---

Exhibit 99.4

ManagementsDiscussion
and Analysisas at November 30, 2011

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,
2011, as compared to the fiscal year ended September 25, 2010. The MD&A
should be read in conjunction with the audited consolidated financial statements
for the fiscal year ended September 24, 2011. All references to quarterly or
Company information relate to Tembec Inc.s fiscal quarters. EBITDA, net debt,
total capitalization, free cash flow and certain other financial measures
utilized in the MD&A are non-GAAP (Generally Accepted Accounting Principles)
financial measures. As they have no standardized meaning prescribed by GAAP,
they may not be comparable to similar measures presented by other
companies.

The MD&A includes forward-looking statements within the
meaning of securities laws. Such statements relate, without limitation, to the
Companys or managements objectives, projections, estimates, expectations or
predictions of the future and can be identified by words such as may, will,
could, anticipate, estimate, expect, and project, the negative or
variations thereof, and expressions of similar nature. Forward-looking
statements are based on certain assumptions and analyses made by the Company in
light of its experience, information available to it and its perception of
future developments. Such statements are subject to a number of risks and
uncertainties, including, but not limited to, changes in foreign exchange rates,
product selling prices, raw material and operating costs and other factors
identified in the Companys periodic filings with securities regulatory
authorities. Many of these risks are beyond the control of the Company and,
therefore, may cause actual actions or results to materially differ from those
expressed or implied herein. The forward-looking statements contained herein
reflect the Companys expectations as of the date hereof and are subject to
change after such date. The Company disclaims any intention to update or revise
any forward-looking statements, whether as a result of new information, future
events or otherwise, unless required by applicable securities legislation. The
information in this MD&A is as at November 30, 2011. Disclosure contained in
this document is current to that date, unless otherwise stated.

Throughout the MD& A, Tembec or Company means
Tembec Inc. and its consolidated subsidiaries. Prior to December 2010, Tembecs
operations consisted of five reportable business segments: Forest Products,
Pulp, Paper, Chemicals and Corporate. During the December 2010 quarter, the
Company reorganized its internal reporting structure. Subsequent to the
organizational changes, the Pulp segment was divided into two segments:
Dissolving and Chemical Pulp, and High-Yield Pulp. Each segment includes three
pulp mills. As well, the Chemicals segment is now part of the Dissolving and
Chemical Pulp segment. A significant portion of Chemicals sales are related to
by-products generated by the two dissolving pulp mills. The Forest Products,
Paper and Corporate segments were unaffected by the organizational changes.
Comparative prior year segment information has been restated to conform with the
new segment presentation. On September 24, 2011, the Company had approximately
4,250 employees, as compared to 4,300 at the end of the prior fiscal year. The
Company operated manufacturing facilities in Quebec, Ontario, British Columbia,
the state of Ohio as well as in Southern France. Principal facilities are
described in the subsequent sections of the MD&A.

4Tembec Financial Report 2011

---

Managements Discussion and Analysis

2011 vs. 2010

|FINANCIAL SUMMARY                                               |  |       |   |  |       |  
|--------------------------------------------------------------- |  | ----- | - |  | ----- | -
|(in millions of dollars, unless otherwise noted)                |  |       |   |  |       |  
|                                                                |  | 2010  |   |  | 2011  |  
|Sales                                                           |  | 1,877 |   |  | 1,743 |  
|Freight and sales deductions                                    |  | 234   |   |  | 237   |  
|Lumber export taxes                                             |  | 10    |   |  | 13    |  
|Cost of sales                                                   |  | 1,426 |   |  | 1,324 |  
|SG&A                                                            |  | 73    |   |  | 72    |  
|Share-based
      compensation                                  |  | 2     |   |  | 2     |  
|EBITDA                                                          |  | 132   |   |  | 95    |  
|Depreciation and amortization                                   |  | 56    |   |  | 45    |  
|Other items                                                     |  | 13    |   |  | 1     |  
|Operating earnings                                              |  | 63    |   |  | 49    |  
|Interest, foreign exchange and other                            |  | 51    |   |  | 32    |  
|Exchange
      loss (gain) on long-term debt                    |  | (27   | ) |  | 1     |  
|Earnings before
      income taxes and non-controlling interest |  | 39    |   |  | 16    |  
|Income tax expense (recovery)                                   |  | (15   | ) |  | 19    |  
|Non-controlling interest                                        |  | 2     |   |  |      |  
|Net earnings
      (loss) and comprehensive earnings (loss)     |  | 52    |   |  | (3    | )
|Basic and diluted
      earnings (loss) in dollars per share    |  | 0.52  |   |  | (0.03 | )
|                                                                |  |       |   |  |       |  
|Total assets (at
      year-end)                                |  | 1,104 |   |  | 1,107 |  
|Total long-term
      debt (at year-end) (1)                    |  | 288   |   |  | 289   |  
|Total long-term
      financial liabilities (at year-end)       |  | 480   |   |  | 459   |  
|(1)includes current portion                                     |  |       |   |  |       |  

|CONSOLIDATED SALES       | CONSOLIDATED SALES BY SEGMENT
|------------------------ | -----------------------------
|(in millions of dollars) | (in millions of dollars)     
|                         |                              

Tembec Financial Report 2011 5

---

Managements Discussion and Analysis

|EBITDA BY SEGMENT        | FINANCIAL PERFORMANCE
|------------------------ | ---------------------
|(in millions of dollars) |                      
|                         |                      

SALES(in millions of dollars)Total
    
    
    Price
    
    
    Volume & mix2010
    
    
    2011
    
    
    variance
    
    
    variance
    
    
    varianceForest Products
    
    434
    
    
    471
    
    
    37
    
    
    (10
    )
    
    47Dissolving and Chemical Pulp
    
    830
    
    
    693
    
    
    (137
    )
    
    71
    
    
    (208
    )High-Yield Pulp
    
    395
    
    
    378
    
    
    (17
    )
    
    (53
    )
    
    36Paper
    
    348
    
    
    339
    
    
    (9
    )
    
    6
    
    
    (15
    )Corporate
    
    5
    
    
    7
    
    
    2
    
    
    
    
    
    22,012
    
    
    1,888
    
    
    (124
    )
    
    14
    
    
    (138
    )Less: internal
      sales
    
    (135
    )
    
    (145
    )
    
    (10
    )Sales
    
    1,877
    
    
    1,743
    
    
    (134
    )


Sales decreased by $134 million as compared to fiscal 2010.
Currency was unfavourable as the Canadian dollar averaged US $1.013, a 5.5%
increase from US $0.960 in the prior year. Forest Products segment sales
increased by $37 million primarily as a result of higher shipments. Dissolving
and Chemical Pulp segment sales declined by $137 million due to significantly
lower shipments, partially offset by higher prices. High-Yield Pulp segment
sales decreased by $17 million due to lower prices, as higher shipments
partially offset the decline. Paper segment sales decreased by $9 million due to
lower shipments, partially offset by higher prices.

In terms of geographical distribution, the U.S. remained the
Companys principal market with 34% of consolidated sales in fiscal 2011, as
compared to 31% in the prior year. Canadian sales represented 18% of sales, as
compared to 20% in the prior year. Sales outside of the U.S. and Canada
represented the remaining 48% in fiscal 2011, as compared to 49% a year ago.

6Tembec Financial Report 2011

---

Managements Discussion and Analysis

EBITDA(in millions of dollars)Total
    
    
    Price
    
    
    Cost & volume2010
    
    
    2011
    
    
    variance
    
    
    variance
    
    
    varianceForest Products
    
    (10
    )
    
    (46
    )
    
    (36
    )
    
    (10
    )
    
    (26
    )Dissolving and Chemical Pulp
    
    120
    
    
    138
    
    
    18
    
    
    71
    
    
    (53
    )High-Yield Pulp
    
    47
    
    
    (4
    )
    
    (51
    )
    
    (53
    )
    
    2Paper
    
    (2
    )
    
    28
    
    
    30
    
    
    6
    
    
    24Corporate
    
    (23
    )
    
    (21
    )
    
    2
    
    
    
    
    
    2132
    
    
    95
    
    
    (37
    )
    
    14
    
    
    (51
    )


EBITDA declined by $37 million over the prior year. Forest
Products segment EBITDA declined by $36 million due to higher costs and lower
prices. Dissolving and Chemical Pulp segment EBITDA increased by $18 million due
to higher prices, partially offset by higher costs. High-Yield Pulp segment EBITDA decreased by $51 million due to lower prices. Paper
segment EBITDA increased by $30 million on a combination of higher prices and
lower costs. Corporate expenses for the current year include a charge of $2
million relating to share-based compensation, unchanged from the prior year.

