioned
closure of the Saint-Raymond paper mill and of the uncoated bleached board
machine in St. Francisville.

|                   |  | Total Sales  |  | Shipments    |  | Selling Prices
|------------------ |  | ------------ |  | ------------ |  | --------------
|                   |  | ($ millions) |  | (000 tonnes) |  | ($ / tonne)   
|                   |  | 2005         |  | 2006         |  | **2005**      
|                  
|Newsprint          |  | 335          |  | **365**      |  | 489.2         
|Coated Paper       |  | 292          |  | **266**      |  | 262.9         
|Specialty Paper    |  | 314          |  | **241**      |  | 285.1         
|                  
|Total Paper sales  |  | 941          |  | **872**      |  | 1,037.2       
|                   |  |              |  |             
|Other sales        |  | 2            |  | **2**        |  |               
|                   |  |              |  |              |  |               
|Consolidated sales |  | 943          |  | **874**      |  |               
|                  

Although the above table shows all shipments in
metric tonnes, coated papers and certain specialty papers are sold primarily in
short tons.





30

---

MANAGEMENT'S
      DISCUSSION AND
      ANALYSIS
    2006

OPERATING
RESULTSLower
average selling prices reduced EBITDA by $16 million or $16 per tonne. Lower
manufacturing costs more than offset the decrease in revenues. In the prior
year, the Paper segment undertook 46,700 tonnes of downtime, including 30,000
tonnes of market related downtime, primarily due to weak demand for newsprint
and coated paperboard. In fiscal 2006, markets were better and downtime was
reduced to 18,500 tonnes. In addition, the segment benefited from a more
favourable exchange rate on the St. Francisville paper mills US $ costs and the
avoidance of EBITDA losses from the idled Saint-Raymond paper
mill.

The Paper groups
mills are large users of virgin fibre, primarily in the form of wood chips.
During fiscal 2006, the operations purchased

0.9 million bone dry
tonnes of virgin fibre, of which approximately 40% was internally sourced. In
the prior year, they had purchased 1.0 million bone dry tonnes of virgin fibre,
with 36% being sourced internally. The operations in Kapuskasing and Pine Falls
both produce

newsprint that
contains recycled fibre. In 2006, these two facilities consumed 86,600 tonnes of
wastepaper, down from 92,800 tonnes in 2005.

Overall, fiscal 2006
was another difficult year. Improving US $ prices were largely negated by a
stronger Canadian $. Although the US $ cost base of the St. Francisville mill
provided a partial currency offset, the segments EBITDA margin remained
negative 1.3% versus a five-year positive average of 1.2% . The Paper segment
reduced the total Company consolidated EBITDA in fiscal 2006 and fiscal
2005.

The Paper segment
absorbed several unusual charges in fiscal 2005 and fiscal 2006. The current
year results include a charge of $7 million relating to severance and related
costs for the restructuring of the St. Francisville paper mill. The prior year
included several unusual item charges. The largest item was a charge of $101
million relating to the permanent closure of the Saint-Raymond paper mill. 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 paper mill,
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 prior year, the Company recorded a non-cash charge of $26 million relating
to the reduction of the carrying value of a dismantled paper machine. Finally,
the Company performed the required annual impairment test of goodwill and found
that impairment did exist in relation to its newsprint business. As a result, a
goodwill impairment charge of $22 million was recorded.

The Paper segment
generated an operating loss of $72 million as compared to an operating loss of
$267 million in the prior year. The reduced loss was the result of the lower
unusual charges in the current fiscal year.





31

---





|     |                                     
|---- | ------------------------------------
|2006 | MANAGEMENT'S DISCUSSION AND ANALYSIS
|     |                                     

|CHEMICALS                                  |  |      |   |      |   |      |   |      |   |      |      
|------------------------------------------ |  | ---- | - | ---- | - | ---- | - | ---- | - | ---- | -----
|(in millions of dollars)                   |  |      |   |      |   |      |   |      |   |      |      
|                                           |  | 2002 |   | 2003 |   | 2004 |   | 2005 |   | 2006 |      
|                                           | 
|Consolidated sales                         |  | 124  |   | 143  |   | 174  |   | 202  |   | 193  |      
|EBITDA                                     |  | 15   |   | 8    |   | 8    |   | 8    |   | 5    |      
|EBITDA margin                              |  | 12.1 | % | 5.6  | % | 4.6  | % | 4.0  | % | 2.6  | **%**
|                                           | 
|Depreciation and
    amortization          |  | 4    |   | 3    |   | 4    |   | 3    |   | 3    |      
|                                           | 
|Operating earnings                         |  | 11   |   | 5    |   | 4    |   | 5    |   | 2    |      
|                                           | 
|Identifiable assets (excluding
      cash) |  | 69   |   | 70   |   | 77   |   | 80   |   | 80   |      
|                                           | 

The Chemical segment
operates in three main areas of activity: resins, lignin and
alcohol.

The resin business
produces powder and liquid phenolic resins at three operating sites in Quebec:
Temiscaming, Longueuil and Trois-Pistoles. The Company also operates a fourth
manufacturing operation located in Toledo, Ohio which manufactures powder and
liquid amino based resins as well as melamine. The Longueuil operation also
produces formaldehyde, both for internal resin production and external sales. In
addition to its manufactured products, the resin business also markets
third-party resin binders to complement its customer offering. Sales of
third-party products totalled $54 million in fiscal 2006, compared to $58
million in the prior year.

The lignin and
alcohol businesses use waste sulphite liquor produced by the specialty pulp
mills located in Temiscaming, Quebec and Tartas, France. Lignin products are
sold in liquid form and are also converted into powder by utilizing two spray
dryers. As well, the group operates an ethyl alcohol plant located in
Temiscaming, Quebec. The lignin and alcohol businesses effectively convert pulp
mill waste into value-added products.

