----

Management's discussion and analysis

 

| 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    24, 2005 as compared to the fiscal year ended September 25, 2004. The MD&A    should be read in conjunction with the audited consolidated financial    statements for the fiscal year ended September 24, 2005. All references to    quarterly or Company information relate to Tembec Inc.'s fiscal quarters. "EBITDA"    refers to earnings before unusual items, interest, income taxes,    depreciation and amortization and other non-operating expenses.

The MD&A contains statements that are forward-looking in    nature. Such statements involve known and unknown risks and uncertainties    that may cause the actual results of the Company to be materially different    from those expressed or implied by such forward-looking statements. Such    items include, among others: general economic and business conditions;    product selling prices; raw material and operating costs; changes in foreign    currency exchange rates and other factors referenced herein and in the    Company's continuous disclosure filings. 

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 operate 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. 
 **MICHEL    J. DUMAS*Executive Vice President,     Finance and Chief Financial Officer* 
17

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

Prior to fiscal 2005, Tembec's operations consisted of fivereportable business segments: Forest Products, Pulp, Paper, Paperboard andChemicals. Due to organizational and reporting changes, the Paper and Paperboardsegments have been regrouped under Paper. Prior year comparable segment data hasbeen restated to conform to the new segment reporting. On September 24, 2005,Tembec had approximately 10,000 employees and operated manufacturing facilitiesin New Brunswick, Quebec, Ontario, Manitoba, Alberta, British Columbia, thestates of Louisiana and Ohio as well as in Southern France. Principal facilitiesare described in the Company's Annual Report and in the Annual Information Form(AIF).

On October 28, 2003, the Company acquired the assets of aspray-dried resin manufacturer located in Toledo, Ohio. The financial resultshave been fully consolidated in the Company's financial statements for the last11 months of fiscal 2004 and all of fiscal 2005.

On November 3, 2003, the Company acquired the assets of twosawmills located in La Sarre and Senneterre, Quebec. The financial results havebeen fully consolidated in the Company's financial statements for the last 11months of fiscal 2004 and all of fiscal 2005.

On December 15, 2003, the Company acquired the assets of asawmill located in Chapleau, Ontario. The financial results have been fullyconsolidated in the Company's financial statements for the last 9 1/2 months offiscal 2004 and all of fiscal 2005.

On August 4, 2004, the Company exercised its option topurchase the remaining 50% interest in Excel Forest Products, a sawmill locatedin Opasatika, Ontario. The initial 50% interest had been purchased in March2001. As the Company had effective control, the financial results have beenfully consolidated since March 2001. Earnings or losses attributable to minorityshareholders were previously reflected in "minority interest". Since August2004, this is no longer required.

Details of these transactions are outlined in the"Acquisitions and Investments" section of the MD&A. 

**Accounting changes**

Effective September 2003, the Company applied the accountingtreatment prescribed by EIC-128 of the Canadian Institute of CharteredAccountants (CICA) with respect to derivative financial instruments that do notqualify for hedge accounting. Prior to the implementation of this guideline, theCompany was applying hedge accounting and gains and losses related to financialinstruments, primarily foreign exchange contracts, were recognized on thematurity dates of the instruments. As well, when derivative financialinstruments were sold or traded prior to their stated maturity dates, the gainsor losses were deferred and recognized on the statement of operations as per theoriginal maturity dates, which corresponded to the hedge relationship date. Theprevious rules required disclosure of outstanding derivative financialinstruments and their mark to market value in the notes to the financialstatements, but the positions were not shown on the Company's balance sheet. TheCompany applied EIC-128 and theaccounting guideline for discontinuing hedge accounting at the beginning offiscal 2004. As a result, the Company recognized a deferred gain of $223.4million relating to derivative financial instruments that were outstanding atthe beginning of fiscal 2004. The same amount was also recognized as an asset onthe balance sheet.
Effective September 2003, the Company adopted the newrecommendations of Section 3063 of the CICA with respect to the impairment oflong-lived assets. These recommendations provide accounting guidance for thedetermination of long-lived asset impairment as well as recognition, measurementand disclosure of the impairment. The work conducted in fiscal 2004 did notindicate impairment of long-lived assets. The work conducted at the end offiscal 2005 indicated an impairment of $3.6 million relating to a specialty woodsawmill. 

18

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

Effective September 2003, the Company adopted prospectivelywithout restatement the new recommendations of Section 3870 of the CICA withrespect to stock-based compensation plans. These recommendations require the useof a fair value based approach to accounting for stock-based compensation awardsgranted to employees. The Company has recorded an expense for stock-basedcompensation plans in fiscal 2004 and fiscal 2005 and has provided the requiredpro forma disclosures for issuances from September 30, 2001 to September 27,2003 in note 13 of the audited consolidated financial statements.

Effective October 2003, the CICA introduced newrecommendations under section 1100 for the application of Generally AcceptedAccounting Principles (GAAP), which, among other things, provides guidance onalternate sources to consult when an issue is not specifically addressed byCanadian GAAP. Previously, the Company presented sales net of shipping, handlingcosts and lumber export duties. As a result of applying this new standard,effective September 28, 2003, the Company has removed references to gross andnet sales.

Effective June 2004, the Company adopted the newrecommendations of Section 3461 of the CICA with regards to employee futurebenefits. Section 3461 requires disclosure of additional information concerningdefined benefit pension plans and other employee future benefit plans. Thedisclosure is included in notes 20 and 21 of the audited consolidated financialstatements.

Effective September 2004, the Company adopted retroactivelywith restatement the new recommendations of Section 3110 of the CICA withrespect to asset retirement obligations. These recommendations require entitiesto record a liability at fair value, in the period in which a legal obligationassociated with the retirement of an asset is incurred. The associated costs arecapitalized as part of the carrying value of the related asset and depreciatedover its remaining useful life. The liability is accreted using a creditadjusted risk free interest rate. For such assets, a liability will be initiallyrecognized in the period in which sufficient information exists to estimate arange of possible settlement dates. For the Company, asset retirementobligations in connection with the adoption of Section 3110 were primarilyrelated to landfill capping obligations. The adoption of Section 3110 reducedthe prior year reported net earnings by $0.4 million.

**Impact of accounting pronouncements on future reporting periods**

As at the date of the MD&A, there were no anticipated accounting changes thatwould materially impact the financial reporting of future periods.

**Critical accounting policies and estimates**
**Fixed asset depreciation**
The Company records its fixed assets, primarily productionbuildings and equipment, at cost. Interest costs are capitalized for projects inexcess of $1 million that have a duration in excess of one year. Investment taxcredits or capital assistance received reduce the cost of the related assets.Fixed assets acquired as a result of a business acquisition are recorded attheir estimated fair value. Depreciation of fixed assets is provided over theirestimated useful lives, generally on a straight-line basis. Forest access roadsare depreciated on the basis of harvested volumes and certain equipment isdepreciated using the unit of production method. The estimated useful lives offixed assets are based on judgement and the best currently availableinformation. Changes in circumstances can result in the actual useful livesdiffering from our estimates. Revisions to the estimated useful lives of fixedassets constitute a change in accounting estimate and are dealt withprospectively by amending the amount of depreciation expense. There were nosignificant adjustments to depreciation rates in fiscal 2004 and 2005. 

19

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

As noted previously, the work conducted at the end of fiscal2005 indicated an impairment of $3.6 million relating to a specialty woodsawmill. In addition, an amount of $37.5 million was included in unusual itemsrelating to additional fixed asset depreciation resulting from the permanentclosure of the pressurized groundwood pulping line and one of the four papermachines at the St. Francisville, Louisiana papermill.
**Impairment of goodwill**
Accounting standards require that goodwill no longer beamortized to earnings, but be periodically tested for impairment. The Companyuses certain operating and financial assumptions to conduct its impairment test,principally those contained in its most recent multi-year operating plan. Thisensures that assumptions are supported, where available, by relevant independentinformation. The fiscal 2005 impairment test did find impairment of goodwill inrelation to the hardwood flooring and newsprint operations. The carrying valueof goodwill was reduced by $25.6 million. The charge to income is included inunusual items.
**Impairment of long-lived assets**
According to recently implemented guidelines, the Companymust now review the carrying value of long-lived assets when events or changesin circumstances indicate that the value may have been impaired and is notrecoverable through future operations and cash flows. To estimate future cashflows, the Company uses operating and financial assumptions, primarily thosecontained in its most recent multi-year operating plan. This ensures that theassumptions are supported, where available, by relevant independent information.The work conducted in fiscal 2004 did not indicate impairment of long-livedassets. The work conducted in fiscal 2005 indicated an impairment of $3.6million relating to a specialty wood sawmill. The charge to income is includedin depreciation and amortization expense.
**Employee future benefits**
Tembec contributes to several defined benefit pension plans,primarily related to employees covered by collective bargaining agreements. TheCompany also provides post-retirement benefits to certain retirees, primarilyhealth-care related. For post-retirement benefits, funding of disbursements isdone on a "pay as you go" basis. The Company uses independent actuarial firms toquantify 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 orassumptions can have a substantial impact on the amount of pension andpost-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. Asof June 30, 2005, ("the measurement date"), the fair value of defined benefitplan assets was $637.5 million, an amount equal to 70% of the estimated accruedbenefit obligation of $911.7 million, generating a deficit of $274.2 million.The plan deficit was $138.8 million at the prior measurement date, June 30,2004. The deficit increase of $135.4 million that occurred over the 12-monthperiod was caused primarily by three items. The deficit was reduced by $16.9million as plan assets generated returns that exceeded the interest cost on theaccrued benefit obligation. The deficit was reduced by a further $18.0 millionas employer contributions of $33.9 million, exceeding the current service costof benefit accruals of $15.9 million. Finally and most significantly, anactuarial loss of $169.7 million increased the accrued benefit obligation at themeasurement date. 

20

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

This last item was caused primarily by the decrease from6.38% to 4.98% of the weighted average discount rate applied to the accruedbenefit obligation. The discount rate is tied to the rates applicable tohigh-quality corporate bonds (AA or higher) in effect as at the measurementdate. Pension expense in fiscal 2005 was $27.7 million, as compared to $34.8million in the prior year. Based on current assumptions, employer contributionsand pension expense in fiscal 2006 are expected to be approximately $49.7million and $35.6 million respectively. A description of the Company's definedbenefit pension plans and assumptions used in the calculations are presented innote 20 of the audited consolidated financial statements.

With regard to other employee future benefit plans, theaccrued benefit obligation at the measurement date was $75.4 million, anincrease from $64.1 million in the prior year. The increase was also due to adecrease in the discount rate, from 6.30% to 4.99%. Employer contributions were$2.9 million as compared to $2.5 million in the prior year. The expenserecognized for other employee benefit plans was $7.8 million, up from $7.4million in the prior year. Based on current assumptions, the amount of employercontributions and the amount of expense to be recognized in fiscal 2006 areexpected to be approximately $2.9 million and $7.3 million respectively. Adescription of the Company's other employee future benefit plans and assumptionsused in the calculations are presented in note 21 of the audited consolidatedfinancial statements.
**Future income taxes**
Future income tax is provided for using the asset andliability method and recognizes temporary differences between the tax values andthe financial statement values of balance sheet items as well as certaincarry-forward items. The Company only recognizes a future income tax asset tothe extent that, in its opinion, it is more likely than not that the futureincome tax asset will be realized. 

This opinion is based on estimates and assumptions as to thefuture financial performance of the various taxable legal entities in thevarious tax jurisdictions. The Company periodically reviews the carrying valueof its future income tax assets. Additional details are provided in note 19 ofthe audited consolidated financial statements.

**Use of non-GAAP financial measures**

EBITDA is defined as earnings before unusual items, interest,income taxes, depreciation and amortization and other non-operating expenses. Ona consolidated basis, the Company believes that it is a useful indicator of itsability to generate funds to meet debt service and capital expenditurerequirements. EBITDA is not intended as an alternative measure of cash flowsfrom operating activities as determined in accordance with GAAP. The Companyalso uses EBITDA internally to evaluate the financial and operating performanceof its reportable business segments and individual business units. 

The Company believes it is a useful indicator of theprofitability of its business segments and individual business units. BecauseEBITDA may not be calculated identically by all companies, the presentation inthe Company's financial statements may not be directly comparable to similarlytitled measures used by other companies. A reconciliation of cash flow fromoperating activities as determined in accordance with Canadian GAAP to EBITDA issummarized in note 15 of the audited consolidated financial statements.