OPERATING EARNINGS (LOSS)(in millions of dollars)Depreciation &
    
    
    OtherTotal
    
    
    EBITDA
    
    
    amortization
    
    
    items2010
    
    
    2011
    
    
    variance
    
    
    variance
    
    
    variance
    
    
    varianceForest Products
    
    (24
    )
    
    (63
    )
    
    (39
    )
    
    (36
    )
    
    3
    
    
    (6
    )Dissolving and Chemical Pulp
    
    105
    
    
    120
    
    
    15
    
    
    18
    
    
    9
    
    
    (12
    )High-Yield Pulp
    
    37
    
    
    (14
    )
    
    (51
    )
    
    (51
    )
    
    
    
    
    Paper
    
    (12
    )
    
    25
    
    
    37
    
    
    30
    
    
    
    
    
    7Corporate
    
    (43
    )
    
    (19
    )
    
    24
    
    
    2
    
    
    (1
    )
    
    2363
    
    
    49
    
    
    (14
    )
    
    (37
    )
    
    11
    
    
    12


The Company generated operating earnings of $49 million
compared to operating earnings of $63 million in fiscal 2010.

The Forest Products segment generated an operating loss of $63
million in fiscal 2011, compared to an operating loss of $24 million in fiscal
2010. In addition to the previously noted decline in EBITDA, the segments
current year results include a charge of $3 million relating to the permanent closure of the
Taschereau, Quebec, SPF sawmill. It also includes a charge of $1 million related
to severance payments at the idled planer facility in Cranbrook, British
Columbia. The prior year included a $2 million gain related to land sales.
Depreciation expense declined by $3 million as the continued difficult market
conditions led to relatively low capital expenditures.

Tembec Financial Report 2011 7

---

Management’s Discussion and Analysis

The Dissolving and Chemical Pulp segment generated operating earnings of $120 million during the most recently completed fiscal year, compared to operating earnings of $105million a year ago. In addition to the previously noted $18
million improvement in EBITDA, depreciation expense decreased by $9 million, primarily as a result of the sale of two pulp mills that occurred in early May of fiscal 2010. In the prior year, this segment had recorded a gain of $12 million
relating to the sale of the aforementioned pulp mills.

The High-Yield Pulp segment generated an operating loss of $14 million during the most recently completed fiscal year, compared to operating earnings of $37 million a year ago. The decline in EBITDA accounted for the weaker operating
results.

The Paper segment generated operating earnings of $25million compared to an operating loss of $12 million in the prior year. Besides the previously noted increase in EBITDA, the segment’s prior year results had absorbed a charge of
$7million relating to the permanent closure of the Pine Falls, Manitoba, newsprint facility.

Corporate expenses decreased by $24 million. The prior year  results included a non-recurring charge of $12 million relating  to the St. Francisville, Louisiana, coated paper mill. The mill  property and equipment were sold in April 2009. A
portion of  the consideration included two US $5 million interest-bearing  notes. In January 2010, the purchaser filed for protection under  the U.S. Bankruptcy Code. Subsequently, the assets were  sold at auction. Based on the amount of the
winning bid, it was unlikely that the Company would recover any portion of the interest-bearing notes. As a result, the Company recorded  a charge of $12 million. The aforementioned amount included  accrued interest as well as certain other
unsecured claims. The  current year results include a gain of $8 million related to the  filing of Tembec USA LLC under Chapter 7 of the Bankruptcy Code of the United States. The Company reduced its accrued  benefit obligation by this amount. It
also includes a $3million  gain related to the sale of its hydro-electric generating facilities  located in Smooth Rock Falls, Ontario.

8Tembec Financial Report 2011

---

Managements Discussion and Analysis

Segment Review  2011 vs. 2010

|FOREST PRODUCTS                      |  |      |    |  |      |   
|------------------------------------ |  | ---- | -- |  | ---- | --
|(in millions of dollars)             |  |      |    |  |      |   
|                                     |  | 2010 |    |  | 2011 |   
|Total sales                          |  | 434  |    |  | 471  |   
|Consolidated sales                   |  | 346  |    |  | 375  |   
|EBITDA                               |  | (10  | )  |  | (46  | ) 
|EBITDA margin on total sales         |  | (2.3 | )% |  | (9.8 | )%
|Depreciation and amortization        |  | 16   |    |  | 13   |   
|Other items                          |  | (2   | )  |  | 4    |   
|Operating loss                       |  | (24  | )  |  | (63  | ) 
|Identifiable assets (excluding cash) |  | 241  |    |  | 264  |   

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

The Forest Resource Management group is responsible for
managing all of the Companys Canadian forestry operations. This includes the
harvesting of timber, either directly or by contractual agreements, and all
silviculture and regeneration work required to ensure a sustainable supply for
the manufacturing units. The group is also responsible for third party timber
purchases, which are needed to supplement total requirements. The groups main
objective is the optimization of the flow of timber into various manufacturing
units. As the Companys forest activity in Canada is conducted primarily on
Crown lands, the Forest Resource Management group works closely with provincial
governments to ensure harvesting plans and operations comply with established
regulations and that stumpage charged by the provinces is reasonable and
reflects the fair value of the timber being harvested. During fiscal
2011, the Companys operations harvested and delivered 3.9 million cubic metres
of timber versus 3.2 million cubic metres in 2010. Additional supply of
approximately 0.9 million cubic metres was secured mainly through purchases and
exchanges with third parties, compared to 0.7 million cubic metres in the prior
year.

The Forest Products segment includes operations located in
Quebec, Ontario and British Columbia. The segment focuses on three main product
areas: SPF lumber, specialty wood and engineered wood. The SPF lumber operations
can produce approximately 1.6 billion board feet of lumber. The specialty wood
operations can annually produce 30 million board feet of hardwood lumber and 20
million square feet of hardwood flooring. The Companys engineered wood
operations consist of two finger joint lumber operations, which were idle for
all of fiscal 2010 and fiscal 2011.

Tembec Financial Report 2011 9

---

Managements Discussion and Analysis

The following summarizes the annual operating level or capacity
of each facility by product group:

|SPF
      LUMBER                                   |  | mbf                 | 
|-------------------------------------------------- |  | ------------------- | 
|Stud lumber - La Sarre, QC                         |  | 160,000             | 
|Stud lumber - Senneterre, QC                       |  | 150,000             | 
|Stud lumber - Cochrane, ON                         |  | 170,000             | 
|Stud lumber - Kapuskasing, ON                      |  | 105,000             | 
|Random lumber - Béarn, QC                          |  | 110,000             | 
|Random lumber - Chapleau, ON                       |  | 135,000             | 
|Random lumber - Timmins, ON                        |  | 100,000             | 
|Random lumber - Hearst, ON                         |  | 160,000             | 
|Random lumber - Canal Flats, BC
      (1)          |  | 180,000             | 
|Random lumber - Elko, BC (1)                       |  | 270,000             | 
|Finger joint lumber - Cranbrook, BC                |  | 25,000              | 
|                                                   |  | 1,565,000           | 
|                                                   |  |                     | 
|                                                   |  |                     | 
|SPECIALTY WOOD                                     |  | mbf                 | 
|Hardwood lumber - Huntsville, ON                   |  | 30,000              | 
|                                                   |  |                     | 
|                                                   |  |                     | 
|                                                   |  | thousand square ft. | 
|Flooring - Huntsville, ON / Toronto, ON            |  | 20,000              | 
|                                                   |  |                     | 
|                                                   |  |                     | 
|ENGINEERED WOOD                                    |  | mbf                 | 
|Engineered finger joint lumber - La Sarre, QC      |  | 60,000              | 
|Engineered finger joint lumber - Kirkland Lake, ON |  | 30,000              | 
|                                                   |  | 90,000              | 

(1) The Elko and Canal Flats sawmills rely on the Cranbrook
planer mill to dry and dress 80,000 mbf of lumber.