Beginning in fiscal
2006, the segment began purchasing and selling pulp mill by-product chemicals
from a related party, AV Nackawic Inc.

|                                          |  | Total Sales  |  | Shipments   |  | Selling Prices
|----------------------------------------- |  | ------------ |  | ----------- |  | --------------
|                                          |  | ($ millions) |  | (000 units) |  | ($ / unit)    
|                                          |  | 2005         |  | 2006        |  | 2005          
|                                         
|Resin and related products
      (tonnes) |  | 160          |  | 152         |  | 113.8         
|Lignin (tonnes)                           |  | 35           |  | 35          |  | 171.1         
|Alcohol (000 litres)                      |  | 8            |  | 6           |  | 12.3          
|Other Chemicals                           |  |             |  | 2           |  |               
|                                         
|Total sales                               |  | 203          |  | 195         |  |               
|                                          |  |              |  |             |  |               
|Internal sales                            |  | (1)          |  | (2)         |  |               
|                                          |  |              |  |             |  |               
|Consolidated sales                        |  | 202          |  | 193         |  |               
|                                         

MARKETS

Chemical products are
sold primarily in North America with sales representing 88% of the total
consolidated sales in 2006, compared to 87% in 2005. Resin products, which
accounted for 79% of total chemical sales, are designed for the OSB industry and
other specialty applications. Lignin is sold as a binder and surfactant for
industrial markets such as animal feed, concrete admixture and carbon black.
Ethyl alcohol is sold into the Canadian vinegar and cosmetics markets. Chemical
group sales represented 6% of consolidated sales in 2006, unchanged from the
prior year.

OPERATING
RESULTSThe
decrease in sales of $9 million is due primarily to lower prices for resins and
related products. Higher shipments of resins and lignin mitigated the drop in
revenues. The lower prices put downward pressure on EBITDA margins, reaching
their lowest level in five years. Manufacturing costs were lower, primarily in
the resin business where raw material prices are linked to selling prices. As a
result of the poor performance of the Pulp and Paper segments, the Chemical
group generated 22% of total Company EBITDA in fiscal 2006. In fiscal 2005, the
Chemical segment EBITDA exceeded that of the total Company due to negative
performance of the Pulp and Paper segments. Operating earnings decreased from $5
million to $2 million because of the aforementioned decline in
EBITDA.



32

---





|                                                 |     
|------------------------------------------------ | ----
|MANAGEMENT'S
      DISCUSSION AND
      ANALYSIS | 2006
|                                                 |     

|Financial position
      and liquidity                         |  |      |  |       |  |       |      
|-------------------------------------------------------------- |  | ---- |  | ----- |  | ----- | -----
|                                                              
|FREE CASH FLOW                                                 |  |      |  |       |  |       |      
|(in millions of
      dollars)                                 |  |      |  |       |  |       |      
|                                                               |  | 2002 |  | 2003  |  | 2004  | 2005 
|                                                              
|Cash flow from operations before
      working capital changes |  | 55   |  | 41    |  | 235   | (13) 
|Net fixed asset
      additions                                |  | (99) |  | (132) |  | (143) | (144)
|                                                              
|                                                               |  | (44) |  | (91)  |  | 92    | (157)
|                                                              

Amounts in the above
table have not been restated to reflect the sale of the OSB business and its
reclassification to discontinued operations.

Cash flow from
operations before working capital changes for fiscal 2006 was negative $97
million, a $84 million decline from the comparable period a year ago. The
reduced cash flow is due primarily to a $133 million decline in proceeds from
derivative financial instruments. The Company had disposed of substantially all
of its foreign exchange derivative instruments in the September 2005 quarter.
After allowing for net fixed asset additions of $86 million, free cash flow for
fiscal 2006 was negative $183 million versus a negative amount of $157 million
in the prior year. The Company defines free cash flow as cash provided by
operating activities before changes in non-cash working capital balances less
net fixed assets. Based on the approved fiscal 2006 budget, the Company had
anticipated that free cash flow for the year would be negative $65 million. A
shortfall in planned EBITDA of approximately $150 million led to the increase in
negative free cash flow. The budget had been prepared on the basis that the
Canadian $ would average US $0.82, whereas the actual exchange rate for the year
was US $0.875. The sensitivity of the Company to foreign exchange is outlined in
a subsequent section of the MD&A. Based on the approved fiscal 2007 budget,
the Companys free cash flow is expected to be negative $55
million.

For the year ended
September 2006, non-cash working capital items generated $66 million, as
compared to $25 million used by the same items in the prior year. A significant
portion of this change relates to inventories. During fiscal 2006, the Company
reduced inventories, primarily in the pulp business, by $82 million. This is the
opposite of what occurred in the prior year when inventories increased by $28
million.

|CAPITAL
      SPENDING                                                                                                                                           |  |      |   |      |   |      |   |      |   |      |      
|---------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | - | ---- | - | ---- | - | ---- | - | ---- | -----
|(in millions of
      dollars)                                                                                                                                   |  |      |   |      |   |      |   |      |   |      |      
|                                                                                                                                                                 |  | 2002 |   | 2003 |   | 2004 |   | 2005 |   | 2006 |      
|                                                                                                                                                                 | 
|Forest Products                                                                                                                                                  |  | 41   |   | 30   |   | 39   |   | 69   |   | 34   |      
|Pulp                                                                                                                                                             |  | 41   |   | 74   |   | 88   |   | 62   |   | 45   |      
|Paper                                                                                                                                                            |  | 10   |   | 19   |   | 13   |   | 11   |   | 7    |      
|Chemical and
    other                                                                                                                                           |  | 7    |   | 9    |   | 3    |   | 2    |   |     |      
|                                                                                                                                                                 | 
|Net fixed asset
      additions                                                                                                                                  |  | 99   |   | 132  |   | 143  |   | 144  |   | 86   |      
|                                                                                                                                                                 | 
|As a % of sales                                                                                                                                                  |  | 3    | % | 4    | % | 5    | % | 4    | % | 3    | **%**
|As a % of fixed asset
      depreciation                                                                                                                         |  | 45   | % | 59   | % | 63   | % | 61   | % | 43   | **%**
|                                                                                                                                                                 | 
|Amounts in the above
      table have not been restated to reflect the sale of the OSB business and
      its reclassification to discontinued
      operations. |  |      |  

In response to
relatively low EBITDA margins brought on by challenging market conditions, the
stronger Canadian $ and continuing export duties on lumber shipped to the U.S.,
the Company continued to limit capital expenditures to mandatory projects and
those with high rates of return. In fiscal 2006, net fixed asset additions
totalled $86 million compared to $144 million a year ago. The amount spent was
equal to 43% of fixed asset depreciation and 3% of sales.