21

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

**Overview**
**FINANCIAL SUMMARY**$ millions, unless otherwise noted2001 2002 2003 2004 **2005**          Sales2,990.8 3,391.0 3,346.1 3,664.8 **3,585.0**Freight and sales deductions322.6 396.7 392.0 422.2 **413.3**Lumber duties10.8 17.5 81.2 111.4 **89.4**Cost of sales2,047.6 2,534.6 2,635.9 2,784.1 **2,885.6**SG& A136.3 166.7 162.2 178.6 **171.6**          EBITDA473.5 275.5 74.8 168.5 **25.1**          Depreciation & amortization202.9 227.5 230.2 234.7 **243.7**Unusual items– 23.8 18.4 46.6 **254.5**          Operating earnings (loss)270.6 24.2 (173.8) (112.8) **(473.1)**          Interest, foreign exchange & other157.0 210.2 118.0 (99.0) **11.1**Loss (gain) on translation of foreign debt69.2 (3.7) (263.9) (93.5) **(124.8)**          Pre-tax earnings (loss)44.4 (182.3) (27.9) 79.7 **(359.4)**Income taxes (recovery)16.4 (66.5) (37.6) 42.3 **(55.1)**Minority interests(0.5) 0.4 (1.7) 0.4 **–**          Net earnings (loss)28.5 (116.2) 11.4 37.0 **(304.3)**          Net earnings (loss) per share0.35 (1.35) 0.13 0.43 **(3.55)**          Diluted earnings (loss) per share0.34 (1.35) 0.13 0.43 **(3.55)**          Total assets (at end of year)4,058.2 3,991.3 3,818.8 3,921.9 **3,424.7**          Total long-term debt(1) (at end of year)1,881.8 1,927.0 1,727.6 1,617.4 **1,515.7**          (1) Includes current portion         
22

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
**SALES 

$ millions         Volume     Total Price & Mix 2004 **2005** Variance Variance Variance          Forest Products1,422.8 **1,353.5** (69.3) (61.3) (8.0)Pulp1,417.6 **1,372.6** (45.0) (83.3) 38.3Paper953.5 **942.8** (10.7) 29.4 (40.1)Chemicals & other180.6 **208.9** 28.3 29.3 (1.0)           3,974.5 **3,877.8** (96.7) (85.9) (10.8)Less: intersegment sales(309.7) **(292.8)** 16.9              Sales3,664.8 **3,585.0** (79.8)    
 

Sales decreased by $79.8 million over the same period a    year ago. The decrease occurred primarily in the Forest Products and Pulp    segments. The Pulp segment price decrease was partially offset by higher    volumes. The opposite occurred in Paper with lower volumes offsetting higher    prices. Canadian $ selling prices were negatively impacted by the stronger    Canadian $, which averaged US $0.817, an increase of 8% over US $0.754 in    the prior year. In terms of geographical distribution the US remained the    Company's principal market with 48% of sales in fiscal 2005, the same    percentage as in the prior year. Canadian sales represented 20% of sales,    also the same percentage as the prior year. Sales outside of the US and    Canada represented the remaining 32% in fiscal 2005, the same as in the    prior year.

Forest Products segment sales decreased by 5% because of    lower prices of SPF lumber and OSB. The Pulp segment saw its sales decrease    by 3%. Lower selling prices for pulp were only partially offset by higher    shipments. Sales for the Paper segment decreased by 1%. Lower shipments of    newsprint and specialty papers were partially offset by higher newsprint and    coated paper prices.
23

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
**EBITDA 

$ millions         Cost &     Total Price Volume 2004 **2005** Variance Variance Variance          Forest Products129.7 **55.0** (74.7) (61.3) (13.4)Pulp61.4 **(24.7)** (86.1) (83.3) (2.8)Paper(29.8) **(13.1)** 16.7 29.4 (12.7)Chemicals & other7.2 **7.9** 0.7 29.3 (28.6)           168.5 **25.1** (143.4) (85.9) (57.5)
 

The $143.4 million decrease in EBITDA was driven    primarily by the lower profitability of the Forest Products and Pulp    segments. All businesses were negatively impacted by higher manufacturing    costs. Total EBITDA of $25.1 million represented a margin of 0.7% of sales    as compared to a five-year average of 6%. Forest Products EBITDA declined by    $74.7 million, primarily as a result of lower selling prices for SPF lumber    and OSB. The EBITDA margin was 4.7% versus a five-year average of 5.2%. Pulp    EBITDA declined by $86.1 million. While US $ reference prices increased, the    8% strengthening of the Canadian $ versus the US $ led to a $83.3 million    negative price variance. The EBITDA margin was negative 1.9% as compared to    a five-year positive average margin of 6.5%. Paper EBITDA increased by $16.7    million as a result of higher newsprint and coated paper prices which more    than offset the increase in manufacturing costs. The EBITDA margin was    negative 1.4% versus a five-year positive average margin of 5.9%. Chemical    segment prices and costs increased by similar amounts and profitability    remained relatively unchanged. This is to be expected for this segment as    raw material prices are linked to selling prices.

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

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**MANAGEMENT'S DISCUSSION AND ANALYSIS**
**DEPRECIATION AND AMORTIZATION**$ millions2004 **2005**    Fixed asset depreciation226.6 **234.0**Deferred development and other costs8.1 **6.1**Asset impairment– **3.6**     234.7 **243.7**
During the September 2005 quarter, the Company recognized an impairmentcharge of $3.6 million relating to the Mattawa, Ontario specialty sawmill.

**Unusual items**
**Fiscal 2004**
During fiscal 2004, the Company recorded a non-cash charge of$36.8 million relating to the write-down of its investment in the GaspésiaPapers Limited Partnership. The charge was the result of a decision made by thepartners to halt work on the modernization project and seek creditor protection.The charge included the write-down of the original investment of $35.0 millionand a provision of $1.8 million for the non-recovery of expenses incurred aspart of service agreements with Gaspésia Papers Limited Partnership. As themajority of the unusual charge was a capital loss, the after-tax impact was$36.2 million or $0.42 per share.

During fiscal 2004, the Company recorded a non-cash charge of$9.8 million relating to the write-down of a newsprint machine at theKapuskasing, Ontario, paper mill. The machine has been idle since February 2004and based on the relatively difficult market conditions it was deemed unlikelythat the newsprint machine would be restarted. The charge includes the completewrite-down of the machine's net book value and related spare parts. Theafter-tax impact of the unusual charge was $6.6 million or $0.08 per share.

25

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
**Fiscal 2005**
During fiscal 2005, the Company recorded an unusual charge of$20.3 million relating to the restructuring of its Ontario sawmill operations.The amount included a non-cash charge of $15.5 million relating to the reductionof the carrying value of the Kirkland Lake and Opasatika sawmills. Employeeseverance and other closure costs amounting to $4.8 million were also recorded.The after-tax effect of the unusual charge was $14.2 million or $0.17 per share.

During fiscal 2005, the Company recorded an unusual charge of$136.1 million relating to the closure of several facilities. These included anSPF lumber sawmill in La Sarre, Quebec; a hardwood and pine sawmill in Davidson,Quebec; a hardwood sawmill in Temiscaming, Quebec; a lumber remanufacturingfacility in Brantford, Ontario and the Saint-Raymond, Quebec papermill. Theafter-tax impact was $91.7 million or $1.07 per share.

The following table summarizes the impact by facility:
     $ millions        Severance    Reduction& Other    of CarryingClosureTotalTaxNet ValuesCostsPre-TaxRecoveryAfter-tax      La Sarre sawmill15.26.121.3(7.2)14.1Davidson sawmill5.74.09.7(3.3)6.4Temiscaming sawmill–0.30.3(0.1)0.2Brantford reman3.20.94.1(1.4)2.7Saint-Raymond papermill90.610.1100.7(32.4)68.3       114.721.4136.1(44.4)91.7
During fiscal 2005, as a result of the permanent closure ofthe pressurized groundwood pulping line and one of the four paper machines atthe St. Francisville, Louisiana papermill, the Company recorded a non-cashcharge of $37.5 million relating to the reduction of the carrying value of fixedassets and a charge of $2.3 million relating to the reduction of the carryingvalue of other related assets. Employee severance and other closure costsamounting to $5.2 million were also recorded. The restructuring of operations atSt. Francisville is expected to improve profitability by approximately US $17million per year, based on fiscal 2005 costs. Also during 2005, the Companyrecorded a non-cash charge of $30.0 million relating to the reduction of thecarrying value of a dismantled pulp machine and a dismantled paper machine. Themachines had been acquired to be possibly installed at the Company's existingfacilities. However, the relatively poor markets of the last several yearscombined with the Company's requirement to limit CAPEX has led to uncertaintyregarding the ultimate disposition of this equipment. Finally, the Companyperformed the required annual impairment test of goodwill and found thatimpairment did exist in relation to its hardwood flooring and its newsprintbusinesses. As a result, a goodwill impairment charge of $1.5 million and $21.6million respectively was recorded. The after-tax effect of these charges was$87.5 million or $1.02 per share. 

26

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

The following table summarizes the impact of each item:
     $ millions        Severance    Reduction& Other    of CarryingClosureTotalTaxNet ValuesCostsPre-TaxRecoveryAfter-tax      St. Francisville papermill39.85.245.0–45.0Dismantled machines30.0–30.0(10.2)19.8Goodwill impairment23.1–23.1(0.4)22.7       92.95.298.1(10.6)87.5
At the end of fiscal 2005, the Company had disbursed $12.6million in relation to severance and other closure costs. A balance of $18.8million remains and is expected to be disbursed in the next fiscal year.Additional details are shown in note 18 of the audited consolidated financialstatements.
**INTEREST, FOREIGN EXCHANGE AND OTHER**$ millions    2004 **2005**    Interest on indebtedness137.1 **130.0**Amortization of deferred gain on foreign    exchange contracts(149.3) **(117.9)**Derivative financial instruments gain(84.6) **(30.3)**Investment income(22.7) **(0.7)**Other foreign exchange items16.6 **17.1**Loss on consolidation of foreign integrated    subsidiaries2.0 **6.0**Other items1.9 **6.9**     (99.0) **11.1**
Interest on indebtedness declined by $7.1 million primarilyas a result of the stronger Canadian $. Approximately 94% of the Company's termdebt relates to US $ senior notes with fixed rates of interest. As such, theonly item affecting interest on indebtedness is a change in the relative valueof the Canadian $ versus the US $.

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

27

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

The following table summarizes the change in the unamortized deferred gain onforeign exchange contracts during the years ended September 2004 and 2005:
   $ millions     Opening Ending BalanceAmortizationBalance    Year ended September 2004305.6(149.3)156.3    **Year ended September 2005****156.3****(117.9)****38.4**
The remaining deferred gain will be amortized in quarterly amounts as per thefollowing:
Quarter Ending$ millions  December 200520.5March 200617.8Thereafter0.1   38.4
Since the beginning of fiscal 2004, the Company has shown themarket value of its derivative financial instruments on its balance sheet andthe resulting gain or loss for the period has been reflected in its statement ofoperations. Derivative financial instruments relate primarily to foreignexchange contracts but also include commodity related instruments such as lumberfutures and hedges for purchased waste fibre and energy.

The following tables summarize the change in the market valueof derivative financial instruments during fiscal 2004 and fiscal 2005:
    $ millions        Disburse-  OpeningGainmentsEndingYear ended September 2004Balance(Loss)(Proceeds)Balance     Market value of outstanding foreign exchange    contracts223.486.5(205.0)104.9Market value of commodity related derivative financial    instruments–(1.9)11.39.4      223.484.6(193.7)114.3                   $ millions        Disburse-  OpeningGainmentsEnding**Year ended September 2005**Balance(Loss)(Proceeds)Balance     Market value of outstanding foreign exchange    contracts**104.9****22.7****(127.4)****0.2**Market value of commodity related derivative financial    instruments**9.4****7.6****(11.3)****5.7**      **114.3****30.3****(138.7)****5.9**
28

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

During fiscal 2005, the Company recorded a gain of $22.7million on its outstanding foreign exchange contracts as the relative value ofthe Canadian $ increased from US $0.784 to US $0.854. In the prior year, theCanadian $ had increased from US $0.739 to US $0.784 and the Company hadrecorded a gain of $86.5 million. The Company received proceeds of $127.4million relating to foreign exchange contracts during fiscal 2005 as compared to$205.0 million in the comparable period a year ago. In the prior year, theCompany had disposed of a substantial portion of its US $ currency contracts tofund the acquisition of three sawmills.