10Tembec Financial Report 2011

---

Managements Discussion and Analysis

The segment is dominated by SPF lumber, which represented 85%
of building material sales in fiscal 2011, compared to 83% in the prior year.
The volume of SPF lumber sold in fiscal 2011 increased by 121 million board feet
or 15%. Shipments were equal to 57% of capacity, up from 49% in fiscal 2010. In
response to very low lumber demand, the Company continued to reduce production
by curtailing operations at several facilities for either indefinite or
temporary periods. The split between Eastern/Western shipments was 62/38 as
compared to 56/44 a year ago. The Eastern sawmills produced more lumber in
fiscal 2011. US $ reference prices for random lumber were up by US $23 per mbf
while stud lumber decreased by US $1 per mbf. Currency more than offset the
increase in selling prices as the Canadian dollar averaged US $1.013, a 5.5%
increase from US $0.960 in fiscal 2010. The net result was a $12 per mbf price
decrease from a year ago.

Specialty wood represented 15% of building material sales in
fiscal 2011, down from 17% in the prior year. The decline was due to higher SPF
sales as absolute levels of specialty wood sales were relatively unchanged.
Prices were also unchanged year-over-year.

There were no engineered wood sales in fiscal 2011. The two
finger joint facilities were idle for all of fiscal 2010 and fiscal 2011.

The Forest Products segment produced and shipped approximately
1.1 million tonnes of wood chips in fiscal 2011, 85% of which were directed to
the Companys pulp and paper operations. In 2010, the segment produced 1.1
million tonnes and shipped 91% of this volume to the pulp and paper mills. The
internal transfer price of wood chips is based on current and expected market
transaction prices.

Total sales for this segment reached $471 million, an increase
of $37 million over the prior year. After eliminating internal sales, the Forest
Products segment generated 22% of Company consolidated sales, up from 18% in the
prior year. The segments main market is North America, which represented 94% of
consolidated sales in fiscal 2011, compared to 98% in the prior year.

Sales
    
    
    
    
    
    Shipments
    
    
    
    
    
    Selling prices($ millions)
    
    
    
    
    
    (000 units
    )
    
    
    
    
    ($ / unit)2010
    
    
    2011
    
    
    2010
    
    
    2011
    
    
    2010
    
    
    2011SPF
      lumber (mbf)
    
    255
    
    
    283
    
    
    786.8
    
    
    907.9
    
    
    324
    
    
    312Specialty woodPine and hardwood (mbf)
    
    6
    
    
    6
    
    
    9.4
    
    
    9.5
    
    
    638
    
    
    632Hardwood flooring (000 square ft)
    
    47
    
    
    45
    
    
    9.5
    
    
    9.1
    
    
    4,947
    
    
    4,94553
    
    
    51Engineered woodEngineered finger joint lumber (mbf)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total building materials
    
    308
    
    
    334Wood chips, logs and by-products
    
    126
    
    
    137Total sales
    
    434
    
    
    471Internal wood chips and other sales
    
    (88
    )
    
    (96
    )Consolidated sales
    
    346
    
    
    375


Tembec Financial Report 2011 11

---

Managements Discussion and Analysis

|QUARTERLY PRICES  WESTERN SPF MILL NET | QUARTERLY PRICES  EASTERN SPF DELIVERED
|--------------------------------------- | ----------------------------------------
|(US $ per mbf)                          | (US $ per mbf)                          
|                                        |                                         

MARKETS

The benchmark random length Western SPF (#2 and better) lumber
net price averaged US $263 per mbf in 2011, an increase from US $240 per mbf in
2010. In the East, the random length Eastern SPF average lumber price (delivered
Great Lakes) increased from US $327 per mbf to US $350 per mbf in 2011. The
Company considers these to be relatively low levels, approximately US $40 to US
$50 below normal trend line prices for random lumber. The reference price for
stud lumber decreased slightly with the Eastern average lumber price (delivered
Great Lakes) down from US $315 per mbf to US $314 per mbf, a level approximately
US $70 to US $80 per mbf below trend line prices. The low prices were driven by a very weak U.S. housing market. Housing starts in the U.S.,
on a seasonally adjusted basis, averaged 577,000 units in fiscal 2011, a
decrease over the 592,000 units in fiscal 2010. These remain well below the 2
million unit mark experienced in the 2004-2006 period and the +1.0 million
average that would be more indicative of normal market conditions. While the
Company recognized several years ago that U.S. housing starts could not maintain
the 2 million unit per year run rate, and that a degree of market correction
would likely occur at some point, the severity and extent of the correction had
not been anticipated. The negative effects of the sub-prime mortgage
difficulties, the latter having fuelled the strong demand in 2004-2006, have
been much greater in terms of impact and duration than originally foreseen.

12Tembec Financial Report 2011

---

Managements Discussion and Analysis

In addition to difficult market conditions, the Companys
financial performance continued to be impacted by export taxes on lumber shipped
to the U.S. Effective October 12, 2006, the governments of Canada and the United
States implemented an agreement for the settlement of the softwood lumber
dispute. The Softwood Lumber Agreement (SLA) requires that an export tax be
collected by the Government of Canada, which is based on the price and volume of
lumber shipped. Beginning on that date, the Companys Eastern Canadian sawmills,
located in Quebec and Ontario, were subject to export quota limitations and 5%
export tax on lumber shipped to the U.S. In April2009, the effective tax on
Eastern lumber shipments increased from 5% to 15% as a result of an arbitration
decision relating to alleged over-shipments of lumber between January2007 and
June2007. During fiscal2010, the Eastern Canadian sawmills export tax rate
declined to 10% in the month of June and returned to 15% in the month of August.
The SLA provides that during periods of relatively high prices, as was the case
during the early summer months, the export tax rate declines. In fiscal2010, the
average rate on all shipments to the U.S. was 14.1% and the total cost was
$4million. During fiscal2011, a second arbitration penalty of approximately 1%
was imposed on Eastern lumber shipments beginning in March2011. However, the
first arbitration penalty of 10% expired in June2011. Overall, the average rate
on all Eastern lumber shipments to the U.S. was 11.7% and the total cost was $6
million. The increase in cost was caused by higher shipments to the U.S., which
more than doubled year-over-year.

As to the Companys two Western sawmills, which are both
located in British Columbia, they are currently subject to a 15% export tax, but
shipments are not quota limited. Under certain circumstances, the tax may be
increased to 22.5%, which was not the case in either fiscal 2010 or fiscal 2011.
During fiscal 2010, the Western Canadian sawmills export tax rate declined to
0% in the month of June and returned to 15% in the month of August. Similarly to
what had occurred for the Eastern Canadian sawmills, higher prices led to the
reduction in the export tax rate. In fiscal 2010, the average rate on shipments
to the U.S. was 11.6% and the total cost was $6 million. During fiscal 2011, the
average rate on shipments to the U.S was 15% and the total cost was $7
million.