33

---

2006
    MANAGEMENT'S DISCUSSION AND ANALYSIS

Significant capital
expenditure items in 2006 include $10 million to convert the previously idled
Kirkland Lake, Ontario sawmill to a finger-joint lumber manufacturer. The
operation is currently in start-up mode. Capital expenditures also include $11
million representing the Companys 50% share of the amount spent to complete a
laminated veneer lumber (LVL) facility in Amos, Quebec. The plant, owned and
operated by the Temlam joint venture, has completed its start-up and is expected
to positively impact EBITDA in fiscal 2007. An investment of $11 million was
made to install a condensing turbine and 20-megawatt electrical generator at the
Saint-Gaudens pulp mill. A further amount of $4 million will be spent in the
December 2006 quarter, at which time the equipment will begin operations. An
amount of $11 million was spent to construct an alkaline liquor evaporator
system at the Tartas pulp mill. A further $2 million will be spent in the
December 2006 quarter, at which time the system will be activated. This will
greatly reduce the impact of the mills waste effluent stream. Also at the
Tartas pulp mill, an amount of $6 million was spent to begin the construction of
a new $50 million biomass/bark boiler. The remaining funds will be spent in
fiscal 2007 and 2008, at which time the new boiler is expected to begin
operations. Finally, an amount of $10 million was spent to complete the
construction of an anaerobic effluent treatment plant at the Temiscaming
Complex. The plant started up in the spring of 2006, reducing site energy and
effluent treatment costs.

Significant items in
fiscal 2005 include $25 million representing the Companys 50% share of capital
expenditures relating to the laminated veneer lumber (LVL) facility in Amos,
Quebec. Capital expenditures of $15 million were incurred to modernize the Elko,
British Columbia sawmill. Finally, an amount of $12 million was spent on the
anaerobic effluent treatment plant in Temiscaming, Quebec.

ACQUISITIONS, INVESTMENTS AND
DIVESTITURESOn November 9, 2005, the Company paid $2.5 million to acquire a 25%
interest in AV Nackawic Inc., which owns and operates a pulp mill in Nackawic,
New Brunswick. The Aditya Birla Group is the controlling shareholder, having
purchased the remaining 75% interest. During fiscal 2006, the Company recorded a
loss of $0.5 million as its proportionate share of the net loss of AV Nackawic
Inc.

On February 27, 2006,
the Company completed the sale of its oriented strandboard (OSB) business
located in Saint-Georges-de-Champlain, Quebec to Jolina Capital Inc. for total
consideration of $98 million, 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. As a result of this transaction, the
Company recorded a gain of $63 million. The after-tax effect was $47 million or
$0.55 per share. The financial results of the OSB operation, as well as the gain
on disposition have been reclassified as discontinued
operations.









34

---

MANAGEMENT'S DISCUSSION AND
      ANALYSIS
    2006

FINANCING
ACTIVITIESNet debt to total capitalization was 65.3% as at September 2006, an
increase from 58.8% as at September 2005. The negative free cash flow of $183
million generated the majority of the increase. Debt also increased by $9
million in relation to the Companys proportionate (50%) share of the Temlam
joint venture debt. As noted previously, the funds were used to construct an LVL
facility in Amos, Quebec. A favourable item affecting leverage was the debt
reduction of $64 million relating to the revaluation of the Companys US $
denominated debt. The Canadian $ ended the 2006 fiscal year at US $0.895,
compared to US $0.854 a year ago. The Companys inability to generate positive
free cash flow under the current pricing environment and lumber duties limited
its ability to reduce financial leverage.

As part of its
long-term strategy, the Company has resolved to maintain its percentage of net
debt to total capitalization to 40% or less. The objective of the plan is to
keep a strong balance sheet and maintain the ability of the Company to access
capital markets at favourable rates. The Company remains committed to this
program. As the Companys leverage as at September 2006 exceeds its stated goal,
the emphasis in the near term will be to maintain relatively high liquidity and
limit capital expenditures. The receipt of US $242 million in October 2006 has
significantly increased the Companys liquidity position. Continued improvement
in the pricing levels and EBITDA margins of the Companys main business segments
will be required before any significant reduction in financial leverage can be
achieved.

Current credit ratings
of various agencies on the Company and its significant long-term debt
instruments are outlined in the table below.