As of September 24, 2005, the Company held lumber futuresequal to approximately 0.5% of its annual SPF lumber capacity, down from 7% atthe end of the prior year. The fair value of these instruments was nil ascompared to $5.8 million at the end of fiscal 2004. The Company had natural gashedges covering approximately 7% of its anticipated requirements for the nextyear. This compared to the end of the prior year when the Company had naturalgas hedges covering approximately 25% of its anticipated requirements for thenext two years. The fair value of these instruments was $5.7 million at the endof 2005 as compared to $3.2 million at the end of 2004. Finally, the Companyheld hedges relating to purchased old newspapers (ONP) representingapproximately 3% of its annual recycled fibre purchases, with a fair marketvalue of nil. At the end of the prior year, the Company held hedges relating toONP representing approximately 21% of its annual recycled fibre purchases, witha fair value of $0.4 million.

During fiscal 2004, the Company realized a gain of $22.7million on the sale of shares of a Canadian publicly traded company, SlocanForest Products. The shares had been acquired in 2002 and subsequentlyappreciated in value as the result of Slocan's acquisition by a third party.

**Gain on translation of foreign debt**

During fiscal 2005, the Company recorded a gain of $124.8million on the translation of its US $ denominated debt as the relative value ofthe Canadian $ increased from US $0.784 to US $0.854. In the prior fiscal year,the Canadian $ had increased from US $0.739 to US $0.784 and the Company hadrecorded a gain of $93.5 million. The after-tax impact of the gain ontranslation of foreign denominated debt was $104.2 million or $1.22 per share ascompared to the prior year after-tax gain of $78.4 million or $0.91 per share.

**Income taxes**

In fiscal 2004, the Company recorded an income tax provision of $42.3 millionon pre-tax earnings of $79.7 million. The income tax provision was $14.8 millionhigher than the projected provision of $27.5 million based on the Company'scombined Canadian federal and provincial income tax rate of 34.5%. Favorableitems reduced this provision by $31.2 million. These included $16.1 millionrelating to the non-taxable portion of the exchange gain on US $ denominateddebt, which currently receives capital gains treatment in Canada and is taxed at50% of regular business income. Lower corporate income tax rates in theCompany's non-Canadian operations decreased the provision by $14.2 million.Finally, the Company benefited by $0.9 million from the manufacturing andprocessing deduction on its Canadian operations. This tax benefit was phased outby Canadian tax authorities and no longer existed in 2005. However, the loss ofthis benefit was offset by lower effective tax rates. The above favorable itemswere more than offset by several items which increased the income tax provisionby $46.0 million. The non-recognition of period losses in certain operationsincreased the provision by $ 28.9 million. The provision was increased by $6.0million to reflect higher income tax rates in the province of Ontario. TheCanadian large corporations tax added a further $5.5 million. Finally, thenon-deductible loss on consolidation of foreign subsidiaries and non-deductibleexpenses increased the provision by $ 3.2 million and $2.4 million respectively.

29

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

In fiscal 2005, the Company recorded an income tax recoveryof $55.1 million on a pre-tax loss of $359.4 million. The income tax recoverywas $64.6 million, lower than the projected recovery of $119.7 million based onthe Company's combined Canadian federal and provincial income tax rate of 33.3%.There was a favourable item which increased the recovery by $19.5 millionrelating to the non-taxable portion of the exchange 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'snon-Canadian operations increased the recovery by $9.1 million. The abovefavourable items were more than offset by several items which reduced the incometax recovery by $93.2 million. The non-recognition of period losses, primarilyrelated to our US operations in St. Francisville, Louisiana, reduced therecovery by $32.9 million. As well, the reduction in carrying value of apreviously recognized income tax asset relating to the St. Francisvilleoperations further reduced the income tax recovery by $32.2 million.Non-deductible expenses, primarily related to goodwill impairment, decreased therecovery by $21.0 million. The non-deductible loss on consolidation of foreignsubsidiaries decreased the recovery by $4.1 million. Finally, the Canadian largecorporation tax reduced the recovery by $3.0 million.

Details regarding the Company's tax position are outlined innote 19 of the audited consolidated financial statements.

**Net earnings (loss)**

The Company generated a net loss of $304.3 million or $3.55per share compared to net earnings of $37.0 million or $0.43 per share in theprior year. As noted previously, the Company's financial results were impactedby certain specific items. The following table summarizes the impact of theseitems on the reported financial results. The Company believes it is usefulsupplemental information as it provides an indication of results excluding thespecific items. This supplemental information is not intended as an alternativemeasure for net earnings (loss) as determined by Canadian GAAP.
 Year ended     Year ended September 2004     September 2005 $ millions$ per share $ millions$ per share      Net earnings (loss) as reported – in    accordance with GAAP37.00.43 **(304.3)****(3.55)**Specific items (after-tax):         Gain on translation of    foreign debt(78.4)(0.91) **(104.2)****(1.22)**    Derivative financial    instruments gain(57.1)(0.67) **(20.4)****(0.24)**    Amortization of deferred    gain on foreign exchange contracts(100.8)(1.17) **(79.6)****(0.93)**    Asset impairment–– **2.4****0.03**    Unusual items42.80.50 **193.4****2.26**      Net loss excluding specific items – not in accordance with    GAAP(156.5)(1.82) **(312.7)****(3.65)**
30

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
**FOREST PRODUCTS 

$ millions
 2001 2002 2003 2004 **2005**          Total sales951.1 1,139.3 1,082.5 1,422.8 **1,353.5**Consolidated sales795.3 966.5 909.0 1,209.6 **1,158.0**Lumber duties10.8 17.5 81.2 111.4 **89.4**EBITDA46.2 70.8 (37.5) 129.7 **55.0**EBITDA margin on consolidated sales5.8% 7.3% (4.1)% 10.7% **4.7%**          Identifiable assets (excluding cash)735.3 752.4 717.2 846.5 **813.8**
The Forest Products segment is divided into two main areas ofactivity: forest resource management and manufacturing operations.

Forest Resource Management is responsible for managing all ofthe Company's Canadian forestry operations. This includes the harvesting oftimber, either directly or by contractual agreements, and all silviculture andregeneration work required to ensure a sustainable supply for all of themanufacturing units. The group is also responsible for third party timberpurchases, which are needed to supplement total requirements. The group's mainobjective is the optimization of the flow of timber into various manufacturingunits. As the Company's forest activity in Canada is conducted primarily onCrown lands, the Forest Resource Management group works closely with provincialgovernments to ensure harvesting plans and operations comply with establishedregulations and that stumpage charged by the provinces is reasonable andreflects the fair value of the timber being harvested. During fiscal 2005, theCompany's operations harvested and delivered 8.0 million cubic meters of timberversus 7.6 million cubic meters in 2004. Additional supply of approximately 1.3million cubic meters was secured mainly through purchases and exchanges withthird parties, down from 1.6 million cubic meters in the prior year.

The Forest Products Group includes operations located inQuebec, Ontario, Alberta, British Columbia and France. The group also has aminority ownership position in a Chilean pine sawmill. As equity accounting isused for this operation, its sales, margins and volumes are not included in theCompany's consolidated results. The group focuses on three main product areas:SPF Lumber and Panels, Specialty Wood and Engineered Wood. The SPF Lumber andPanels operations can produce approximately 1.7 billion board feet of lumber and1.7 million square feet (1/16" basis) of OSB per year. The Specialty Woodoperations annually produce 171 million board feet of pine lumber, hardwoodlumber and hardwood flooring. The Engineered Wood operations produce laminatedveneer lumber (LVL), finger joint lumber, wood I-Beams, rim joists, metal platesand webs. The normal annual capacities of the Forest Products Group'smanufacturing sites are outlined in the Company's Annual Report and AnnualInformation Form.

The segment is dominated by SPF lumber, which represented 68%of building material sales in fiscal 2005, as compared to 65% in the prior year.The average selling price of SPF lumber was $22 per mfbm (thousand foot boardmeasure) lower than in the prior year. Average OSB selling prices decreased by$21 per msf (thousand square feet), 28% lower than in the prior year. The lowerprices were the result of lower US $ reference prices for random length lumberand a Canadian $ that averaged 8% higher versus the US $. Specialty Wood andEngineered Wood prices and revenues were also negatively impacted by thestronger Canadian $. Overall, Specialty Wood represented 15% of buildingmaterial sales in fiscal 2005, down from 16% in fiscal 2004. Engineered Woodsales in the year were at 8%, up from 7% in the prior year.

31

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

In addition to the above, the Forest Products Group producedand shipped approximately 2.0 million tonnes of wood chips in fiscal 2005, 85%of which were directed to the Company's pulp and paper operations. In 2004, thegroup produced 2.3 million tonnes and shipped 79% of this volume to the pulp andpaper mills. The internal transfer price of wood chips is based on current andexpected market transaction prices.

Total sales for this segment reached $1,353.5 million, adecrease of $69.3 million over the prior year. Lower selling prices for SPFlumber and OSB accounted for most of the decline in sales. Overall, the ForestProducts segment generated 32% of Company consolidated sales, down from 33% inthe prior year. The group's main market is North America, which represented 94%of consolidated sales in fiscal 2005, as compared to 95% in the prior year.
 Sales                     Shipments                Selling Prices               ($ millions)                (000 units)                ($ / unit)                   2004**2005**2004**2005**2004**2005**       **SPF LUMBER & PANELS**      SPF Lumber (mfbm) (1) (2)703.0**681.1**1,443.6**1,464.0**487**465**OSB (msf – 1/16")109.6**80.0**1,452.5**1,487.8**75**54**Remanufactured Lumber (mfbm)17.4**14.7**37.7**36.6**462**402**        830.0**775.8**           **SPECIALTY WOOD**      Pine and Hardwood (mfbm)90.8**85.8**108.5**107.3**837**800**Hardwood Flooring (mfbm)80.6**67.8**17.8**15.3**4,528**4,431**        171.4**153.6**           **ENGINEERED WOOD**      LVL (cubic feet)15.6**16.8**658.8**633.8**24**27**Eng. Finger Joint Lumber (mfbm)9.1**2.2**15.2**4.9**599**449**Wood I-Beams and Rim Joists (linear ft)39.9**49.7**27,239**31,274**1.46**1.59**Metal Plates & Webs ('000 lbs)10.0**9.9**9,795**10,062**1.02**0.98**        74.6**78.6**           **TOTAL BUILDING MATERIALS**1,076.0**1,008.0**           Wood chip & other sales346.8**345.5**           **TOTAL SALES**1,422.8**1,353.5**           Internal wood chip & other sales(213.2)**(195.5)**           **CONSOLIDATED SALES**1,209.6**1,158.0**           (1) Includes La Sarre    and Senneterre for the last 11 months of fiscal 2004 and all of fiscal 2005. (2) Includes Chapleau    for the last 9 1/2 months of fiscal 2004 and all of fiscal 2005. 
32

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
**Markets**
The benchmark random length Western SPF lumber net priceaveraged US $348 per mfbm in 2005, a decrease from US $376 per mfbm in 2004. Inthe East, the random length Eastern SPF average lumber price (delivered GreatLakes) decreased from US $448 per mfbm to US $422 per mfbm in 2005. The Companyconsiders these to be relatively high levels, approximately US $30 to US $40above normal trendline prices for random lumber. The reference price for studlumber did increase, with the Eastern average lumber price (delivered GreatLakes) up from US $395 per mfbm to US $421 per mfbm, a level approximately US$30 to US $40 per mfbm above trendline prices. This relatively good pricingcorrelated with a favourable interest rate environment and strong lumber demandas evidenced by US annual housing starts in excess of 2.0 million units. 

It has now been approximately 4 1/2 years since the five-yearCanada/US Softwood Lumber Agreement (SLA) expired on April 1, 2001. On April 2,2001, petitions for the imposition of antidumping and countervailing duties onsoftwood lumber to the US were filed with the US Department of Commerce (USDOC)and the US International Trade Commission (USITC) by certain US industry andtrade groups. In August 2001, the USDOC made a preliminary countervailing dutydetermination, imposing a bonding rate of 19.31% on Canadian softwood lumbershipped to the US after August 16, 2001.