Tembec Financial Report 2011 13

---

Managements Discussion and Analysis

OPERATING RESULTS

The following summarizes EBITDA variances by major element:

Variance - favourable (unfavourable)Export
    
    
    Mill
    
    
    Inventory NRV(in
      millions of dollars)
    
    Price
    
    
    taxes
    
    
    costs
    
    
    adjustments
    
    
    Other
    
    
    TOTALSPF lumber
    
    (10
    )
    
    (3
    )
    
    (12
    )
    
    (10
    )
    
    1
    
    
    (34
    )Specialty wood
    
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    
    (1
    )Engineered wood
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other segment items
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    (1
    )(10
    )
    
    (3
    )
    
    (13
    )
    
    (10
    )
    
    
    
    
    (36
    )


In fiscal 2011, EBITDA was negative $46 million compared to
negative EBITDA of $10 million in the prior year. SPF lumber EBITDA declined by
$34 million. In addition to the previously noted decrease in selling prices and
higher export taxes on lumber shipped to the U.S., the sawmills absorbed
significantly higher cost of sales. Sawmill manufacturing costs increased by $11
million. The current year absorbed higher costs of $12 million, primarily for
timber. In the prior year, the segment had benefited from an $11 million
favourable adjustment to the carrying values of logs and lumber inventories
compared to a favourable adjustment of $1 million in the current year. Specialty
wood EBITDA decreased by $1 million due to higher costs. Engineered wood results
were unchanged as both plants remained idle for the entire year. The EBITDA
margin to total sales was negative 9.8% compared to negative 2.3% in the prior
year.

The following summarizes operating results variances by major
element:

|                               |  |      |   |  |      |   |  | Variance       |  
|------------------------------ |  | ---- | - |  | ---- | - |  | -------------- | -
|                               |  |      |   |  |      |   |  | favourable     |  
|(in
      millions of dollars) |  | 2010 |   |  | 2011 |   |  | (unfavourable) |  
|EBITDA                         |  | (10  | ) |  | (46  | ) |  | (36            | )
|Depreciation and amortization  |  | 16   |   |  | 13   |   |  | 3              |  
|Other items                    |  | (2   | ) |  | 4    |   |  | (6             | )
|Operating loss                 |  | (24  | ) |  | (63  | ) |  | (39            | )

The Forest Products segment generated an operating loss of $63
million in fiscal 2011, compared to an operating loss of $24million in fiscal
2010. Depreciation expense continued to trend downwards primarily as a result of
relatively low fixed asset additions. In view of operating rates that are
approximately 50%, capital expenditures have only averaged $8million per year
over the last three years. The segments current year results include a charge
of $3 million relating to the permanent closure of the Taschereau, Quebec, SPF
sawmill. It also includes a charge of $1 million related to severance payments
at the idled planer facility in Cranbrook, British Columbia. The prior year
included a $2million gain related to land sales.

14Tembec Financial Report 2011

---

Managements Discussion and Analysis

|DISSOLVING AND
      CHEMICAL PULP         |  |       |   |  |       | 
|------------------------------------------ |  | ----- | - |  | ----- | 
|(in millions of dollars)                   |  |       |   |  |       | 
|                                           |  | 2010  |   |  | 2011  | 
|Total sales - Pulp                         |  | 737   |   |  | 600   | 
|Total sales -
      Chemicals              |  | 93    |   |  | 93    | 
|Total sales                                |  | 830   |   |  | 693   | 
|Consolidated sales                         |  | 816   |   |  | 681   | 
|EBITDA                                     |  | 120   |   |  | 138   | 
|EBITDA margin on
      total sales         |  | 14.4% |   |  | 19.9% | 
|Depreciation and amortization              |  | 27    |   |  | 18    | 
|Other items                                |  | (12   | ) |  |      | 
|Operating earnings                         |  | 105   |   |  | 120   | 
|Identifiable
      assets (excluding cash) |  | 444   |   |  | 437   | 

The Dissolving and Chemical Pulp segment consists of three
market pulp manufacturing facilities. The facilities are divided into two main
types. Two dissolving pulp mills produce specialty and commodity dissolving
pulps. The remaining facility produces chemical softwood kraft paper pulp
(NBSK). During fiscal 2010, the Company also owned two kraft paper pulp mills
located in Southern France. The two pulp mills, with an annual capacity of
565,000 tonnes, were sold in May 2010.

The two dissolving pulp mills can produce approximately 310,000
tonnes per year. The softwood kraft mill has an annual capacity of 270,000
tonnes. The specialty dissolving pulp produced at the two dissolving pulp mills
is a high purity cellulose utilized in a wide variety of specialized products
such as pharmaceuticals, food additives, and industrial chemicals. T he
Temiscaming dissolving pulp mill also produces commodity dissolving pulp,
which is utilized in the production of viscose staple fibre, which in turn is
used to produce rayon for the textile industry. The Tartas mill also produced
specialized fluff pulp, which is utilized in the production of sanitary
products. The production of specialized fluff pulp was discontinued in September
2011.

The two dissolving pulp mills generate lignin as a by-product
of the sulphite process, which is sold to third parties. The Temiscaming mill
also includes a facility that produces ethanol as a by-product that is also sold
to third parties.

The segment also includes a stand-alone resin business, which
produces powder and liquid phenolic resins at three operating sites in Quebec:
Temiscaming, Longueuil, and Trois-Pistoles. The Company also operates a fourth
facility located in Toledo, Ohio, which manufactures powder and liquid
amino-resins. The chemical business also purchases and resells pulp mill
by-product chemicals from third parties.

The following summarizes the annual operating level or capacity
of each facility:

|DISSOLVING PULP                                  | tonnes 
|------------------------------------------------ | -------
|Specialty and commodity dissolving pulp          |        
|- Temiscaming, QC                                | 160,000
|Specialty
      dissolving pulp - Tartas, France | 150,000
|                                                 | 310,000
|                                                 |        
|SOFTWOOD KRAFT
      PULP                        |        
|Softwood kraft -
      Skookumchuck, BC          | 270,000
|                                                 |        
|CHEMICALS                                        |        
|Resin and related products                       | 170,000
|Lignin                                           | 190,000
|Ethanol (million
      litres)                   | 12.1   

Tembec Financial Report 2011 15

---

Managements Discussion and Analysis

Dissolving pulp shipments represented 53% of segment shipments
in fiscal 2011, compared to 35% in the prior year. The increase in percentage
was not due to higher shipments, but rather to a decline in chemical paper pulp
shipments as a result of the sale of two kraft pulp mills. Dissolving pulp sales
as a percentage of total segment pulp sales increased from 48% to 68% due to
previously noted shipment impact and significant price increase.

Chemical paper pulp represented 47% of segment shipments in
fiscal 2011, compared to 65% in the prior year. The volume of chemical paper
pulp shipped in fiscal 2011 declined by 278,700 tonnes. In May 2010, the Company
completed the sale of two kraft pulp mills and related operations located in
Southern France. In the prior fiscal year, the two mills had shipped 272,500
tonnes of pulp, generating sales of $191million and EBITDA of $19 million.

Total 2011 pulp shipments of 507,300 tonnes include 15,300
tonnes of softwood kraft pulp consumed by the Companys paperboard operations as
compared to 17,700 tonnes in the prior year.

Total sales for the Dissolving and Chemical Pulp segment were
$693 million, a decrease of $137 million from the prior year. After eliminating
internal sales, the Dissolving and Chemical Pulp segment generated 39% of
Company consolidated sales, down from 43% in the prior year. The Dissolving and
Chemical Pulp segment is a global business. In 2011, 64% of consolidated pulp
sales were generated outside of Canada and the U.S., as compared to 66% in the
prior year.

Sales
    
    
    
    
    
    Shipments
    
    
    
    
    
    Selling prices($ millions)
    
    
    
    
    
    (000 units
    )
    
    
    
    
    ($ / unit)2010
    
    
    2011
    
    
    2010
    
    
    2011
    
    
    2010
    
    
    2011Dissolving pulpsSpecialty dissolving (tonnes)
    
    238
    
    
    311
    
    
    189.2
    
    
    209.5
    
    
    1,258
    
    
    1,484Commodity dissolving (tonnes)
    
    83
    
    
    85
    
    
    62.1
    
    
    52.4
    
    
    1,337
    
    
    1,622Specialty fluff (tonnes)
    
    28
    
    
    9
    
    
    35.1
    
    
    8.1
    
    
    798
    
    
    1,111349
    
    
    405
    
    
    286.4
    
    
    270.0Chemical paper pulpsSoftwood kraft (tonnes)
    
    293
    
    
    195
    
    
    381.4
    
    
    237.3
    
    
    768
    
    
    822Hardwood kraft (tonnes)
    
    91
    
    
    
    
    
    134.6
    
    
    
    
    
    676
    
    
    384
    
    
    195
    
    
    516.0
    
    
    237.3Total dissolving and chemical pulp sales
    
    733
    
    
    600
    
    
    802.4
    
    
    507.3ChemicalsResin and related products (tonnes)
    
    54
    
    
    55
    
    
    58.8
    
    
    55.2
    
    
    918
    
    
    996Lignin (tonnes)
    
    30
    
    
    29
    
    
    123.3
    
    
    131.5
    
    
    243
    
    
    221Ethanol (000 litres)
    
    8
    
    
    7
    
    
    9.9
    
    
    8.9
    
    
    808
    
    
    78792
    
    
    91Other sales
    
    5
    
    
    2Total sales
    
    830
    
    
    693Internal pulp sales
    
    (14
    )
    
    (12
    )
    
    (17.7
    )
    
    (15.3
    )Consolidated sales
    
    816
    
    
    681


16Tembec Financial Report 2011

---

Managements Discussion and Analysis

MARKETS

The Company markets its pulp on a world-wide basis, primarily
through its own sales force. Sales offices are maintained in Toronto, Canada;
Dax, France; and Beijing, China.