Dominion Bond Rating Service
    
    Moodys Investors
      Service
    
    Standard &
      PoorsCCC
      (negative trend)
    
    Ca (stable
      outlook)
    
    CCC- (negative
      outlook)


The Companys ratings
were reduced during 2006 as the continued low selling prices combined with a
stronger Canadian $ and lumber export duties resulted in relatively low levels
of EBITDA.

|LONG-TERM
      DEBT                                                    |  |       |  |      
|----------------------------------------------------------------------- |  | ----- |  | -----
|(in millions of dollars)                                                |  |       |  |      
|                                                                        |  | 2005  |  | 2006 
|                                                                       
|Tembec Inc.  6% unsecured
      notes                                  |  | 24    |  | 24   
|Tembec Industries  US $500 million 8.5%
      unsecured senior notes   |  | 586   |  | 559  
|Tembec Industries  US $350 million 7.75%
      unsecured senior notes  |  | 410   |  | 391  
|Tembec Industries  US $350 million 8.625%
      unsecured senior notes |  | 410   |  | 391  
|Tembec SAS debt                                                         |  | 11    |  | 10   
|Tembec Envirofinance SAS
    debt                                       |  | 12    |  | 21   
|Proportionate share of Marathon debt
      (50%)                        |  | 13    |  | 10   
|Proportionate share of Temlam debt
      (50%)                          |  | 32    |  | 40   
|                                                                       
|Other debt                                                              |  | 17    |  | 15   
|                                                                       
|                                                                        |  | 1,515 |  | 1,461
|                                                                       
|Current portion included in
      above                                 |  | 21    |  | 21   
|                                                                       



35

---

2006
    MANAGEMENT'S DISCUSSION AND ANALYSIS

During the year, the Companys French operations increased, via Tembec
Envirofinance SAS, their non-interest bearings loans by $9 million (Euro 6
million) to assist with the financing of certain capital expenditures being
undertaken at the pulp mills.

The
Marathon joint venture does not currently meet certain financial covenants on
its operating line and its term loan with a syndicate of banks. Discussions with
lenders are ongoing and the Company believes it will reach a satisfactory
agreement to maintain and extend the credit agreement. There is no recourse to
the shareholders on either of these loan facilities. The $10 million loan
balance is included in the current portion of the long-term
debt.

At
the end of September 2006, Tembec had cash, temporary investments and derivative
financial instruments of $31 million plus unused operating lines of $34 million.
At the date of the previous audited financial statements, the Company had cash,
temporary investments and derivative financial instruments of $57 million and
unused operating lines of $211 million. The Company defines operating lines to
include loans of various duration which are secured by charges on accounts
receivable and/or inventories. Operating lines are used primarily to fund
short-term requirements associated with both seasonal and cyclical inventory
increases which can occur in the Companys business segments. The Company would
not normally draw on the operating lines to fund capital expenditures or normal
average working capital requirements. The operating lines are established across
multiple entities and jurisdictions to ensure they meet the needs of the various
operating units.

The
following table summarizes the unused operating lines by major area at the end
of the last two fiscal years.

|OPERATING LINES 
      UNUSED              |  |      |  |     
|------------------------------------------- |  | ---- |  | ----
|(in millions of
      dollars)              |  |      |  |     
|                                            |  | 2005 |  | 2006
|                                           
|Canadian
      operations                   |  | 161  |  |    
|U.S.
      operations                       |  | 6    |  | 1   
|French
      operations                     |  | 34   |  | 20  
|Proportionate share of
      joint ventures |  | 10   |  | 13  
|                                           
|                                            |  | 211  |  | 34  
|                                           

The
Canadian operations utilize two separate operating lines. The Company has in
place a committed facility of $150 million maturing in March 2009. At the end of
September 2006, the amount available on this facility (borrowing base) was $99
million and it was fully utilized. The facility is secured by receivables and
inventory. The Company also has in place a committed facility of $136 million
maturing in June 2008, secured by receivables and inventory. At the end of
September 2006, the facility was fully utilized.

During fiscal 2006, the St. Francisville operating line of US $20 million
expired. The Company is currently in discussions with a potential lender to put
in place a similar facility for the operation. The Company would expect to
finalize the new loan in the December 2006 quarter.

The
French operations are supported by several mill specific receivable factoring
agreements. As such, the borrowing base fluctuates periodically, depending on
shipments and cash receipts. As at September 30, 2006, the amount available was
$55 million, of which $20 million was unused.

The
joint ventures maintain their own various operating lines, without recourse to
the Company, to meet working capital and liquidity
requirements.

The
Company has a stated objective of maintaining at least $400 million of
liquidity, comprising cash on hand, temporary investments and unused operating
lines. As previously noted, liquidity at year-end was $65 million, well below
our stated objective. In response to this situation, the Company had set an
objective of generating between $100 million and $150 million of additional
liquidity during fiscal 2006. The funds were to be raised through several
initiatives, including but not limited to, selective asset divestitures and the
monetization of a portion of the lumber duties previously held on
deposit.

During the course of fiscal 2006, the Company did generate in excess of
$100 million of proceeds from various initiatives, with the sale of the OSB mill
generating nearly that amount in one single transaction. The receipt of US $242
million relating to lumber export duty refunds in late October 2006 has further
enhanced the Companys liquidity position.



36

---

MANAGEMENT'S DISCUSSION AND
      ANALYSIS
    2006

The consolidated
financial statements are presented on the assumption that the Company continues
as a going concern in accordance with GAAP. The going concern basis of
presentation assumes that the Company will continue its operations for the
foreseeable future and will be able to realize its assets and discharge its
liabilities and commitments in the normal course of business. In the March 2006
and June 2006 quarterly financial statements, there was reasonable doubt about
the appropriateness of using the going concern assumption because of the
Companys relatively low liquidity position coupled with its expected operating
cash flow. On October 30, 2006, the Company received a US $242 million payment
pertaining to the recovery of lumber export duties (see note 22 Subsequent
events of the audited consolidated financial statements). Because of the
uncertainty of the recovery, these funds had not been included in prior period
forecasted operating cash flows. The receipt of these funds has resulted in the
withdrawal of the going concern issue.

|COMMON SHARES                                      |  |       |  |     
|-------------------------------------------------- |  | ----- |  | ----
|(in millions of
      dollars)                     |  |       |  |     
|                                                   |  | 2005  |  | 2006
|                                                  
|Shares outstanding 
      opening                 |  | 85.9  |  | 85.6
|Issued pursuant to long-term incentive
      plans |  |      |  |    
|Normal course issuer bid
      repurchases         |  | (0.3) |  |    
|                                                  
|Shares outstanding 
      ending                  |  | 85.6  |  | 85.6
|                                                  