The preliminary countervailing duty continued in fiscal 2002as the Company accrued $11.0 million on lumber shipments to the US fromSeptember 30 to December 15, 2001. Preliminary countervailing duty effectivelyexpired on the latter date. In addition, on October 31, 2001, the USDOC made apreliminary antidumping determination imposing a bonding requirement at the rateof 10.76% on the Company's shipments of Canadian softwood lumber to the US.

The aforementioned average rate was assigned specifically tothe Company based on the USDOC review of our actual historical shipments to theUS. During the first half of fiscal 2002, the Company accrued a total of $9.7million relating to shipments to the US between November 6, 2001 and March 30,2002.

33

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

On May 16, 2002, the USITC announced it had found no currentinjury, but a threat of injury, to the US lumber industry, effectively removingthe requirement to remit the $21.8 million of accrued preliminary countervailingduty and the $9.7 million of accrued preliminary antidumping duty. The findingof threat of injury by USITC resulted in the USDOC issuing an order to collectcash deposits of estimated countervailing and antidumping duties on a goingforward basis. Effective May 22, 2002, the Company's softwood lumber exports tothe US were subject to a countervailing duty cash deposit rate of 18.79% and anantidumping cash deposit rate of 10.21%. During fiscal 2003, the Companyincurred a charge of $49.7 million relating to countervailing duty and a chargeof $31.5 million for antidumping duty for lumber shipped to the US. Duringfiscal 2004, the Company incurred a charge of $68.3 million relating tocountervailing duty and a charge of $43.1 million for antidumping duty. OnDecember 20, 2004, the USDOC reduced the countervailing duty deposit rate to17.18% and increased the antidumping rate to 10.59%. On February 17, 2005, thecountervailing duty rate was further corrected to 16.37% and the antidumpingrate to 9.1%. During fiscal 2005, the Company incurred a charge of $57.0 millionrelating to countervailing duty and a charge of $32.4 million for antidumpingduty. The Company continues to remit cash deposits to cover the applicableestimated duties based on the revised February 17, 2005 rates. 

Overall, the net impact of duties in fiscal 2005 was a chargeof $89.4 million, down from $111.4 million in the prior year. Lower pricescombined with the lower rates for the last three quarters of fiscal 2005generated the decrease. To the end of September 2005, the Company had expensed atotal of $310.3 million in duties since May 22, 2002. The following tablesummarizes duty expensed and remitted over that period. Additional details areoutlined in note 14 of the audited consolidated financial statements.
   $ millions     DutiesDutiesDuties Expensedremittedremitted C $C $US $    Fiscal 200228.325.215.7Fiscal 200381.273.850.8Fiscal 2004111.4106.380.9Fiscal 200589.491.473.2     310.3296.7220.6**Operations**
While the volume of SPF lumber sold in fiscal 2005 wassimilar to the shipments of the prior year, there were significant changes tothe Company's Eastern Canadian SPF operations. In response to lower allowableharvesting levels of timber on Crown lands, the Company permanently idled threestud lumber sawmills: Kirkland Lake, Ontario; Opasatika, Ontario; and La Sarre,Quebec. The net impact is estimated to be a reduction of production capacity ofapproximately 100 million fbm. However, the remaining Eastern Canadian sawmillswill be approximately 21% larger, in terms of normal production capacity. Whilethe restructuring will yield benefits in future periods, the Company did incurtransition costs associated with the shutdown. As well, higher fuel prices ledto increased costs for delivered timber. Overall, timber costs increased by$23.6 million and sawmill processing costs increased by $8.7 million.

34

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

Overall, lower selling prices for SPF lumber and OSB were theprimary cause of the EBITDA decrease of $74.7 million. The EBITDA margin was4.7%, compared to a five-year average of 5.2%. In fiscal 2005, the ForestProducts segment generated more EBITDA than the consolidated EBITDA of theentire Company, as the Pulp and Paper segments generated negative EBITDA. Infiscal 2004, the segment generated 77% of consolidated EBITDA.
**PULP

$ millions
 2001 2002 2003 2004 **2005**          Total sales1,276.3 1,301.7 1,380.4 1,417.6 **1,372.6**Consolidated sales1,202.9 1,228.2 1,290.6 1,334.3 **1,290.1**EBITDA209.8 96.4 72.7 61.4 **(24.7)**EBITDA margin on consolidated sales17.4% 7.8% 5.6% 4.6% **(1.9)%**          Identifiable assets (excluding cash)1,599.8 1,600.7 1,490.1 1,522.7 **1,490.1**
The Pulp Group consists of eleven market pulp manufacturingfacilities operating at ten sites. The facilities are divided into two maintypes. Paper pulp mills produce softwood kraft, hardwood kraft and high-yieldpulps. Specialty pulp mills produce specialty cellulose, fluff and dissolvingpulps. Nine of the pulp mills are wholly owned and the Company has a 50% jointventure position in the Marathon, Ontario, softwood kraft pulp mill and in theAtholville, New Brunswick dissolving pulp mill. All of the Company's financialand statistical data include only its 50% proportionate share of these twomills. The Company does however have responsibility for marketing the entireoutput of the two joint ventures. The Company's partner in the AV Cell jointventure is the Aditya Birla Group of India, which effectively purchases theentire output of the mill at market prices. The paper pulp mills can produceapproximately 1,860,000 tonnes per year after adjusting for proportionate jointventures. The specialty pulp mills can produce approximately 380,000 tonnes peryear. The annual capacities of the pulp manufacturing sites are outlined in theCompany's Annual Report and Annual Information Form.

Total sales for the Pulp Group reached $1,372.6 million, adecrease of $45.0 million from the all-time high of the prior year. While thesegment benefited from higher US $ reference prices and shipments, it was notsufficient to offset the impact of a stronger Canadian $, which averaged 8%higher versus the US $. The group benefited from higher softwood paper pulpselling prices and set a new record for shipments. The Company sold anadditional 59,100 tonnes of pulp in fiscal 2005, up 3% from the prior year.After eliminating internal sales, the Pulp Group generated 36% of consolidatedsales, the same percentage as in the prior year. 

35

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
**Markets**
The Pulp segment is more "global" than the other businessgroups within Tembec. In 2005, 80% of consolidated sales were generated outsideof Canada and the US, unchanged from the prior year. The Company markets itspulp on a world-wide basis, primarily through its own sales force. The PulpGroup maintains sales or representative offices in Toronto, Canada, Signy/Nyon,Switzerland, San Sebastian, Spain, Beijing, China. The Company's sales forcealso markets pulp and paperboard produced by third parties. In fiscal 2005,agency pulp sales totalled 4,400 tonnes compared to 12,100 tonnes in 2004.

Year over year, average selling prices of pulp decreased by$41 per tonne. In fiscal 2004, the benchmark NBSK pulp price (delivered US)increased from US $550 per tonne to US $610 per tonne, and averaged US $626 pertonne. In fiscal 2005, price increases for NBSK continued during the first halfof the year, eventually reaching US $645 by March 2005, before falling back toUS $585 by September 2005. The average selling price for the year was US $644per tonne, an increase of US $18 per tonne over the prior year. In last year'sMD&A, we had expressed a view that prices would increase in 2005. 

Although our view on US $ prices turned out to be relativelyaccurate, we had not anticipated the impact of the declining US $, as theCanadian $ averaged 8% higher and mitigated much of the positive impact of thehigher pulp prices. The only positive area was Specialty Pulps, where areasonably good market resulted in price increases that effectively outpaced thestronger Canadian $. Average selling prices increased by $16 per tonne.

Although the Company did attain record shipments in fiscal2005, the market weakness experienced in the months of August and September 2005led to increased inventories of 16,500 tonnes over the prior year. The Companyviews this as a temporary correction and expects to reduce its inventories infiscal 2006.

 
 Sales                      Shipments                    Selling Prices                 ($ millions)                 (000 tonnes)                  ($ / tonne)                   2004**2005**2004**2005**2004**2005**       **PAPER PULPS**      Softwood kraft508.6**495.4**702.2**749.7**724**661**Hardwood kraft184.0**173.4**292.0**286.3**630**606**Hardwood high-yield391.0**372.9**658.0**683.5**594**546****SPECIALTY PULPS**309.9**308.0**344.8**336.6**899**915**       **TOTAL PULP SALES**1,393.5**1,349.7**1,997.0**2,056.1**         Other sales24.1**22.9**           **TOTAL SALES**1,417.6**1,372.6**           Internal sales(83.3)**(82.5)**(100.7)**(103.4)**         **CONSOLIDATED SALES**1,334.3**1,290.1**1,896.3**1,952.7**  
36

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
**Operations**
While total shipments in fiscal 2005 increased by 59,100tonnes over the prior year, establishing a new record, the total amount of pulpproduced declined by 17,900 tonnes. During 2004, the Pulp Group took 73,900tonnes of total downtime, including 23,100 tonnes lost due to the flooding ofthe Tarascon pulp mill located next to the Rhone River in Southern France. Thiscompares to 101,600 tonnes of downtime taken in fiscal 2005, which included46,800 tonnes of market related downtime, primarily in high-yield pulp. Therehad been no market related downtime in fiscal 2004.

Despite the increased production curtailments, year over yearmanufacturing costs remained relatively unchanged with higher chemical, energy,freight and supply costs offset by lower labour costs and a more favourableexchange rate on the French pulp mills' Euro costs.

As noted previously, the Company remains mindful of allowingits inventories to increase beyond normal levels. Total consolidated pulpinventories at September 24, 2005, represented approximately 42 days ofproduction. This was higher than in 2004 when we ended the year with 40 days ofproduction in inventory. The Company considers 40 days to be a maximum level.

Total 2005 shipments of 2,056,100 tonnes include 56,500tonnes of high-yield pulp and 34,900 tonnes of softwood kraft pulp consumed bythe Company's paperboard operations as compared to 55,700 tonnes and 32,500tonnes respectively in the prior year. As well, 12,000 tonnes of pulp wereconsumed internally by various other pulp and paper operations, as compared to12,500 tonnes in 2004. In all, internal pulp consumption representedapproximately 5% of total shipments, unchanged from the prior year. 

The eight North American pulp mills purchased approximately2.3 million bone dry tonnes of wood chips in fiscal 2005, compared to 2.6million tonnes in the prior year. Of this amount, approximately 49% weresupplied by the Forest Products Group, the same percentage as in the prior year.The remaining requirements were purchased from third parties under contracts andagreements of various duration. The three pulp mills located in Southern Francepurchased 1.4 million bone dry tonnes of wood chips in fiscal 2005, unchangedfrom the prior year. The fibre is mainly sourced from many private landowners.

Overall, improved US $ reference pricing was not able tooffset the stronger Canadian $ and margins dropped from 4.6% to negative 1.9%.This compares with a five-year positive average margin of 6.5%. As margins werenegative, the Pulp Group did not contribute to total Company EBITDA in fiscal2005. The Pulp Group EBITDA represented 37% of total Company EBITDA in 2004.
**PAPER 

$ millions
 2001 2002 2003 2004 **2005**          Consolidated sales894.9 1,077.8 1,010.3 953.5 **942.8**EBITDA206.7 93.6 31.4 (29.8) **(13.1)**EBITDA margin23.1% 8.7% 3.1% (3.1)% **(1.4)%**          Identifiable assets (excluding cash)1,304.6 1,272.6 1,240.0 1,168.6 **913.7**
37

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

Prior to fiscal 2005, the Paper and Paperboard operationswere divided into two reportable segments. Due to organizational and reportingchanges, these operations have been regrouped under the Paper segment. Prioryear comparable segment data has been restated to conform to the new segmentreporting.

The Paper segment includes five paper manufacturingfacilities with a total of 13 paper machines. The mills located in Kapuskasing,Ontario, and Pine Falls, Manitoba, produce newsprint. The facility located inTemiscaming, Quebec, produces multi-ply bleached coated paperboard. Thepaperboard mill is partially integrated with the high-yield pulp mill and alsoconsumes pulp manufactured by the Company at other sites. The facility locatedin Saint-Raymond, Quebec, produced specialty papers and was permanently shutdown in May 2005. The St. Francisville, Louisiana, mill produces coated andspecialty papers. The total capacity of the Paper Group is 1,140,000 tonnes. Theannual capacities of the paper manufacturing sites are outlined in the Company'sAnnual Report and Annual Information Form.