The shipments to capacity ratio for dissolving pulp was at 87%
in fiscal 2011 versus 89% in the prior year. These are relatively high
percentages, which reflect strong demand and favourable market conditions. The
decrease in shipment ratio was due to a decrease of 16,400 tonnes in dissolving
pulp shipments. This was due to the Companys objective of focusing on
specialty or higher purity dissolving pulps and reducing its exposure to
commodity and fluff pulps. Specialty dissolving pulps have a lesser yield, which
in turn reduces the production capacity of the two mills. During fiscal 2010 and
2011, both mills operated at full rates and no downtime was taken for market
conditions. The strong market conditions led to higher US dollar and euro
prices, which more than offset the negative currency impact of a weaker US
dollar. Pricing for specialty dissolving increased by $226 per tonne, commodity
grade dissolving increased by $285 per tonne and specialty fluff increased by
$313 per tonne on average. The favourable market conditions also kept inventory
levels of finished pulp below 30 days for most of the year and ending fiscal
2011 at only 22 days of supply.

The shipments to capacity ratio for chemical paper pulp was 88%
in fiscal 2011 versus 84% in the prior year. The 88% level is also reflective of
favourable market conditions, as the mill operated at full capacity and no
downtime was taken for market conditions. The strong market led to higher US
dollar prices as the benchmark NBSK pulp price (delivered U.S.) increased by US
$66 per tonne and the benchmark NBSK pulp price (delivered China) increased by
US $77 per tonne. This more than offset the negative impact of the weaker US
dollar and prices increased by $27 per tonne year-over-year. The $54 per tonne
increase for softwood kraft shown in the table includes a positive mix variance
as fiscal 2011 no longer includes sales from the French mills, which had
traditionally sold their pulp for less than the Skookumchuck mill. The
favourable market conditions also kept inventory levels of finished pulp below
20days for most of the year. Fiscal 2011 inventory of NBSK ended the year at
only six days, as year-end coincided with the annual maintenance shutdown. This
level does not allow for effective customer service and will need to be
increased in the first quarter of fiscal 2012.

|QUARTERLY PRICES  DISSOLVING PULP | QUARTERLY PRICES  NBSK
|---------------------------------- | -----------------------
|(US $ per tonne)                   | (US $ per tonne)       
|                                   |                        

Tembec Financial Report 2011 17

---

Managements Discussion and Analysis

OPERATING RESULTS

The following summarizes EBITDA variances by major element:

Variance - favourable (unfavourable)ForeignInventory
    
    
    exchangeMill
    
    
    NRV
    
    
    impact(in millions of dollars)
    
    Price
    
    
    Freight
    
    
    costs
    
    
    adjustments
    
    
    on costs
    
    
    Other
    
    
    TOTALDissolving pulps
    
    66
    
    
    (1
    )
    
    (33
    )
    
    2
    
    
    3
    
    
    4
    
    
    41Chemical paper pulps
    
    6
    
    
    (3
    )
    
    
    
    
    (1
    )
    
    
    
    
    (3
    )
    
    (1
    )Chemicals
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )Other segment costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21
    )
    
    (21
    )71
    
    
    (4
    )
    
    (33
    )
    
    1
    
    
    3
    
    
    (20
    )
    
    18


Fiscal 2011 EBITDA was $138 million compared to $120million in
the prior year. The previously noted increases in pulp selling prices increased
EBITDA by $72 million. Higher freight and shipping costs reduced EBITDA by $4
million. Manufacturing costs at the two dissolving pulp mills increased by
$33million. Higher fibre, chemicals and supplies costs caused the majority of
the increase. The mills produced more specialty dissolving pulp grades, which
have lower yields and are more costly to produce. Costs were also impacted by an
increase in maintenance downtime. During fiscal 2011, the three pulp mills
incurred 30,200 tonnes of maintenance downtime compared to 14,100 tonnes in the
prior year. The translation of the euro costs of the French dissolving pulp mill
decreased the Canadian dollar equivalent costs by $3 million. The $21million
unfavourable variance in the Other category relates to the sale of two kraft
pulp mills and related operations located in Southern France. The mills were
sold part way through the prior year and had contributed $19 million to fiscal
2010 reported EBITDA.

The two North American pulp mills purchased approximately
845,000 bone dry tonnes of wood chips in fiscal 2011, down from 873,000 in the
prior year. Of this amount, approximately 67% was supplied by the Forest
Products segment, compared to 69% in the prior year. The remaining requirements
were purchased from third parties under contracts and agreements of various
durations. The pulp mill located in Southern France purchased 308,000 bone dry
tonnes of wood in fiscal 2011 as compared to 307,000 tonnes in the prior year.
The fibre is sourced from many private landowners.

Overall, higher pr ices were partially offset by higher
manufacturing costs, which led to EBITDA margins of 19.9% compared to 14.4% in
the prior year.

The following summarizes operating results variances by major
element:

|                               |  |      |   |  |      |  |  | Variance       |  
|------------------------------ |  | ---- | - |  | ---- |  |  | -------------- | -
|                               |  |      |   |  |      |  |  | favourable     |  
|(in
      millions of dollars) |  | 2010 |   |  | 2011 |  |  | (unfavourable) |  
|EBITDA                         |  | 120  |   |  | 138  |  |  | 18             |  
|Depreciation and amortization  |  | 27   |   |  | 18   |  |  | 9              |  
|Other items                    |  | (12  | ) |  |     |  |  | (12            | )
|Operating earnings             |  | 105  |   |  | 120  |  |  | 15             |  

The Dissolving and Chemical Pulp segment generated operating
earnings of $120 million during the most recently completed fiscal year,
compared to operating earnings of $105 million in the prior year. In addition to
the previously noted increase in EBITDA, the segment depreciation expense
declined by $9 million. The sale of two pulp mills located in Southern France in
May 2010 accounted for a significant portion of the decline in depreciation
expense. In the prior year, the Company had recorded a gain of $12 million
related to the sale of the aforementioned pulp mills.

18Tembec Financial Report 2011

---

Managements Discussion and Analysis

|HIGH-YIELD
      PULP                      |  |       |  |  |      |   
|------------------------------------------ |  | ----- |  |  | ---- | --
|(in millions of dollars)                   |  |       |  |  |      |   
|                                           |  | 2010  |  |  | 2011 |   
|Total sales                                |  | 395   |  |  | 378  |   
|Consolidated sales                         |  | 367   |  |  | 348  |   
|EBITDA                                     |  | 47    |  |  | (4   | ) 
|EBITDA margin on
      total sales         |  | 11.9% |  |  | (1.1 | )%
|Depreciation and
      amortization        |  | 10    |  |  | 10   |   
|Operating earnings
      (loss)            |  | 37    |  |  | (14  | ) 
|Identifiable
      assets (excluding cash) |  | 213   |  |  | 174  |   

The High-Yield Pulp segment consists of three market pulp
manufacturing facilities. High-yield pulps are produced with a combination of
mechanical and chemical processes. The Company produces hardwood grades made
from maple, aspen and birch. High-yield pulps have a lower tensile and tear
strength than kraft pulps, but they offer advantages on bulk and opacity. They
compete against other hardwood or short fibre grades, with Bleached Eucalyptus
Kraft (BEK) being the most prominent.