The following table
summarizes the Companys quarterly repurchases of common stock over the last two
years, pursuant to its normal course issuer bid. The bid expired on October 18,
2006 and was not renewed.

|                  |  | 2005            |  | 2006        
|----------------- |  | --------------- |  | ------------
|                  |  | Number          |  |             
|                  |  | of
      Shares |  | Average     
|                  |  | Purchased       |  | Price       
|                 
|December quarter  |  | 244,700         |  | $
      7.63
|March quarter     |  |                |  |            
|June quarter      |  |                |  |            
|September
quarter |  |                |  |            
|                 
|                  |  | 244,700         |  | $
      7.63
|                  |  |                 |  |             

In fiscal 2005, the
Company purchased and cancelled 244,700 shares at a total cost of $1.9 million.
As the average price paid was less than the average issue price at September
2004, a purchase discount of $0.5 million was credited to contributed surplus.
During the last two fiscal years, the Companys focus on maintaining its
liquidity combined with balance sheet leverage exceeding its stated target
significantly reduced its ability to repurchase common shares. This continued
focus will likely limit purchases in future periods as well.

As to dilution, an
additional 4.8 million shares may be issued pursuant to options granted under
the Long-Term Incentive Plan (LTIP). The exercise price of the options ranges
from $1.67 per share to $17.92 per share with expiry dates from 2007 to 2016. As
at September 30, 2006, there were 1.9 million exercisable share options,
compared to 2.0 million at the end of the prior year.

Loans to employees of
approximately $3 million are outstanding under the LTIP on 467,875 shares as at
September 30, 2006. This compares to loans of $6 million on 489,575 shares at
the end of the prior year. The shares are held in trust as collateral for the
loans. Effective July 2002, the LTIP was amended and participants are no longer
eligible to receive Company loans to purchase shares.



37

---





|     |                                     
|---- | ------------------------------------
|2006 | MANAGEMENT'S DISCUSSION AND ANALYSIS
|     |                                     

|CONTRACTUAL OBLIGATIONS              |  |       |  |          |  |             |  |             |  |        
|------------------------------------ |  | ----- |  | -------- |  | ----------- |  | ----------- |  | -------
|(in millions of
      dollars)       |  |       |  |          |  |             |  |             |  |        
|                                     |  |       |  | Within 1 |  | 2 
      3 |  | 4 
      5 |  | After 5
|                                     |  | Total |  | year     |  | years       |  | years       |  | years  
|                                    
|FISCAL 2006                          |  |       |  |          |  |             |  |             |  |        
|Long-term debt                       |  | 1,461 |  | 21       |  | 418         |  | 596         |  | 426    
|Interest on long-term
      debt     |  | 484   |  | 117      |  | 223         |  | 129         |  | 15     
|Operating leases                     |  | 25    |  | 8        |  | 10          |  | 4           |  | 3      
|Purchase
    obligations             |  | 238   |  | 95       |  | 70          |  | 41          |  | 32     
|Balance of price 
      acquisition |  | 4     |  | 1        |  | 3           |  |            |  |       
|                                    
|                                     |  | 2,212 |  | 242      |  | 724         |  | 770         |  | 476    
|                                    
|                                    
|                                    
|CONTRACTUAL OBLIGATIONS              |  |       |  |          |  |             |  |             |  |        
|(in millions of
      dollars)       |  |       |  |          |  |             |  |             |  |        
|                                     |  |       |  | Within 1 |  | 2 
      3 |  | 4 
      5 |  | After 5
|                                     |  | Total |  | year     |  | years       |  | years       |  | years  
|                                    
|FISCAL 2005                          |  |       |  |          |  |             |  |             |  |        
|Long-term debt                       |  | 1,516 |  | 22       |  | 14          |  | 456         |  | 1,024  
|Interest on long-term
      debt     |  | 636   |  | 121      |  | 241         |  | 203         |  | 71     
|Operating leases                     |  | 27    |  | 9        |  | 8           |  | 4           |  | 6      
|Purchase
    obligations             |  | 292   |  | 114      |  | 83          |  | 56          |  | 39     
|Balance of price 
      acquisition |  | 8     |  | 1        |  | 4           |  | 3           |  |       
|                                    
|                                     |  | 2,479 |  | 267      |  | 350         |  | 722         |  | 1,140  
|                                    

The table shows the
Companys contractual obligations as at September 2005 and 2006. The Company has
long-term debt with contractual maturities and applicable interest as described
in note 9 of the audited consolidated financial statements. The operating lease
obligations relate primarily to property and equipment rentals entered into in
the normal course of business. Purchase obligations relate to ongoing normal
commercial commitments to purchase timber, wood chips, energy, chemicals and
other operating inputs. They also include outstanding obligations relating to
capital expenditures. Finally, the balance of price obligation represents the
Companys proportionate (50%) share of the balance payable by the Temlam joint
venture to the previous owners of Jager Building Systems pursuant to its
acquisition by Temlam in August 2001.