The $10.7 million decline in sales resulted, primarily fromlower shipments of newsprint and specialty papers, partially offset by highernewsprint and coated paper prices. In February 2004, the Company idled papermachine (PM) No.1 (70,000 tonnes of annual capacity) at the Kapuskasing,Ontario, newsprint mill as a result of weak demand for newsprint. PM No.1produced approximately 25,000 tonnes in fiscal 2004 compared to no production infiscal 2005. The decline in specialty paper shipments relates primarily to thepermanent closure of the Saint-Raymond, Quebec, papermill (68,000 tonnes ofannual capacity) which occurred in May 2005. The mill produced 57,100 tonnes infiscal 2004 compared to 36,600 tonnes in fiscal 2005. In last year's MD&A, wehad commented on an initiative to convert the Saint-Raymond mill's production to100% specialty papers from a combination of coated and specialty papers. Thisinitiative was not successful, primarily as a result of lower demand and pricesfor the targeted specialty grade, and the mill was closed. The costs of closurewas reviewed earlier in the MD&A under "Unusual Items". Overall, the Paper Groupgenerated 26% of consolidated sales in fiscal 2005, unchanged from the prioryear.
**Markets**
The focus of the Paper business is North America, whichaccounted for 98% of sales in 2005, compared to 96% in 2004. The US aloneaccounted for 87% of sales. In fiscal 2004, the benchmark price for newsprint(48.8 gram - East Coast) increased from US $500 per tonne to US $550 per tonne,and averaged US $530 per tonne. In fiscal 2005, the price increases continuedending the year at US $615 per tonne. The average selling price for the year wasUS $585 per tonne, an increase of US $55 per tonne over the prior year. Aftergiving effect to the stronger Canadian $, the Company's average selling pricefor newsprint increased by $15 per tonne. 

The anticipated recovery in pricing of coated papers finallyoccurred in fiscal 2005. In the prior year, the benchmark price for coatedpapers (No. 5-40 lbs) increased from US $695 per short ton to US $740 per shortton and averaged US $706 per short ton. In fiscal 2005, the price increasescontinued, ending the year at US $880 per short ton. The average selling pricefor the year was US $821 per short ton, an increase of US $115 per short tonover the prior year. This increase was partially offset by the stronger Canadian$ and effective prices increased by $93 per short ton or $102 per tonne.

The benchmark for coated bleached boxboard (15 point)averaged US $937 per short ton in fiscal 2005, a US $78 per short ton increaseover the prior year. Here again, the improved US $ reference prices were notenough to offset the stronger Canadian $ and lower prices reduced sales by $18per tonne. The reduction was partially offset by a higher percentage of moreexpensive sheeted board which reached 35% of paperboard sales in fiscal 2005,compared to 31% in the prior year. The net result was that averaged coatedpaperboard prices declined by $3 per tonne.

38

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
 Total sales                Shipments                 Selling Price                ($ millions)                (000 tonnes)               ($ / tonne)                  2004**2005**2004**2005**2004**2005**       Newsprint352.1**335.3**525.7**489.2**670**685**Coated papers277.0**291.4**275.3**262.9**1,006**1,108**Coated paperboard165.1**176.8**139.0**149.1**1,188**1,185**Specialty papers159.3**137.2**158.4**136.0**1,006**1,009**       **TOTAL PAPER SALES**953.5**940.7**1,098.4**1,037.2**         Other sales–**2.1**           **CONSOLIDATED SALES**953.5**942.8**    
Although the above table shows all shipments in "metric" tonnes, coatedpapers and certain specialty papers are sold primarily in short tons.
**Operations**
In addition to the previously noted production curtailmentsat Kapuskasing and Saint-Raymond, the Paper Group also undertook approximately30,000 tonnes of market related downtime in fiscal 2005, compared to only 1,000tonnes in the prior year. Weak demand in newsprint and coated paperboardaccounted for the bulk of the increased market downtime. Total cash costs at thefour Canadian mills increased by $10.8 million, primarily as a result of highercost for chemicals, energy and freight. Higher fibre, chemical and energy costsalso negatively impacted the St. Francisville, Louisiana papermill, but werelargely offset by a more favourable exchange rate. The offset was due to therelative increase in the value of the Canadian $ versus the US $. The St.Francisville facility is the Paper Group's largest operation and provides asignificant natural hedge against the negative impact of a weaker US $. Infiscal 2005, the St. Francisville mill cash cost of manufacturing, including SG&A,represented approximately 43% of the group's total costs.

39

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

The Paper Group's mills are large users of virgin fibre,primarily in the form of wood chips. During fiscal 2005, the operationspurchased 1.0 million bone dry tonnes of virgin fibre, of which approximately36% was internally sourced, unchanged from the prior year. The operations inKapuskasing and Pine Falls both produce newsprint that contains recycled fibre.In 2005, these two facilities consumed 92,800 tonnes of wastepaper, down from103,500 tonnes in 2004.

Overall, fiscal 2005 was another difficult year. Improving US$ prices were largely negated by a stronger Canadian $. Although the US $ costbase of the St. Francisville mill provided a partial currency offset, thegroup's EBITDA margin remained negative 1.4% versus a five-year positive averageof 5.9%. The Paper segment reduced total consolidated EBITDA in fiscal 2005 andfiscal 2004.
**CHEMICALS

$ millions
 2001 2002 2003 2004 **2005**          Consolidated sales97.6 118.0 133.5 167.3 **194.1**EBITDA10.6 14.9 8.4 7.7 **8.2**EBITDA margin10.9% 12.6% 6.3% 4.6% **4.2%**          Identifiable assets (excluding cash)68.7 68.5 69.9 77.3 **79.8**
The Chemical segment operates in three main areas of activity: resins, ligninand alcohol. 

The Resin Division produces powder and liquid phenolic resinsat three operating sites in Quebec: Temiscaming; Longueuil and Trois-Pistoles.In October 2003, the Company acquired a fourth manufacturing operation locatedin Toledo, Ohio, which manufactures powder and liquid amino-based resins as wellas melamine. The Longueuil operation also produces formaldehyde, both forinternal resin production and external sales. In addition to its manufacturedproducts the Resin Division also markets third-party resin binders to complementits customer offering. Sales of third party products totalled $58.1 million infiscal 2005, compared to $50.9 million in the prior year.

The Lignin and Alcohol Divisions use waste sulphite liquorproduced by the specialty pulp mills located in Temiscaming, Quebec, and Tartas,France. Lignin products are sold in liquid form and are also converted intopowder by utilizing the two spray dryers. As well, the group operates an ethylalcohol plant located in Temiscaming, Quebec. The Lignin and Alcohol Divisionseffectively convert pulp mill waste into value-added products.

40

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
 Total Sales               Shipments                Selling Price                 ($ millions)               (000 units)                ($ per unit)                  2004**2005**2004**2005**2004**2005**       Resin and related products (tonnes)(1)130.0**160.1**111.5**113.8**1166**1,407**Lignin (tonnes)38.5**35.3**175.0**171.1**220**206**Alcohol (000 litres)6.2**7.7**9.7**12.3**639**626**       Total sales174.7**203.1**           Internal sales(7.4)**(9.0)**           Consolidated sales167.3**194.1**           (1) Includes 100% of    BTLSR for the last 11 months of fiscal 2004 and all of fiscal 2005. **Markets**
Chemical products are sold primarily in North America withsales representing 86% of the total consolidated sales in 2005, compared to 82%in 2004. Resin products, which accounted for 79% of chemical sales, are designedfor the OSB industry and other specialty applications. Lignin is sold as abinder and surfactant for industrial markets such as animal feed, concreteadmixture and carbon black. Ethyl alcohol is sold into the Canadian vinegar andcosmetics markets. Chemical Group sales represented 5% of consolidated sales in2005, unchanged from the prior year.

The increase in sales of $26.8 million is due primarily tohigher prices for resins and related products. The increase in the selling priceof resins is due to a higher average value for the mix of products sold as wellas higher individual product prices. Despite the higher prices, the EBITDAmargin of 4.2% remained relatively unchanged from the prior year. This is to beexpected for the Resin Division as raw material prices are linked to sellingprices. As a result of the poor performance of the Pulp and Paper segments, theChemical Group generated 33% of total Company EBITDA in fiscal 2005, up from 5%in the prior year.
**FREE CASH FLOW 

$ millions
 2001 2002 2003 2004 **2005**          Cash flow from operations before             working capital changes279.8 55.1 40.7 235.4 **(12.6)**Net fixed asset additions(230.8) (98.9) (131.8) (142.7) **(145.0)**           49.0 (43.8) (91.1) 92.7 **(157.6)**
Cash flow from operations before working capital changes forthe fiscal 2005 was negative $12.6 million, a $248.0 million decline from thecomparable period a year ago. The reduced cash flow is due primarily to a $55.0million decline in proceeds from derivative financial instruments and a $143.4million decline in EBITDA. Cash components of unusual items, primarily employeeseverance, reduced cash flow from operations by a further $31.4 million. In theyear ago period, the Company had disposed of a substantial portion of its US $currency contracts to fund the acquisition of three sawmills. For the year endedSeptember 2005, non-cash working capital items used $24.6 million, as comparedto $28.6 million used by the same items in the prior year. After allowing fornet fixed asset additions of $145.0 million, "free cash flow" for fiscal 2005was negative $157.6 million versus a positive amount of $92.7 million a yearago. The Company defines free cash flow as "cash provided by operatingactivities before changes in non-cash working capital balances less net fixedasset additions".

41

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

The Company had set a free cash flow target of $200 millionfor fiscal 2005. A shortfall in planned EBITDA of approximately $460 million waspartially offset by higher than planned proceeds on derivative financialinstruments, principally currency contracts. The EBITDA target was based on aresolution of the lumber dispute with the United States and a refund of dutiespreviously deposited. This did not occur in fiscal 2005. The net result was theCompany missed its target by $357.6 million. Based on the approved fiscal 2006budget, the Company's free cash flow will be negative $65 million.
**CAPITAL SPENDING 

$ millions
 2001 2002 2003 2004 **2005**          Forest Products30.1 41.1 30.3 38.8 **70.2**Pulp94.2 40.6 74.3 88.1 **62.5**Paper104.4 10.4 18.5 13.1 **11.1**Chemicals and other2.1 6.8 8.7 2.7 **1.2**          Net fixed asset additions230.8 98.9 131.8 142.7 **145.0**          As a % of sales8% 3% 4% 4% **4%**As a % of fixed asset depreciation118% 45% 59% 63% **63%**
In response to relatively low EBITDA margins brought on bychallenging market conditions, the stronger Canadian $ and continuing exportduties on lumber shipped to the US, the Company has limited capital expendituresto mandatory projects and those with high rates of return. In fiscal 2005, netfixed asset additions totalled $145.0 million compared to $142.7 million a yearago. The amount spent was equal to 63% of fixed asset depreciation and 4% ofsales, unchanged from the prior year. Significant items in fiscal 2005 include$25.4 million representing the Company's 50% share of capital expendituresrelating to the completion of a laminated veneer lumber (LVL) facility in Amos,Quebec. The plant, owned and operated by the Temlam joint venture, is nowcomplete and in start-up. Capital expenditures of $15.4 million were incurred tomodernize the Elko, British Columbia sawmill. Project is now complete andbenefits will be realized in fiscal 2006. Finally, an amount of $12.1 millionwas spent on the construction of an anaerobic effluent treatment plant inTemiscaming, Quebec. There remains an amount of $10.0 million to be spent infiscal 2006. The plant is expected to be operational by the spring of 2006,reducing the sites energy and effluent treatment costs.

**Acquisitions and investments**

On October 28, 2003, the Company acquired all of the assetsof BTLSR Toledo Inc., a custom manufacturer of spray-dried resins located inToledo, Ohio. The total price paid for the manufacturing assets and the networking capital was $8.5 million in cash. Depending on the financial results ofthe operation over the five year period following the purchase, the seller maybe entitled to additional payments of up to US $3 million. Based on itsperformance to the end of September 2005, no additional payments to the sellerwould be required.

42

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

On November 3, 2003, the Company acquired the assets and networking capital related to two sawmills located in La Sarre and Senneterre,Quebec, from Nexfor Inc. The purchase price was $59.1 million paid in cash.

On December 15, 2003, the Company acquired the assets and networking capital related to a sawmill located in Chapleau, Ontario, fromWeyerhaueser Company Limited. The purchase price was $25.4 million in cash.

On August 4, 2004, the Company exercised its option toacquire the remaining 50% interest in Excel Forest Products, which owned andoperated a sawmill located in Opasatika, Ontario, for cash consideration of $6.7million. The initial 50% interest had been purchased in March 2001.

There were no acquisitions in fiscal 2005.