The following summarizes the annual operating level or capacity
of each facility:

|HIGH-YIELD PULP                          |  | tonnes  | 
|---------------------------------------- |  | ------- | 
|Hardwood high-yield - Temiscaming, QC    |  | 315,000 | 
|Hardwood high-yield - Matane, QC         |  | 250,000 | 
|Hardwood
      high-yield - Chetwynd, BC |  | 240,000 | 
|TOTAL                                    |  | 805,000 | 

Total 2011 shipments of 664,300 tonnes include 57,500 tonnes of
high-yield pulp consumed by the Companys paperboard operations as compared to
56,700 tonnes in the prior year.

Total sales for the High-Yield Pulp segment were $378 million,
a decrease of $17 million from the prior year. After eliminating internal sales,
the High-Yield Pulp segment generated 20% of Company consolidated sales,
unchanged from the prior year. The High-Yield Pulp segment is more export
oriented than the other business segments within the Company. In 2011, 99% of
consolidated pulp sales were generated outside of Canada and the U.S., as
compared to 98% in the prior year. China alone accounted for 49% of sales
compared to 57% in the prior year.

Sales
    
    
    
    
    
    Shipments
    
    
    
    
    
    Selling prices($ millions)
    
    
    
    
    
    (000 units
    )
    
    
    
    
    ($ / unit)2010
    
    
    2011
    
    
    2010
    
    
    2011
    
    
    2010
    
    
    2011Hardwood high-yield
    
    395
    
    
    378
    
    
    615.6
    
    
    664.3
    
    
    642
    
    
    569Internal sales
    
    (28
    )
    
    (30
    )
    
    (56.7
    )
    
    (57.5
    )
    
    494
    
    
    522Consolidated sales
    
    367
    
    
    348
    
    
    558.9
    
    
    606.8
    
    
    657
    
    
    573


Tembec Financial Report 2011 19

---

Managements Discussion and Analysis

MARKETS

The Company markets its pulp on a world-wide basis, primarily
through its own sales force. Sales offices are maintained in Toronto, Canada;
Dax, France; and Beijing, China.

The shipments to capacity ratio for high-yield pulp was at 83%
versus 76% in the prior year. These are relatively low percentages, which are
not indicative of a strong market. Fiscal2010 began with weak prices and demand.
As a result, the Company idled the Chetwynd mill for 110 days, resulting in
67,200 tonnes of market downtime. The mill was restarted in January 2010 as
demand and pricing were on an upturn. By summer, prices were more than $100 per
tonne higher than at the beginning of the fiscal year. The average selling price
for third party sales was $657 per tonne. Inventory levels of finished goods
ended the prior fiscal year at 26 days, indicative of a relatively balanced
market. However, as fiscal 2011 began, new high-yield pulp capacity was started
in China, which had a negative impact on the market in terms of pricing. The
effect was grade specific to high-yield pulp as other hardwood grades, such as
BEK, were not as severely impacted. As the fiscal year progressed, prices
continued to decline, compounded by a stronger Canadian dollar, which averaged
US $1.013 in fiscal2011, a 5.5% increase versus the prior year. The combined
effect reduced prices by approximately $100 per tonne during the fiscal year.
The average selling price for third party sales was $573 per tonne, a decrease
of $84 per tonne from the prior year average. Inventory levels ended the year at
15days of supply. The abnormally low level of inventory was related to a labour
strike that occurred at the Matane mill in the second half of fiscal 2011. The
impact of the strike is analysed in the section that follows.

QUARTERLY PRICES  HIGH-YIELD(US $ per
tonne)



20Tembec Financial Report 2011

---

Managements Discussion and Analysis

OPERATING RESULTS

The following summarizes EBITDA variances by major element:

Variance - favourable (unfavourable)InventoryMix &
    
    
    Freight
    
    
    Mill
    
    
    NRV(in
      millions of dollars)
    
    Price
    
    
    volume
    
    
    and SGA
    
    
    costs
    
    
    adjustments
    
    
    Other
    
    
    TOTALHigh-yield pulps
    
    (53
    )
    
    (6
    )
    
    5
    
    
    5
    
    
    (4
    )
    
    2
    
    
    (51
    )


Fiscal 2011 EBITDA was negative $4 million compared to positive
$47million in the prior year. The previously noted decrease in pulp selling
prices decreased EBITDA by $53million. While costs were relatively unchanged
across the combined three mills, there were significant variances at individual
mills. At Chetwynd, the mill had experienced significant downtime in the prior
year. In addition to the previously noted 110-day market curtailment, the mill
lost 29days in June2010 related to a fire at the mill site. In fiscal2011, the
mill experienced full operations and production increased by 85,600 tonnes.
Cost of manufacturing improved by $18 million year-over-year. The opposite
effect occurred at the Matane mill. In the prior year, the mill had experienced
fulloperations. In the most recent year, a labour strike began in May 2011 and
resulted in 127days of downtime before the mill resumed operations in
mid-September 2011. The mill produced 102,200tonnes less than in the prior year
and its costs increased by $12 million.

The three pulp mills purchased approximately 682,800 bone dry
tonnes of wood chips in fiscal 2011, up from 621,100 in the prior year. Of this
amount, approximately 19% was supplied by the Forest Products segment, compared
to 14% in the prior year. The remaining requirements were purchased from third
parties under contracts and agreements of various durations.

Overall, lower prices reduced profitability with a negative
EBITDA margin of 1.1% compared to a positive margin of 11.9% in the prior
year.

The following summarizes operating results variances by major
element: Variance

|                               |  |      |  |  |      |   |  | favourable     |  
|------------------------------ |  | ---- |  |  | ---- | - |  | -------------- | -
|(in
      millions of dollars) |  | 2010 |  |  | 2011 |   |  | (unfavourable) |  
|EBITDA                         |  | 47   |  |  | (4   | ) |  | (51            | )
|Depreciation and amortization  |  | 10   |  |  | 10   |   |  |               |  
|Operating earnings (loss)      |  | 37   |  |  | (14  | ) |  | (51            | )

The High-Yield Pulp segment generated an operating loss of $14
million during the most recently completed fiscal year, compared to operating
earnings of $37 million in the prior year. The previously noted decrease in
EBITDA led to the weaker operating results.

Tembec Financial Report 2011 21

---

Managements Discussion and Analysis

|PAPER                                |  |      |    |  |      | 
|------------------------------------ |  | ---- | -- |  | ---- | 
|(in millions of dollars)             |  |      |    |  |      | 
|                                     |  | 2010 |    |  | 2011 | 
|Consolidated sales                   |  | 348  |    |  | 339  | 
|EBITDA                               |  | (2   | )  |  | 28   | 
|EBITDA margin                        |  | (0.6 | )% |  | 8.3% | 
|Depreciation and amortization        |  | 3    |    |  | 3    | 
|Other items                          |  | 7    |    |  |     | 
|Operating earnings (loss)            |  | (12  | )  |  | 25   | 
|Identifiable assets (excluding cash) |  | 123  |    |  | 119  | 

The Paper segment currently includes two paper manufacturing
facilities with a total of three paper machines. The mill located in
Kapuskasing, Ontario, produces newsprint on two machines. The facility located
in Temiscaming, Quebec, produces multiply coated bleached board on one machine.
The board mill is partially integrated with a high-yield pulp mill and also
consumes pulp manufactured by the Company at its British Columbia paper pulp
mill. In late fiscal2010, the Company announced the permanent closure of the
Pine Falls, Manitoba, newsprint mill, removing 185,000tonnes of newsprint
capacity. A third newsprint machine at the Kapuskasing mill with an annual
capacity of 90,000tonnes has been idle for several years and is no longer
included in the capacity figures. The total capacity of the Paper segment is now
420,000tonnes. Prior to April2010, the Paper segment also included the financial
results of a hydro-electric dam located in Smooth Rock Falls, Ontario. The dam
was sold on March 29, 2011.