38

---





|                                                 |     
|------------------------------------------------ | ----
|MANAGEMENT'S
      DISCUSSION AND
      ANALYSIS | 2006
|                                                 |     

|2005 vs
      2004                                     |  |       |  |       
|------------------------------------------------------ |  | ----- |  | ------
|                                                      
|FINANCIAL SUMMARY                                      |  |       |  |       
|(in millions of dollars, unless
      otherwise noted) |  |       |  |       
|                                                       |  | 2004  |  | 2005  
|                                                      
|Sales                                                  |  | 3,556 |  | 3,507 
|                                                      
|EBITDA                                                 |  | 114   |  | 3     
|                                                      
|Depreciation and
      amortization                    |  | 231   |  | 238   
|Unusual items                                          |  | 47    |  | 255   
|                                                      
|Operating loss                                         |  | (164) |  | (490) 
|                                                      
|Net earnings (loss) from continuing
      operations   |  | 3     |  | (315) 
|Net earnings
    (loss)                                |  | 37    |  | (304) 
|                                                      
|Net loss per share 
      basic                       |  | 0.43  |  | (3.55)
|Diluted earnings (loss) per
      share                |  | 0.43  |  | (3.55)
|                                                      
|Total assets (at end of
      year)                    |  | 3,922 |  | 3,457 
|                                                      
|Total long-term debt(1) (at
      end of year)         |  | 1,617 |  | 1,515 
|                                                      
|(1) Includes current
      portion                     |  |       |  |       

Sales in fiscal 2005
decreased by $49 million as compared to fiscal 2004. The Forest Products segment
sales declined by $23 million as a result of lower prices and volumes. Pricing
was impacted by lower US $ reference prices and a stronger Canadian $, which
averaged 8% higher versus the US $. The Pulp segment sales declined by $44
million as a result of lower selling prices, partially offset by higher
shipments. While US $ reference prices for various grades of pulp increased, it
was not sufficient to offset the impact of the stronger Canadian $. The Paper
segment sales declined by $10 million due to lower shipments of newsprint and
specialty papers, partially offset by higher newsprint and coated paper prices.
The decline in shipments was caused by the permanent shutdown of approximately
138,000 tonnes of production capacity. US $ reference prices increased for all
grades of paper, more than offsetting the impact of the stronger Canadian $. The
Chemical segment sales increased by $28 million as a result of higher selling
prices for resin and related products.

EBITDA in fiscal 2005
decreased by $111 million as compared to fiscal 2004. The Forest Products
segment EBITDA declined by $43 million. In addition to the lower selling prices,
margins in SPF lumber were negatively impacted by higher processing costs,
partially offset by lower lumber export duties. During fiscal 2005,
countervailing and antidumping duties totalled $89 million, down from $111
million in fiscal 2004. Pulp segment EBITDA declined by $86 million, primarily
resulting from lower selling prices. Manufacturing costs remained relatively
unchanged with higher chemical, energy, freight and mill supply costs offset by
lower labour costs and a more favourable exchange rate on the French pulp mills
Euro costs. The Paper segment EBITDA increased by $18 million as a result of the
previously noted higher prices. The increase would have been greater if not for
increased manufacturing costs, primarily related to chemicals, energy and
freight. The higher costs were partially mitigated by a more favourable exchange
rate on the St. Francisville, Louisiana coated paper mills US $
costs.

Depreciation expense
in fiscal 2005 was $7 million higher than in fiscal 2004. In fiscal 2005, the
Company recognized an impairment charge of $4 million relating to the fixed
assets of a specialty sawmill.

Unusual items in
fiscal 2005 were $208 million higher than in fiscal 2004. During the latter
year, the Company recorded unusual items totalling $47 million. This included
$37 million for the complete write-down of the Companys investment in the
Gaspesia Papers Limited Partnership, which had sought creditor protection at
that time. A charge of $10 million was also recorded to eliminate the book value
of an idled newsprint machine, including related spare parts. In fiscal 2005,
the Company recorded unusual items of $255 million. This included $56 million
relating to the restructuring and closure of several sawmills; a charge of $101
million for the permanent closure of a paper mill; a charge of $45 million
related to the closure of a pulp line and one of the four paper machines at the
St. Francisville paper mill; a charge of $23 million relating to goodwill
impairment; and a charge of $30 million to reduce the carrying value of a
dismantled pulp machine and a dismantled paper machine.

Interest, foreign
exchange and other items totalled to a charge of $11 million in fiscal 2005 as
compared to a credit amount of $99 million in fiscal 2004. In fiscal 2005, the
Company had realized and amortized derivative financial instrument gains of $148
million. In fiscal 2004, the amount recorded was $234 million. In the prior
year, the Company had also realized an investment gain of $23 million on the
sale of shares of a Canadian publicly-traded forest products
company.



39

---

2006
    MANAGEMENT'S DISCUSSION AND ANALYSIS

During fiscal 2005,
the Company recorded a gain of $125 million on the translation of its US $
denominated debt as the relative value of the Canadian $ increased from US
$0.784 to US $0.854. In fiscal 2004, the Canadian $ had increased from US $0.739
to US $0.784, and the Company had recorded a gain of $94
million.

In 2006, the Company
sold its OSB mill. As a result of the sale, the financial results have been
reclassified as discontinued operations. The earnings from this operation
amounted to $11 million in fiscal 2005 as compared to $34 million in fiscal
2004. Lower OSB selling prices led to the reduction in
earnings.

For the year ended
September 2005, the Company generated a net loss of $304 million or $3.55 per
share versus net earnings of $37 million or $0.43 per share in fiscal
2004.

Risks and
uncertainties

PRODUCT
PRICESOur
financial performance is dependent on the selling prices of our products. The
markets for most lumber, pulp and paper products are cyclical and are influenced
by a variety of factors. These factors include periods of excess product supply
due to industry capacity additions, periods of decreased demand due to weak
general economic activity, inventory de-stocking by customers, and fluctuations
in currency exchange rates. During periods of low prices, the Company is subject
to reduced revenues and margins, resulting in substantial declines in
profitability and possibly net losses.