**Financing activities**

Net debt to total capitalization was 58.8% at September 2005,an increase from 48.3% at September 2004. The negative free cash flow of $157.6million combined with unusual items totalling $254.5 million generated themajority of the increase. Debt also increased by $25.0 million in relation tothe Company's proportionate (50%) share of the Temlam joint venture debt. Asnoted previously, the funds were used to construct an LVL facility in Amos,Quebec. A favourable item affecting leverage was the debt reduction of $124.8million relating to the revaluation of the Company's US $ denominated debt. TheCanadian $ ended the 2005 fiscal year at US $0.854, compared to US $0.784 a yearago. The Company's inability to generate positive free cash flow under thecurrent pricing environment and lumber duties limited its ability to reducefinancial leverage.

As part of its long-term strategy, the Company has resolvedto 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 theability of the Company to access capital markets at favourable rates. TheCompany remains committed to this program. As the Company's leverage atSeptember 2005 exceeds its stated goal, the emphasis in the near term will be tomaintain relatively high liquidity and limit capital expenditures. Improvementin the pricing levels and EBITDA margins of the Company's main business segmentsor a satisfactory resolution of the lumber trade dispute, including refund ofdeposits, will be required before any reduction in financial leverage can beachieved.

Current credit ratings of various agencies on the Company andits significant long-term debt instruments are outlined in the table below.
DominionMoody'sStandardBond RatingInvestors& Poor'sServiceService    B (low)B3CCC+
The Company's ratings were reduced during 2005 as thecontinued low selling prices combined with a stronger Canadian $ and lumberexport duties reduced EBITDA margins to very low levels.

43

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
**LONG-TERM DEBT 

$ millions
 2004 **2005**    Tembec Inc. – non-interest bearing unsecured    notes23.9 **23.9**Tembec Industries – US $500 million 8.5%    unsecured senior notes637.6 **585.6**Tembec Industries – US $350 million 7.75%    unsecured senior notes446.3 **409.9**Tembec Industries – US $350 million 8.625%    unsecured senior notes446.3 **409.9**Tembec SAS debt13.4 **11.0**Tembec Envirofinance SAS debt7.7 **12.6**Proportionate share of Marathon debt (50%)15.5 **12.9**Proportionate share of Temlam debt (50%)7.5 **32.5**Other debt19.2 **17.4**     1,617.4 **1,515.7**    Current portion included in above9.4 **21.3**
During the year, the Company's French operations increased,via Tembec Envirofinance SAS, its non-interest bearings loans by $4.9 million(Euro 4.0 million) to assist with the financing of certain capital expendituresbeing undertaken at the pulp mills.

The Marathon joint venture does not currently meet certainfinancial covenants on its operating line and its term loan with a syndicate ofbanks. Discussions with lenders are ongoing and the Company believes it willreach a satisfactory agreement to maintain and extend the credit agreement.There is no recourse to the shareholders on either of these loan facilities.

At the end of September 2005, Tembec had cash, temporaryinvestments and derivative financial instruments of $21.7 million plus unusedoperating lines of $211.6 million. At the date of the previous audited financialstatements, the Company had cash, temporary investments and derivative financialinstruments of $206.3 million and unused operating lines of $253.8 million. TheCompany defines "operating lines" to include loans of various duration which aresecured by charges on accounts receivable and/or inventories. Operating linesare used to fund short-term requirements associated with both seasonal andcyclical inventory increases which can occur in the Company's business segments.The Company would not normally draw on the operating lines to fund capitalexpenditures or normal average working capital requirements. The operating linesare established across multiple entities and jurisdictions to ensure they meetthe needs of the various operating units. 

The following table summarizes the unused operating lines bymajor area at the end of the last two fiscal years.
**OPERATING LINES–UNUSED 

$ millions
 2004 **2005**    Canadian operations177.7**161.4**US operations21.6**6.2**French operations44.6**34.1**Proportionate share of joint ventures9.9**9.9**     253.8 **211.6**
44

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

The availability in Canadian operations relates primarily totwo separate operating lines. The Company had in place a $140.0 millioncommitted 364-day facility which expired in March 2005. It was replaced by a newthree-year committed facility of $150 million. The new facility is secured byreceivables and inventory. As at September 2005, the amount available on thisfacility (borrowing base) was $123.4 million. This availability reduction isnormal as inventories are at low levels in September, but increase untilMarch/April due to timber purchases for the Forest Products segment. A second364-day facility of $100 million expired in June 2005. The facility was replacedwith a new three-year committed facility of $200 million. This facility is alsosecured by receivables and inventory. This amount was fully available atSeptember 2005.

The US operations are supported by a US $20 millionthree-year operating facility renewable in May 2006. This facility does havemaintenance covenants. They are not unduly onerous and were also met despiterelatively poor financial performance of the recent years.

The French operations are supported by several mill specificoperating lines totalling approximately Euro 38.2 million. These are essentially"demand" type credits with no specific maturity, subject to periodic reviews.There are no maintenance covenants associated with these operating lines, andunlike the Company's other credits, they are secured by receivables only.

The Company has a stated objective of maintaining at least$400 million of liquidity, comprising cash on hand, temporary investments andunused operating lines. As can be seen, liquidity at year-end was $233.3million, well below our stated objective. As well, the fiscal 2006 budget showsa negative free cash flow projection of $65 million, which will further reduceliquidity. In response to this situation, the Company has set an objective ofgenerating between $100 million and $150 million of additional liquidity duringfiscal 2006. These funds will be raised through several initiatives, includingbut not limited to, selective asset divestitures and the monetization of aportion of the lumber duties currently held on deposit.

The joint ventures maintain their own various operatinglines, without recourse to the Company, to meet working capital and liquidityrequirements.
**COMMON SHARESmillions
 2004 **2005**    Shares outstanding – opening85.8 **85.9**Issued pursuant to long term incentive plans0.1 **–**Normal course issuer bid repurchases– **(0.3**)    Shares outstanding – ending85.9 **85.6**
45

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

The following table summarizes the Company's quarterlyrepurchases of common stock over the last two years, pursuant to its normalcourse issuer bid. The bid was recently extended. 

For the period beginning October 19, 2005, and ending October18, 2006, Tembec is entitled to repurchase up to 4,280,811 common shares.
  
2004 
**2005**      Number of Number of  SharesAverageSharesAverage PurchasedPricePurchasedPrice     December quarter––**244,700****7.63**March quarter––**–****–**June quarter––**–****–**September quarter––**–****–**      ––**244,700****7.63**
In fiscal 2004, no shares were purchased under the normalcourse issuer bid. In fiscal 2005, the Company purchased and cancelled 244,700shares at a total cost of $1.9 million. As the average price paid was less thanthe average issue price at September 2004, a purchase discount of $0.5 millionwas credited to contributed surplus. During the last two fiscal years, theCompany's focus on maintaining its liquidity combined with balance sheetleverage exceeding its stated target significantly reduced its ability torepurchase its common shares. This continued focus will likely limit purchasesin fiscal 2006 as well.

As to dilution, an additional 4.1 million shares may beissued pursuant to options granted under the Long-Term Incentive Plan (LTIP).The exercise price of the options ranges from $3.46 per share to $17.92 pershare with expiry dates from 2006 to 2015. As at September 24, 2005, there were2.0 million exercisable share options, compared to 2.6 million at the end of theprior year.

Loans to employees of approximately $5.6 million areoutstanding under the LTIP on 489,575 shares as at September 25, 2004. Thiscompares to loans of $6.3 million on 552,625 shares at the end of the prioryear. The shares are held in trust as collateral for the loans. Effective July2002, the LTIP was amended and participants are no longer eligible to receiveCompany loans to purchase shares.
**CONTRACTUAL OBLIGATIONS**$ millions       Within 12 – 34 – 5After 5 Totalyearyearsyearsyears      **FISCAL 2004**     Long-term debt1,617.49.429.4458.21,120.4Interest on long-term debt806.3129.4257.3255.8163.8Operating leases25.89.38.23.35.0Purchase obligations258.2124.385.538.410.0Balance of price – acquisition8.91.22.63.41.7       2,716.6273.6383.0759.11,300.9
46

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
**CONTRACTUAL OBLIGATIONS 

$ millions
  Within 12 – 34 – 5After 5 Totalyearyearsyearsyears      **FISCAL 2005**     Long-term debt**1,515.7****21.3****14.0****456.2****1,024.2**Interest on long-term debt**636.3****121.2****240.7****203.4****71.0**Operating leases**27.5****8.6****8.1****4.6****6.2**Purchase obligations**292.1****114.4****83.3****55.6****38.8**Balance of price – acquisition**7.7****1.4****3.4****2.9****–**       **2,479.3****266.9****349.5****722.7****1,140.2**
The table shows the Company's contractual obligations as atSeptember 2004 and 2005. The Company has long-term debt with contractualmaturities and applicable interest as described in note 9 of the auditedconsolidated financial statements. The operating lease obligations relateprimarily to property and equipment rentals entered into in the normal course ofbusiness. Purchase obligations relate to ongoing normal commercial commitmentsto 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 previousowners of Jager Building Systems pursuant to its acquisition by Temlam in August2001.
**QUARTERLY FINANCIAL INFORMATION 

$ millions, except per share amounts
  2004  **2005**  Dec. 27Mar. 27June 26Sept. 25Dec. 26Mar. 26June 25Sept. 24         Sales766.3887.21,030.0981.3**888.8****904.1****957.9****834.2**         EBITDA(9.8)2.591.284.6**(14.2)****15.6****27.5****(3.8)**         Operating earnings (loss)(67.5)(94.9)32.617.0**(94.2)****(47.4)****(167.0)****(164.5)**         Net earnings (loss)52.1(93.2)(12.6)90.7**(0.7)****(26.2)****(142.5)****(134.9)**Net earnings (loss) per    share:            Basic0.61(1.09)(0.15)1.06**(0.01)****(0.31)****(1.66)****(1.58)**    Fully diluted0.61(1.09)(0.15)1.06**(0.01)****(0.31)****(1.68)****(1.58)**         Cash flow per share (1)1.49(0.15)1.000.40**(0.30)****0.21****(0.13)****0.07**         (1)    Before changes in non-cash working capital items       
47

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

Fourth quarter analysis

The Company reported a net loss of $134.9 million or $1.58per share in the fourth quarter ended September 24, 2005 compared to netearnings of $90.7 million or $1.06 per share in the same quarter of fiscal 2004.The weighted average number of common shares outstanding was 85.6 million, asmall decrease from 85.9 million in the same quarter of the prior year.

The Company generated negative EBITDA of $3.8 million onsales of $834.2 million compared to EBITDA of $ 84.6 million on sales of $981.3million in September 2004 quarter. The decrease in sales of $147.1 million wasdue primarily to lower selling prices and volumes in Forest Products and lowerselling prices in Pulp. Effective Canadian $ prices were also negativelyimpacted by a stronger Canadian $, which averaged US $0.831, an increase of 9%over US $0.763 in the same quarter of the prior year. The $88.4 million declinein EBITDA was driven by the lower selling prices for Forest Products and Pulp.

During the September 2005 quarter, the Company recognized animpairment charge of $3.6 million relating to the Mattawa, Ontario specialtysawmill. The charge to income was included in depreciation and amortizationexpense.

During the September 2004 quarter, the Company recorded anon-cash charge of $9.8 million relating to the write-down of a newsprintmachine at the Kapuskasing, Ontario, paper mill. The machine has been idle sinceFebruary 2004 and based on the relatively difficult market conditions it wasdeemed unlikely that the newsprint machine would be restarted. The chargeincludes the complete write-down of the machine's net book value and relatedspare parts. The after-tax impact was $6.6 million or $0.08 per share.