The following summarizes the products and operating level or
capacity of each facility:

|COATED BLEACHED BOARD |  | tonnes  | 
|--------------------- |  | ------- | 
|Temiscaming, QC       |  | 180,000 | 
|                      |  |         | 
|NEWSPRINT             |  |         | 
|Kapuskasing, ON       |  | 240,000 | 
|                      |  |         | 
|TOTAL                 |  | 420,000 | 

Coated bleached board shipments represented 42% of Paper
segment shipments in fiscal 2011, unchanged from the prior year. As a percentage
of total segment sales, coated bleached board represented 57% of sales compared
to 59% in the prior year.

Newsprint shipments represented 58% of Paper segment shipments
in fiscal 2011, unchanged from the prior year. In terms of total segment sales,
newsprint represented 42% of sales compared to 40% in the prior year.

Sales for the Paper segment totalled $339 million, as compared
to $348 million in the prior year. The segment generated 19% of Company
consolidated sales, the same as in fiscal 2010. The focus of the paper business
is North America, which accounted for 92% of consolidated sales in 2011,
compared to 95% in the prior year. The U.S. alone accounted for 74% of sales in
fiscal 2011, unchanged from the prior year.

22Tembec Financial Report 2011

---

Managements Discussion and Analysis

Sales
    
    
    
    
    
    Shipments
    
    
    
    
    
    Selling prices($ millions)
    
    
    
    
    
    (000 units
    )
    
    
    
    
    ($ / unit)2010
    
    
    2011
    
    
    2010
    
    
    2011
    
    
    2010
    
    
    2011Coated bleached board (rolls and sheets)
    
    204
    
    
    194
    
    
    173.0
    
    
    165.2
    
    
    1,179
    
    
    1,174Newsprint
    
    141
    
    
    143
    
    
    236.0
    
    
    228.5
    
    
    597
    
    
    626Electricity sales
    
    3
    
    
    2Consolidated sales
    
    348
    
    
    339
    
    
    409.0
    
    
    393.7


MARKETS

The benchmark for coated bleached board (16 point) averaged US
$1,150 per short ton in fiscal 2011, a US $98 per short ton increase over the
prior year. A favourable pricing trend was supported by good market demand. The
benchmark began the year at US $1,110 per short ton. It increased to US $1,150
in October 2010 and remained at that level for the next 12months. The shipments
to capacity ratio for coated bleached board was 92% in fiscal 2011 compared to
96% in the prior year. These high percentages reflect the very strong market
fundamentals of the North American coated bleached board market over the last
two years. The small decrease in ratio was due to inventory reduction in the
prior year as production volumes cannot sustain a ratio above 95%. The board
mill operated at full capacity in both fiscal 2010 and fiscal 2011, with no
market downtime taken in either year. While US $ reference prices increased, the
impact was offset by the negative currency impact of the stronger Canadian
dollar. As a result, Canadian dollar prices were relatively unchanged
year-over-year. Inventory levels at year-end were at 52 days. This is a normal
level given the product sales mix, which includes both rolls and sheets.

The benchmark newsprint grade (48.8 gram  East Coast) averaged
US $640 per tonne in fiscal 2011, a US $67 per tonne increase over the prior year. The increase was due to
improved pricing that occurred in the latter half of fiscal 2010. The benchmark
began the current year at US $638 per tonne. It increased to US $640 per tonne
in October 2010 and remained at that level for the next 12 months. The shipments
to capacity ratio for newsprint was 69% as compared to 46% in the prior year.
The increase in the ratio was not due to increased shipments as they declined by
7,500 tonnes year-over-year. It was caused by a 185,000 tonnes capacity
reduction related to the permanent closure of the Pine Falls newsprint mill that
was announced at the end of the prior fiscal year. The relatively low ratios are
a reflection of the relatively weak North American newsprint market. In response
to continued declines in demand, the Company continued to curtail production. A
newsprint machine at the Kapuskasing mill remained idle for the entire year,
removing approximately 91,000tonnes of production. This compares to 273,000
tonnes in the prior year, which included the same machine in Kapuskasing and the
entire capacity of the idled mill in Pine Falls, which was removed from the
current year figures as a result of its closure. While US $ reference prices
increased by US $67 per tonne, the impact was partially offset by the negative
impact of the stronger Canadian dollar. As a result, Canadian dollar prices
increased by $29 per tonne. Inventory levels at year-end were at 14 days, a
normal level for the newsprint mill.

|QUARTERLY PRICES  COATED BLEACHED BOARD | QUARTERLY PRICES  NEWSPRINT
|---------------------------------------- | ----------------------------
|(US $ per short ton)                     | (US $ per tonne)            
|                                         |                             

Tembec Financial Report 2011 23

---

Managements Discussion and Analysis

OPERATING RESULTS

The following summarizes EBITDA variances by major element:

Variance - favourable (unfavourable)InventoryMill
    
    
    Mix &
    
    
    NRV(in millions of
      dollars)
    
    Price
    
    
    costs
    
    
    volume
    
    
    adjustments
    
    
    Other
    
    
    TOTALCoated bleached board
    
    -
    
    
    (1
    )
    
    (3
    )
    
    
    
    
    1
    
    
    (3
    )Newsprint
    
    6
    
    
    17
    
    
    
    
    
    (2
    )
    
    1
    
    
    22Other segment
      items
    
    -
    
    
    
    
    
    
    
    
    
    
    
    11
    
    
    116
    
    
    16
    
    
    (3
    )
    
    (2
    )
    
    13
    
    
    30


Fiscal 2011 EBITDA was $28 million compared to negative $2
million in the prior year. Higher newsprint prices increased EBITDA by $6
million. Manufacturing costs at the newsprint mill also declined by $17 million,
primarily as a result of lower energy costs. The operation benefited from lower
electricity costs as new industrial user rates were implemented at the beginning
of the 2011 calendar year. The favourable $11 million variance in other segment
items relates to the permanent closure of the Pine Falls newsprint mill, which
had negative EBITDA of $11 million in the prior year. Custodial and legacy costs
for the facility were $3 million in fiscal 2011 and were included in the
Corporate segment.

The coated bleached board mill utilizes a combination of
chemical kraft and high-yield pulps to produce a three-ply sheet. During fiscal
2011, the mill utilized 15,300 tonnes of NBSK supplied by the Companys
Skookumchuck pulp mill as compared to 17,700 tonnes in the prior year. The mill
also consumed 57,500 tonnes of high-yield pulp supplied by the Temiscaming mill
versus 56,700 tonnes in fiscal 2010. The balance of pulp requirements is
purchased from third parties.

The newsprint mill utilizes virgin fibre, primarily in the form
of wood chips. During fiscal 2011, the operations purchased 257,400 bone dry
tonnes of virgin fibre, of which approximately 81% was internally sourced. In
the prior year, 244,200 bone dry tonnes of virgin fibre were purchased, with 68%
being sourced internally.

Overall, the higher news print prices and the lower costs
increased EBITDA margins from negative 0.6% to positive 8.3%.

The following summarizes operating results variances by major
element:

|                               |  |      |   |  |      |  |  | Variance       | 
|------------------------------ |  | ---- | - |  | ---- |  |  | -------------- | 
|                               |  |      |   |  |      |  |  | favourable     | 
|(in
      millions of dollars) |  | 2010 |   |  | 2011 |  |  | (unfavourable) | 
|EBITDA                         |  | (2   | ) |  | 28   |  |  | 30             | 
|Depreciation and amortization  |  | 3    |   |  | 3    |  |  |               | 
|Other items                    |  | 7    |   |  |     |  |  | 7              | 
|Operating earnings (loss)      |  | (12  | ) |  | 25   |  |  | 37             | 

The Paper segment generated operating earnings of $25 million
compared to an operating loss of $12 million in the prior year. In addition to
the previously noted improvement in EBITDA, the segment was impacted by other
items. In the prior year, the Company had absorbed a charge of $7 million
related to the permanent closure of the Pine Falls newsprint mill.