Based on 2007 planned
sales volumes, the following table illustrates the approximate annual impact of
changes to average Canadian dollar selling prices on after-tax
earnings.

|SELLING PRICE
    SENSITIVITY |  |                    |  |                    
|----------------------------- |  | ------------------ |  | -------------------
|                              |  |                    |  | Average            
|                              |  | Impact on          |  | selling            
|                              |  | after-tax          |  | prices ($)         
|                              |  | earnings           |  | 4th
      quarter 
|                              |  | ($
      millions) |  | 2006               
|                             
|Pulp  $25/tonne              |  | 31                 |  | 685                
|Paper 
$25/tonne             |  | 17                 |  | 887                
|SPF lumber 
      $10/mfbm   |  | 10                 |  | 367                
|                             

The Companys
strategy is to mitigate price volatility by maintaining operations in three core
sectors, namely wood products, pulp and paper; maintaining low cost, high
quality flexible production facilities; establishing and developing long-term
relationships with its customers; developing specialty niche products where
possible. In addition, the Company may periodically purchase lumber, pulp and
newsprint price hedges to mitigate the impact of price volatility. As at
September 30, 2006, the Company did not hold any product price hedges. As at
September 24, 2005, the Company held lumber futures equal to approximately 0.5%
of its annual SPF lumber capacity. The fair value of the contracts was
nil.



40

---

MANAGEMENT'S DISCUSSION AND
      ANALYSIS
    2006

FOREIGN
EXCHANGEOur
revenues for most of our products are affected by fluctuations in the relative
exchange rates of the Canadian $, the US $ and the Euro. The prices for many of
our products, including those we sell in Canada and Europe are generally driven
by US $ reference prices of similar products. We generate approximately US $2.2
billion of US $ denominated sales annually from our Canadian and European
operations. As a result, any decrease in the value of the US $ relative to the
Canadian $ and the Euro reduces the amount of revenues we realize on our sales
in local currency. In addition, since business units purchase the majority of
their production inputs in local currency, fluctuations in foreign exchange can
significantly affect the units relative cost position when compared to
competing manufacturing sites in other currency jurisdictions. This could result
in the units inability to maintain its operations during periods of low prices
and/or demand.

Based on 2007 planned
sales volumes and prices, the following table illustrates the impact of a 1%
change in the value of the US $ versus the Canadian $ and the Euro. For
illustrative purposes, we have assumed an increase of 1% in the value of the US
$. A decrease would have the opposite effects of those shown
below.

|FOREIGN EXCHANGE
      SENSITIVITY  |  |     
|----------------------------------- |  | ----
|(in millions of
      dollars)      |  |     
|                                   
|Increase EBITDA                     |  | 25  
|Increase interest
      expense     |  | (1) 
|                                   
|Increase cash
    flow              |  | 24  
|Loss on US $ debt
      translation |  | (14)
|                                   
|Pre-tax earnings                    |  | 10  
|Tax provision                       |  | (5) 
|                                   
|Net earnings                        |  | 5   
|                                   

As can be seen,
interest expense on the Companys US $ denominated debt provides only a small
offset to its total US $ exposure. To further reduce the impact of fluctuations
in the value of the US $, the Company has adopted a policy of hedging up to 50%
of its anticipated US $ receipts for up to 36 months in duration. As at
September 30, 2006, the Company held US $7 million of US $ foreign exchange
contracts. The fair value of these instruments was nil. As at September 24,
2005, the Company held US $ foreign exchange contracts totalling US $11 million
with a fair value of $0.2 million. The Companys derivative financial holdings
at the end of fiscal 2006 are disclosed in note 21 of the audited consolidated
financial statements.

OPERATIONAL
RISKSThe
manufacturing activities conducted by our operations are subject to a number of
risks including availability and price of fibre, competitive prices for
purchased energy, a productive and reliable workforce, compliance with
environmental regulations, maintenance and replacement/upgrade of process
equipment to manufacture competitive quality products and the requirement to
operate the manufacturing facilities at high rates of utilization and efficiency
to maintain a competitive cost structure.

Fibre represents the
Companys major raw material in the production of wood products, pulp and paper.
In Canada, virgin fibre or timber is sourced primarily by agreements with
provincial governments. The agreements are granted for various terms from five
to 25 years and are generally subject to regular renewals every five years. The
agreements incorporate commitments with respect to sustainable forest
management, silvicultural work, forest and soil renewal, as well as cooperation
with other forest users. In addition, the Company has undertaken, on a voluntary
basis, to have its timber harvesting certified by the Forest Stewardship Council
(FSC). The Company expects the agreements to be extended as they come up for
renewal. Aboriginal groups have claimed substantial portions of land in various
provinces over which they claim aboriginal title or in which they have a
traditional interest and for which they are seeking compensation from various
levels of government. The Company has taken a proactive approach to enhance the
economic participation of the First Nations in its operations wherever feasible.
The Companys operations in the United States and France source their fibre
requirements from various private sources, primarily through long-term supply
arrangements. The Company also purchases approximately 90,000 tonnes per year of
recycled waste fibre. To mitigate the impact of price fluctuations, the Company
periodically purchases old newspaper (ONP) hedges. As at September 30, 2006, the
Company did not hold any ONP hedges. As at September 24, 2005, the Company held
hedges relating to ONP representing approximately 3% of its annual recycled
fibre purchases. The fair value of these instruments was nil.



41

---

2006
    MANAGEMENT'S DISCUSSION AND ANALYSIS

Energy is an
important component of mill costs, especially for high-yield pulp mills,
newsprint and paper mills. In 2006, we purchased approximately $310 million of
energy, 60% of which was electricity. Electrical purchases are made primarily
from large public utilities, at rates set by regulating bodies. In certain
jurisdictions, electricity is deregulated which can lead to greater price
volatility. To mitigate the effect of price fluctuations on its financial
performance, the Company employs several strategies, including the securing of
longer term supply agreements, the purchase of derivative financial instruments
and operational curtailments in periods of high prices (load shedding). As at
September 2006 and September 2005, the Company did not hold any derivative
financial instruments relating to purchased electricity. Fossil fuels, primarily
natural gas, are purchased at market rates. The Company periodically purchases
derivative financial instruments to hedge its exposure. As at September 30,
2006, the Company did not hold any natural gas hedges. As at September 24, 2005
the Company had natural gas hedges covering approximately 7% of its anticipated
requirements for the next year. The fair value of these instruments was $6
million.