During the September 2005 quarter, as a result of thepermanent closure of the pressurized groundwood pulping line and one of the fourpaper machines at the St. Francisville, Louisiana, papermill, the Companyrecorded a non-cash charge of $37.5 million relating to the reduction of thecarrying value of fixed assets and a charge of $2.3 million relating to thereduction of the carrying value of other related assets. Employee severance andother closure costs amounting to $5.2 million were also recorded. Therestructuring of operations at St. Francisville is expected to improveprofitability by approximately US $17 million per year, based on fiscal 2005costs. Also during the September 2005 quarter, the Company recorded a non-cashcharge of $30.0 million relating to the reduction of the carrying value of adismantled pulp machine and a dismantled paper machine. The machines had beenacquired to possibly be installed at the Company's existing facilities. However,the relatively poor markets of the last several years combined with theCompany's requirement to limit CAPEX have led to uncertainty regarding theultimate disposition of this equipment. Finally, the Company performed therequired annual impairment test of goodwill and found that impairment did existin relation to its hardwood flooring and its newsprint business. As a result,goodwill impairment charges of $1.5 and $21.6 million respectively wererecorded. The after-tax effect of these charges was $87.5 million or $1.02 pershare. The following table summarizes the impact of each item:
     $ millions        Severance    Reduction& Other    of CarryingClosureTotalTaxNet ValuesCostsPre-TaxRecoveryAfter-tax      St. Francisville papermill39.85.245.0–45.0Dismantled machines30.0–30.0(10.2)19.8Goodwill impairment23.1–23.1(0.4)22.7       92.95.298.1(10.6)87.5
48

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

At the end of fiscal 2005, the Company had disbursed $12.6million in relation to severance and other closure costs. A balance of $18.8million remains and is expected to be disbursed in the next fiscal year.

During the September 2005 quarter, the Company recorded again of $73.6 million on the translation of its US $ denominated debt as therelative value of the Canadian $ increased from US $0.811 to US $0.854. In thecomparable period a year ago, the Canadian $ had increased from US $0.741 to US$0.784, and the Company had recorded a gain of $90.4 million. The after-taximpact of the gain on translation of foreign denominated debt was $61.3 millionor $0.72 per share as compared to the prior year after-tax gain of $75.8 millionor $0.88 per share.

The fourth quarter 2005 interim MD&A issued on November 17,2005 provides a more extensive analysis of items having impacted the Company'sfinancial results.

**Summary of quarterly results**

On a quarterly basis, sales have benefited from improvementsin US $ reference prices for lumber, pulp and paper over the last two years.However, much of the benefit was offset by a strengthening Canadian $ comparedto the US $, increasing from an average of US $0.759 in the first quarter offiscal 2004 to US $0.831 in the fourth quarter of fiscal 2005, a 9% increase. Asa result, except for the last two quarters of fiscal 2004, the Company hasgenerated marginal levels of EBITDA.

The Company's financial performance and that of its ForestProducts segment for the last eight quarters were negatively impacted bysubstantial export duties on lumber shipped to the US. Total amount incurredover the last two years was $200.8 million, an amount greater than the totalreported EBITDA of $193.6 million.

During the March 2004 quarter, the Company recorded anon-cash charge of $36.8 million relating to the write-down of its investment inthe Gaspesia Papers Limited Partnership. The charge is the result of a decisionto halt work on the modernization project and seek creditor protection. Thecharge includes the write-down of the original investment of $35.0 million and aprovision of $1.8 million for the non-recovery of expenses incurred as part ofservice agreements with Gaspesia Papers Limited Partnership. As the majority ofthe unusual charge is a capital loss, the after-tax impact was $36.2 million or$0.42 per share.

During the September 2004 quarter, the Company recorded anon-cash charge of $9.8 million relating to the write-down of a newsprintmachine at the Kapuskasing, Ontario paper mill. The machine has been idle sinceFebruary 2004 and based on the relatively difficult market conditions it wasdeemed unlikely that the newsprint machine would be restarted. The chargeincludes the complete write-down of the machine's net book value and relatedspare parts. The after-tax impact of the unusual charge was $6.6 million or$0.08 per share.

During the December 2004 quarter, the Company recorded anunusual charge of $20.3 million relating to the restructuring of its Ontariosawmill operations. The amount included a non-cash charge of $15.5 millionrelating to the reduction of the carrying value of the Kirkland Lake andOpasatika sawmills. Employee severance and other closure costs amounting to $4.8million were also recorded. The after-tax effect of the unusual charge was $14.2million or $0.17 per share. 

49

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

During the June 2005 quarter, the Company recorded an unusualcharge of $136.1 million relating to the closure of several facilities. Theseincluded an SPF lumber sawmill in La Sarre, Quebec; a hardwood and pine sawmillin Davidson, Quebec; a hardwood sawmill in Temiscaming, Quebec; a lumberremanufacturing facility in Brantford, Ontario, and the Saint-Raymond, Quebecpapermill. The after-tax impact was $91.7 million or $1.07 per share. Thefollowing table summarizes the impact by facility:
     $ millions        Severance    Reduction& Other    of CarryingClosureTotalTaxNet ValuesCostsPre-TaxRecoveryAfter-tax      La Sarre sawmill15.26.121.3(7.2)14.1Davidson sawmill5.74.09.7(3.3)6.4Temiscaming sawmill–0.30.3(0.1)0.2Brantford reman3.20.94.1(1.4)2.7Saint-Raymond papermill90.610.1100.7(32.4)68.3       114.721.4136.1(44.4)91.7
During the September 2005 quarter, as a result of thepermanent closure of the pressurized groundwood pulping line and one of the fourpaper machines at the St. Francisville, Louisiana, papermill, the Companyrecorded a non-cash charge of $37.5 million relating to the reduction of thecarrying value of fixed assets and a charge of $2.3 million relating thereduction of the carrying value of other related assets. Employee severance andother closure costs amounting to $5.2 million were also recorded. Therestructuring of operations at St. Francisville is expected to improveprofitability by approximately US $17 million per year, based on fiscal 2005costs. Also during the September 2005 quarter, the Company recorded a non-cashcharge of $30.0 million relating to the reduction of the carrying value of adismantled pulp machine and a dismantled paper machine. The machines had beenacquired to be possibly installed at the Company's existing facilities. However,the relatively poor markets of the last several years combined with theCompany's requirement to limit CAPEX has led to uncertainty regarding theultimate disposition of this equipment. Finally, the Company performed therequired annual impairment test of goodwill and found that impairment did existin relation to its hardwood flooring and its newsprint business. As a result, agoodwill impairment charge of $1.5 and $21.6 million respectively was recorded.The after-tax effect of these charges was $87.5 million or $1.02 per share. Thefollowing table summarizes the impact of each item:
     $ millions        Severance    Reduction& Other    of CarryingClosureTotalTaxNet ValuesCostsPre-TaxRecoveryAfter-tax      St. Francisville papermill39.85.245.0–45.0Dismantled machines30.0–30.0(10.2)19.8Goodwill impairment23.1–23.1(0.4)22.7       92.95.298.1(10.6)87.5
50

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

While the stronger Canadian $ reduced EBITDA, the Companyrealized significant gains on its derivative financial instruments, primarily US$ foreign exchange contracts. Over the last eight quarters, the Company hasrecorded $382.1 million of realized and amortized gains on derivative financialinstruments, an amount greater than the $267.1 million of interest onindebtedness incurred during the same period.

The Company also recorded a gain of $218.3 million on thetranslation of its US $ denominated debt over the last two years. However, theimpact of the quarterly translation gains and losses added considerablevolatility to the results, with the impact ranging from a gain of $90.4 millionin the September 2004 quarter to a loss of $38.5 million in the June 2004quarter.
**FISCAL 2004 COMPARED TO FISCAL 2003 $ million, unless otherwise noted
 20032004   Sales3,346.13,664.8   EBITDA74.8168.5   Operating loss(173.8)(112.8)   Net earning (loss)11.437.0   Net earnings (loss) per share0.130.43   Diluted earnings (loss) per share0.130.43   Total assets (at end of year)3,818.83,921.9   Total long-term debt(1) (at end of year)1,727.61,617.4   (1) Includes current portion  
The increase in consolidated gross sales of $318.7 million in2004 was due primarily to higher selling prices and shipment in the ForestProducts segment.

In fiscal 2003, the Company absorbed unusual item charges of$18.4 million relating to reduced fixed asset carrying values and goodwillimpairment. The after-tax impact was $17.5 million or $0.21 per share. In fiscal2004, the Company absorbed unusual item charges of $46.6 million relating toreduced fixed asset and investment carrying values. The after-tax impact was$42.8 million or $0.50 per share.

Interest, foreign exchange and other items totalled to acredit amount of $99.0 million in fiscal 2004 as compared to a charge of $118.0million in fiscal 2003. In fiscal 2004, the Company had realized and amortizedderivative financial instrument gains of $233.9 million, an increase of $170.6million over gains of $63.3 million recorded in the prior year. 

The Company also realized an investment gain of $22.7 millionor the sale of an investment in shares of a Canadian publicly-traded forestproducts company.

During fiscal 2004, the Company recorded a gain of $93.5million on the translation of its US $ denominated debt as the relative value ofthe Canadian $ increased from US $0.739 to US $0.784. In the prior fiscal year,the Canadian $ had increased from US $0.634 to US $0.739 and the Company hadrecorded a gain of $263.9 million. The after-tax impact of the gain ontranslation of foreign-denominated debt was $78.4 million or $0.91 per share ascompared to the prior year after-tax gain of $221.0 million or $2.56 per share.

For the year ended September 25, 2004, the Company generatednet earnings of $37.0 million or $0.43 per share compares to net earnings of$11.4 million or $0.13 per share in fiscal 2003.

51

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

**Risks and uncertainties**
**Product prices**
Our financial performance is dependent on the selling pricesof our products. The markets for most lumber, pulp and paper products arecyclical and are influenced by a variety of factors. These factors includeperiods of excess product supply due to industry capacity additions, periods ofdecreased demand due to weak general economic activity, inventory de-stocking bycustomers, and fluctuations in currency exchange rates. During periods of lowprices, the Company is subject to reduced revenues and margins, resulting insubstantial declines in profitability and possibly net losses.

Based on 2006 planned sales volumes, the following tableillustrates the approximate annual impact of changes to average Canadian $selling prices on after-tax earnings.
**SELLING PRICE SENSITIVITY** Average Impact onselling after-taxprices ($) earnings4th Quarter – ($ millions)2005   Pulp – $25/tonne35.8**650**Papers – $25/tonne17.4**927**SPF lumber – $10/mfbm10.5**436**
The Company's strategy is to mitigate price volatility bymaintaining operations in three core sectors, namely wood products, pulp andpaper; 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 mayperiodically purchase lumber, pulp and newsprint price hedges to mitigate theimpact of price volatility. At September 24, 2005, the Company held lumberfutures equal to approximately 0.5% of its annual SPF lumber capacity. The fairvalue of the contracts was nil. At September 25, 2004, the Company held lumberfutures equal to approximately 7% of its capacity, the fair value of which was$5.8 million.

52

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
**Foreign exchange**
Our revenues for most of our products are affected byfluctuations in the relative exchange rates of the Canadian $, the US $ and theEuro. The prices for many of our products, including those we sell in Canada andEurope are generally driven by US $ reference prices of similar products. Wegenerate approximately US $2.2 billion of US $ denominated sales annually fromour Canadian and European operations. As a result, any decrease in the value ofthe US $ relative to the Canadian $ and the Euro reduces the amount of revenueswe realize on our sales in local currency. In addition, since business unitspurchase the majority of their production inputs in local currency, fluctuationsin foreign exchange can significantly affect the unit's relative cost positionwhen compared to competing manufacturing sites in other currency jurisdictions.This could result in the unit's inability to maintain its operations duringperiods of low prices and/or demand.

Based on 2006, planned sales volumes and prices, thefollowing 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 assumedan increase of 1% in the value of the US $. A decrease would have the oppositeeffects of those shown below.
**FOREIGN EXCHANGE    SENSITIVITY** $ millions   Increase EBITDA27.1Increase interest expense(1.2)  Increase cash flow25.9Loss on US $ debt translation(14.8)  Pre-tax earnings11.1Tax provision(6.0)  Net earnings5.1
As can be seen, interest expense on the Company's US $denominated debt provides only a small offset to its total US $ exposure. Tofurther reduce the impact of fluctuations in the value of the US $, the Companyhas adopted a policy of hedging up to 50% of its anticipated US $ receipts forup to 36 months in duration. At September 24, 2005, the Company held US $foreign exchange contracts totalling US $10.8 million with a fair value of $0.2million. This compares to September 25, 2004, when the Company held US $ foreignexchange contracts totalling US $348.9 million with a fair value of $104.9million. The Company's derivative financial holdings at the end of fiscal 2005are disclosed in note 22 of the audited consolidated financial statements.

53

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
**Operational Risks**
The manufacturing activities conducted by our operations aresubject 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/upgradeof process equipment to manufacture competitive quality products and therequirement to operate the manufacturing facilities at high rates of utilizationand efficiency to maintain a competitive cost structure.

Fibre represents the Company's major raw material in theproduction of wood products, pulp and paper. In Canada, virgin fibre or timberis sourced primarily by agreements with provincial governments. The agreementsare granted for various terms from five to 25 years and are generally subject toregular renewals every five years. The agreements incorporate commitments withrespect to sustainable forest management, silvicultural work, forest and soilrenewal, as well as cooperation with other forest users. In addition, theCompany has undertaken, on a voluntary basis, to have its timber harvestingcertified by the Forest Stewardship Council (FSC). The Company expects theagreements to be extended as they come up for renewal. Aboriginal groups haveclaimed substantial portions of land in various provinces over which they claimAboriginal title or in which they have a traditional interest and for which theyare seeking compensation from various levels of government. The Company hastaken a proactive approach to enhance the economic participation of the FirstNations in its operations wherever feasible. The Company's operations in theUnited States and France source their fibre requirements from various privatesources, primarily through long-term supply arrangements. The Company alsopurchases approximately 105,000 tonnes per year of recycled waste fibre. Tomitigate the impact of price fluctuations, the Company periodically purchasesONP hedges. At September 24, 2005, the Company held hedges relating to ONPrepresenting approximately 3% of its annual recycled fibre purchases. The fairvalue of these instruments was nil. At the end of the prior year, the Companyheld hedges relating to ONP representing approximately 21% of its annualrecycled fibre purchases, with a fair value of $0.4 million.

Energy is an important component of mill costs, especiallyfor high-yield pulp mills, newsprint and paper mills. In 2005, we purchasedapproximately $319 million of energy, 60% of which was electricity. Electricalpurchases are made primarily from large public utilities, at rates set byregulating bodies. In certain jurisdictions, electricity is deregulated whichcan lead to greater price volatility. To mitigate the effect of pricefluctuations on its financial performance, the Company employs several tactics,including the securing of longer-term supply agreements, the purchase ofderivative financial instruments and operational curtailments in periods of highprices (load shedding). At September 24, 2005, the Company did not hold anyderivative financial instruments relating to purchased electricity.

54

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

Fossil fuels, primarily natural gas, are purchased at marketrates. The Company purchases derivative financial instruments to hedge itsexposure. At September 24, 2005, the Company had natural gas hedges coveringapproximately 7% of its anticipated requirements for the next year. The fairvalue of these instruments was $5.6 million. This compared to the end of theprior year when the Company had natural gas hedges covering approximately 25% ofits anticipated requirements for the next two years. The fair value of theseinstruments was $3.2 million.

Nearly all the Company's manufacturing units have a unionizedworkforce. Over the past 30 years, the Company has successfully negotiated newcollective agreements in nearly all instances, with very few work stoppages. Atmany of the Company's facilities, as well as those of the North Americanindustry as a whole, we have seen reductions in employment levels followingtechnological and process improvements resulting in a workforce with more yearsof service. This increases the relative costs of pensions and benefits. AtSeptember 2005, the Company had approximately 6,600 hourly paid employees,nearly all of which are covered by collective bargaining agreements. At the endof September 24, 2005, there were seven agreements covering 1,388 employees thathad expired and were under active negotiations. During fiscal 2006, a total of17 agreements covering 2,053 employees will expire. The remaining contractsexpire at various dates to August 2011. The Company anticipates it will reachsatisfactory agreements on contracts currently under active negotiations andthose expiring in the future.

The Company's operations are subject to industry specificenvironmental regulations relating to air emissions, wastewater (effluent)discharges, solid waste, landfill operations, forestry practices, and siteremediation. The Company has made significant progress in reducing theenvironmental impact of its operations over the last 15 years. This has occurredas a result of changes in manufacturing processes, the installation ofspecialized equipment to treat/eliminate the materials being discharged and theimplementation of standardized practices such as ISO 14001.

The production of pulp and paper products is capitalintensive. The Company estimates it must spend approximately $100 million peryear on capital expenditures to avoid degradation of its current operations.

Because of the relatively high fixed cost component ofcertain manufacturing processes, especially in pulp and paper, the operationsare 24/7 with target efficiency in the 80-85% range. Failure to operate at theselevels jeopardizes the continued existence of a mill. Producers are forced tooperate the facilities at "full" rate even when demand is not sufficient toabsorb all of the output. This can lead to over-supply and lower prices, furtherincreasing the inherent cyclicality of the industry. 

55

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
**Trade restrictions /Lumber export duties**
The Company's manufacturing operations are located primarilyin Canada. However sales into the Canadian market represented only 20% ofconsolidated sales in 2005. As such, the Company's financial results are highlydependant on its ability to sell its products into the "export" markets. Tariffsand trade barriers that reduce or prohibit the movement of our products acrossinternational borders constitute an ongoing risk. The current dispute betweenCanada and the United States over softwood lumber is a case in point. The UnitedStates Department of Commerce initially assessed the Company with aggregatecountervailing and antidumping duties at an average rate of 29%. The combinedrate was subsequently reduced to 25.47% in February 2005. The Company has madethe required cash deposits on its exports of softwood lumber to the US. Thefinal outcome of the dispute is not known at this time.
**Financial risks/Debt service**
The Company currently has a non-investment grade rating ofCCC+/B3/B (low). The ratings reflect the relatively high use of debt combinedwith periods of reduced operating earning due to the cyclicality of its threeprincipal business segments. Of the total long-term debt of $1.5 billion, 94%relates to US $ denominated high-yield "Senior Notes". The annual interestcoupon on the high-yield debt ranges between 7.75% and 8.625%, generating anannual expense of US $100 million. The Senior Notes do not require periodicpayments for principal amortization. Since the entire principal amount becomesdue on the maturity dates of the Senior Notes, it is unlikely that the Companywill have the required funds to repay the principal due. The Company willrequire access to the public or private debt markets to issue new notes or debtinstruments to replace or partially replace the Senior Notes prior to theirstated maturity dates. The nearest maturity relates to the 8.625% US $350million Senior Notes maturing in June 2009. The Company's objective is to reduceits leverage and improve its credit ratings prior to the refinancing of theaforementioned Senior Notes.
**Growth strategy/Acquisition**
The Company has a publicly stated objective of growing itsoperations. Based on past experience, a significant portion of this growth willlikely occur through acquisitions and other forms of business combinations. Theability to properly evaluate the fair value of acquisitions, to successfullyintegrate them into our current business operations and to realize the projectedprofits and returns are inherent risks related to acquisitions. The Company hasgained significant expertise in evaluating businesses, performing due diligenceand integrating new businesses. We believe the industry consolidation of therecent years will continue and that "size" will be required to effectivelycompete in the global forest products industry. 

56

**MANAGEMENT'S DISCUSSION AND ANALYSIS**

**Outlook**
**Forest products**
In last year's MD&A, we indicated that we expected a refundof lumber duties deposited and a satisfactory resolution to the long runningdispute. This did not occur in fiscal 2005. While Canadian lumber producers madesignificant progress in improving their relative position via various legalchallenges, it has not been possible to convince US authorities to respect theirlegal obligations as set out by the North American Free Trade Agreement (NAFTA).The $310.3 million of duties charged since May 22, 2002, including $89.4 millionin fiscal 2005, have negatively impacted the Company's reported financialresults. Although we remain optimistic that a solution could occur in fiscal2006, we will manage our business on the basis that the duties will continue tobe paid throughout the year, albeit on a reduced basis due to a lowerantidumping rate expected to be effective in December 2005. As for lumbermarkets, we were correct in our view that pricing in fiscal 2005 would not be asstrong as in the prior year. 

The weaker US $ also negatively impacted Canadian producersby increasing their relative cost position. In response to this challengingenvironment and anticipated reductions in future allowable timber harvestinglevels, the Company restructured its Eastern Canadian SPF sawmill operations.This resulted in the permanent closure of three sawmills. Although totalproduction was reduced by approximately 100 million fbm, the remaining sawmillswill be 21% larger on average. The restructuring is expected to yield annualcost savings of approximately $30 million beginning in fiscal 2006. Our view onlumber markets is relatively cautious. Housing starts in North America arecurrently running at a record pace and we would expect a reduction to morenormal levels at some point in the future. As well, the beetle infestation inBritish Columbia and wider access to timberlands in the US is leading toincreased lumber production in the near and medium term.
**Pulp**
Twelve months ago, we expressed a view that US $ referenceprices would exceed US $700 per tonne (NBSK – North America) by early calendar2005. Although we did see a gradual improvement, prices actually peaked at US$680 per tonne in the February – April 2005 period. We had identified a fewrisks associated with our outlook, including the requirement for a strongerprinting and writing paper business to support the market pulp business. Thisdid not occur in fiscal 2005. As well, for the third consecutive year, we sawthe benefit of higher US$ reference prices for pulp largely offset by a strongerCanadian $ and Euro. As at September 2005, the benchmark price for NBSK stood atUS $620 per tonne. Given the current weakness of the US $ versus the Canadian $and the Euro, we view this as an unsustainable price for many producers,particularly those in Eastern Canada where fibre availability and cost remainchallenging. Going forward, we anticipate prices to increase to the US $675-700range in fiscal 2006. If demand is not sufficient to increase prices, we believea combination of permanent and temporary curtailments will occur, ultimatelyyielding the same result. On a longer-term basis, the reduced softwood fibreavailability in Eastern Canada will require that a few pulp mills be permanentlyshut. The Company is confident that past and planned future improvements at theTemiscaming, Smooth Rock Falls and Marathon pulp mills will ensure theircontinued operation. However, their fibre costs and margins will continue to beunder pressure until the rationalization occurs.

57

**MANAGEMENT'S DISCUSSION AND ANALYSIS**
**Paper**
Our view of the newsprint market in fiscal 2005 turned out tobe absolutely correct. Price increases, from US $550 per tonne in September 2004to US $615 per tonne in September 2005, were driven primarily by the strongerCanadian $ and its negative impact on the relative cost position of Canadiannewsprint producers. Faced with a continued decline in demand, producerscontinued to reduce production capacity. In February 2004, the Company reducedits capacity by 70,000 tonnes or approximately 12% when it idled PM No.1 at theKapuskasing newsprint mill. Our view on newsprint is one of modest improvement.At some point, the decline in North American demand should cease, allowingproducers to take a pause on capacity reduction. As well, the relatively strongCanadian $ will continue to put upward pressure on prices. The Company has anopportunity to greatly improve its financial performance if satisfactoryelectricity pricing in Ontario can be achieved. The Kapuskasing newsprintoperation, which remains EBITDA positive because of higher efficiencies in allareas except purchased energy, continues to pay $20 million to $30 million moreper year for electricity than would be charged in other Canadian provinces.Industry in Ontario effectively subsidizes individual consumers. At some point,economics will prevail over politics, although there is no assurance this willoccur in the near term.

Our view of coated papers in fiscal 2005 was also correct.The benchmark price (No. 5 – 40 lbs) increased by US $140 per short tonnereaching US $880 per short tonne. This actually represented a return to morehistorical levels after a very low pricing period in 2003 and 2004. Unlike ourother businesses, which are primarily based in Canada and Europe, our coatedpaper manufacturing is based in the US. As such, the weaker US $ improves ourrelative cost position versus non-US producers, which normally leads to betterpricing. At current levels, we would not expect any significant price increasesin fiscal 2006. The US $ has appreciated versus the Euro in the last six months,which will allow imports to be more competitive versus domestic producers.However, higher fossil fuel costs, which are a global phenomenon, will helpharden the resolve of producers to maintain or improve pricing. Our efforts in2006 will be directed at improving the St. Francisville operation by reducingits costs and increasing coated paper production by 10%.
**Summary**
In summary, the financial results of 2005 fell short of ourexpectations. Our view of pricing was reasonably accurate but we had notforeseen the weakness of the US $. We had also expected that the softwood lumberdispute would have been resolved by now, leading to a substantial refund ofprevious deposits and significantly improved cash flow going forward. TheCompany, like its competitors, is facing higher costs for energy. Thepass-through of these costs has proven challenging in light of relatively weakdemand in certain areas. The Company remains focused on generating between $100million and $150 million of liquidity via several initiatives in fiscal 2006 andis confident it will achieve this goal. The potential resolution of the softwoodlumber battle and the refund of deposits will be a key determinant of financialperformance in fiscal 2006.
**Additional information**
Additional information relating to Tembec, including theAnnual Information Form, can be found on SEDAR at www.sedar.com and on theCompany's website at www.tembec.com

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