Nearly all the
Companys manufacturing units have a unionized workforce. Over the past 30
years, the Company has successfully negotiated new collective agreements in
nearly all instances, with very few work stoppages. At many of the Companys
facilities, as well as those of the North American industry as a whole, we have
seen reductions in employment levels associated with technological and process
improvements resulting in a workforce with more years of service. This increases
the relative costs of pensions and benefits. As at September 2006, the Company
had approximately 6,050 hourly paid employees covered by collective bargaining
agreements. As at September 30, 2006, there were 17 agreements covering 1,300
employees that had expired and were under active negotiations. During fiscal
2007, a total of four agreements covering 450 employees will expire. The
remaining contracts expire at various dates to August 2011. The Company
anticipates it will reach satisfactory agreements on contracts currently under
active negotiations and those expiring in the future.

The Companys
operations are subject to industry specific environmental regulations relating
to air emissions, wastewater (effluent) discharges, solid waste, landfill
operation, forestry practices, and site remediation. The Company has made
significant progress in reducing the environmental impact of its operations over
the last 15 years. This has occurred as a result of changes in manufacturing
processes, the installation of specialized equipment to treat/eliminate the
materials being discharged and the implementation of standardized practices such
as ISO 14001.

The production of
pulp and paper products is capital intensive. The Company estimates it must
spend approximately $90-$100 million per year on capital expenditures to avoid
degradation of its current operations.

Because of the
relatively high fixed cost component of certain manufacturing processes,
especially in pulp and paper, the operations are 24/7 with target efficiency in
the 80-85% range. Failure to operate at these levels jeopardizes the continued
existence of a mill. Producers are forced to operate the facilities at full
rate even when demand is not sufficient to absorb all of the output. This can
lead to oversupply and lower prices, further increasing the inherent cyclicality
of the industry.

TRADE
RESTRICTIONS / LUMBER EXPORT DUTIESThe Companys manufacturing operations are located
primarily in Canada. However sales into the Canadian market represented only 20%
of consolidated sales in 2006. As such, the Companys financial results are
highly dependant on its ability to sell its products into the export markets.
Tariffs and trade barriers that reduce or prohibit the movement of products
across international borders constitute an ongoing risk. The dispute between
Canada and the United States over softwood lumber is a case in point. The United
States Department of Commerce initially assessed the Company with aggregate
countervailing and antidumping duties at an average rate of 29%. The combined
rate was subsequently reduced to 25.47% in February 2005. and to 12.72% in
December 2005. 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. 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.



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MANAGEMENT'S DISCUSSION AND
      ANALYSIS
    2006

FINANCIAL
RISKS / DEBT SERVICEThe Company currently has a non-investment grade rating of
CCC-/Ca/CCC. The ratings reflect the relatively high use of debt combined with
periods of reduced operating earning due to the cyclicality of its three
principal business segments. Of the total long-term debt of $1.5 billion, 92%
relates to US $ denominated high-yield Senior Notes. The annual interest
coupon on the high-yield debt ranges between 7.75% and 8.625%, generating an
annual expense of US $100 million. The Senior Notes do not require periodic
payments for principal amortization. Since the entire principal amount becomes
due on the maturity dates of the Senior Notes, it is unlikely that the Company
will have the required funds to repay the principal due. The Company will
require access to the public or private debt markets to issue new notes or debt
instruments to replace or partially replace the Senior Notes prior to their
stated maturity dates. The nearest maturity relates to the 8.625% US $350
million Senior Notes maturing in June 2009. The Companys objective is to reduce
its leverage and improve its credit ratings prior to the refinancing of the
aforementioned Senior Notes.

GROWTH
STRATEGY / ACQUISITIONThe Company has a publicly stated objective of growing its
operations. Based on past experience, a significant portion of this growth will
likely occur through acquisitions and other forms of business combinations. The
ability to properly evaluate the fair value of acquisitions, to successfully
integrate them into our current business operations and to realize the projected
profits and returns are inherent risks related to acquisitions. The Company has
gained significant expertise in evaluating businesses, performing due diligence
and integrating new businesses. We believe the industry consolidation of the
recent years will continue and that size will be required to effectively
compete in the global forest products industry.

Evaluation of disclosure controls and
procedures

Disclosure controls
and procedures have been established by the Company to ensure that information
disclosed by the Company in this MD&A and the related financial statements
was properly recorded, processed, summarized and reported within the time
periods specified in the U.S. Securities and Exchange Commission rules and
forms. Disclosure controls and procedures are designed to ensure that the
information required to be disclosed by the Company in the reports that are
filed or submitted is accumulated and communicated to the management, including
the Companys President and Chief Executive Officer and the Companys Executive
Vice President, Finance and Chief Financial Officer, to allow timely decisions
regarding required disclosure.

The Companys
President and Chief Executive Officer and the Companys Executive Vice
President, Finance and Chief Financial Officer have evaluated the disclosure
controls and procedures and have determined that such disclosure controls and
procedures are effective.

Changes in
internal controlsDuring the period covered by this
report, there have been no changes that have materially affected, or are
reasonably likely to materially affect the Companys internal control over
financial reporting.

Oversight
role of Audit Committee and Board of
Directors

The Audit Committee
reviews the Companys annual MD&A and related financial statements with
management and the external auditors, and recommends their approval to the
Board. Management and the internal auditor of the Company also present
periodically to the Committee a report of their assessment of the Companys
internal controls and procedures for financial reporting. The external auditors
periodically prepare for management a report on internal control weaknesses
identified during the course of the auditors annual audit, which is reviewed by
the Audit Committee.

Additional
informationAdditional information relating to
Tembec, including the Annual Information Form, can be found on SEDAR at
www.sedar.com and on the Companys website at www.tembec.com.



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