24Tembec Financial Report 2011

---

Managements Discussion and Analysis

|CORPORATE                           |  |      |  |  |      |  
|----------------------------------- |  | ---- |  |  | ---- | -
|(in millions of dollars)            |  |      |  |  |      |  
|                                    |  | 2010 |  |  | 2011 |  
|General and administrative expenses |  | 21   |  |  | 19   |  
|Share-based compensation            |  | 2    |  |  | 2    |  
|Other items                         |  | 20   |  |  | (3   | )
|Depreciation and amortization       |  |     |  |  | 1    |  
|Operating expenses                  |  | 43   |  |  | 19   |  

The Company incurred a $2 million share-based compensation
expense in the current year, unchanged from the prior year. The expense relates
to two long-term incentive programs maintained by the Company. Senior executives
participate in a Performance Conditioned Restricted Share Unit (PCRSU) plan.
The PCRSUs have a defined vesting period and performance conditions that will
ultimately determine the amount of PCRSUs that will vest and be paid to
participating employees. Non-executive members of the Board of Directors receive
a portion of their fees in the form of Deferred Share Units (DSU). The DSUs
vest at specified dates. Details regarding both of these plans can be found in
note 9 of the 2011 annual audited financial statements and in the Management
Information Circular. The period expense for these two plans consists of normal
periodic variation in the number of units based on anticipated or normal
vesting, but is also impacted by the changes in the value of the Companys share
price, as the PCRSUs and DSUs have the same value as one common share.

The Corporate segments other items include expenses relating
to several permanently idled facilities. The costs include legal costs, site
security and custodial. These legacy costs totalled $8 million in fiscal 2011,
unchanged from the prior year. The current year other items also includes a
gain of $8million related to the filing of Tembec USA LLC under Chapter 7 of the
Bankruptcy Code of the United States. The Company reduced its accrued benefit
obligation by this amount. It also includes a $3 million gain related to the
sale of its hydro-electric generating facilities located in Smooth Rock Falls,
Ontario. The prior year included a non-recurring charge of $12 million relating
to the St. Francisville, Louisiana, coated paper mill. The mill property and
equipment were sold in April 2009. A portion of the consideration included two
US $5 million interest-bearing notes. In January 2010, the purchaser filed for
protection under the U.S. Bankruptcy Code. Subsequently, the assets were sold at
auction. Based on the amount of the winning bid, it was unlikely that the
Company would recover any portion of the interest-bearing notes. As a result,
the Company recorded a charge of $12 million. The aforementioned amount included
accrued interest as well as certain other unsecured claims.

Tembec Financial Report 2011 25

---

Managements Discussion and Analysis

Non-operating Items

|INTEREST, FOREIGN EXCHANGE AND OTHER |  |      |  |  |      |  
|------------------------------------ |  | ---- |  |  | ---- | -
|(in millions of dollars)             |  |      |  |  |      |  
|                                     |  | 2010 |  |  | 2011 |  
|Interest on indebtedness             |  | 30   |  |  | 32   |  
|Fees - new working capital facility  |  |     |  |  | 2    |  
|Debt prepayment premium              |  | 6    |  |  |     |  
|Foreign exchange items               |  | 14   |  |  | (1   | )
|Bank
      charges and other         |  | 2    |  |  | (1   | )
|                                     |  | 52   |  |  | 32   |  

There were no significant interest variances. The major portion
of the prior year interest on debt related to a US $300 million term loan. This
credit facility was repaid in August 2010. The Company incurred a $6 million
debt prepayment premium. The Company issued US $255 million of senior secured
notes maturing in December 2018. In March 2011, the Company entered into a new
working capital facility and incurred $2million in expenses. Foreign exchange
items relate primarily to gains or losses on the translation of US $ net
monetary assets. When the Canadian dollar strengthens versus the US dollar, as
was the case during the prior year, losses are generated.

|TRANSLATION OF FOREIGN DEBT
|---------------------------

During fiscal 2011, the Company recorded a loss of $1 million
on the translation of its US $ denominated debt as the relative value of the
Canadian dollar decreased from US $0.975 to US $0.971. There was no gain or loss
on the translation of euro-denominated debt as the value of the euro versus the
Canadian dollar was relatively unchanged.

During fiscal 2010, the Company recorded a gain of $19 million
on the translation of its US $ denominated debt as the relative value of the
Canadian dollar increased from US $0.916 to US$0.975. The Company recorded a
gain of $8 million on the translation of its euro-denominated debt as the
relative value of the euro versus the Canadian dollar decreased from C $1.602 to
C $1.384.

|INCOME TAXES
|------------

During fiscal 2011, the Company recorded an income tax expense
of $19 million on earnings before income taxes and non-controlling interest of
$16 million. The income tax expense reflected a $15 million unfavourable
variance versus an anticipated tax expense of $4 million based on the Companys
effective tax rate of 27.8%. The current year absorbed an $11million unfavourable change in valuation allowance. Based on past financial performance,
future income tax assets of the Companys Canadian operations have not been
recognized as it has not been determined that the future realization of these
assets is more likely than not to occur.

During fiscal 2010, the Company recorded an income tax recovery
of $15 million on earnings before income taxes and non-controlling interest of
$39 million. This income tax recovery reflected a $27 million favourable
variance versus an anticipated income tax expense of $12 million based on the
Companys effective tax rate of 29.8%. The change in valuation allowance
increased the recovery by $20 million. The most significant item included in the
above was a $19 million favourable adjustment relating to the recognition of
future tax assets of the Companys remaining operations in France as it was
determined that the future realization of these assets was more likely than
not to occur. The non-taxable portion of the gain on consolidation of foreign
integrated subsidiaries increased the income tax recovery by $10 million.

26Tembec Financial Report 2011

---

Managements Discussion and Analysis

Net Earnings (Loss)

The Company generated a net loss of $3 million or $0.03 per
share for the year ended September 24, 2011, compared to net earnings of $52
million or $0.52 per share for the year ended September 25, 2010. As noted
previously, the Companys financial results were impacted by certain specific
items. The following table summarizes the impact of these items on the reported
financial results. The Company believes it is useful supplemental information as
it provides an indication of results excluding the specific items. This
supplemental information is not intended as an alternative measure for net earnings as
determined by Canadian GAAP. The table below contains one recurring item, namely
the gain or loss on translation of foreign debt. Because the Company has a
substantial amount of US$ denominated debt, relatively minor changes in the
value of the Canadian dollar versus the US dollar can lead to large unrealized
periodic gains or losses. As well, this item receives capital gain/loss tax
treatment and is not tax-affected at regular business income rates.

|                                                  |  | Year ended         |   |  | Year ended         |  
|------------------------------------------------- |  | ------------------ | - |  | ------------------ | -
|                                                  |  | September 25, 2010 |   |  | September 24, 2011 |  
|                                                  |  | $ millions         |   |  | $ per share        |  
|Net earnings (loss) as reported                   |  |                    |   |  |                    |  
|- in accordance with GAAP                         |  | 52                 |   |  | 0.52               |  
|Specific items (after-tax):                       |  |                    |   |  |                    |  
|Gain on translation of foreign debt               |  | (23                | ) |  | (0.23              | )
|Gain on derivative financial
      instruments    |  |                   |   |  |                   |  
|Gain on sale of land                              |  | (1                 | ) |  | (0.01              | )
|Write-down of notes receivable                    |  | 10                 |   |  | 0.10               |  
|Sale of French pulp mills                         |  | (16                | ) |  | (0.16              | )
|Recognition of future tax asset                   |  |                    |   |  |                    |  
|- French operations                               |  | (19                | ) |  | (0.19              | )
|Pine Falls closure charge                         |  | 6                  |   |  | 0.06               |  
|Debt prepayment premium                           |  | 4                  |   |  | 0.04               |  
|Taschereau sawmill closure charge                 |  |                   |   |  |                   |  
|Cranbrook planer mill severance charge            |  |                   |   |  |                   |  
|Gain on Tembec USA LLC filing                     |  |                   |   |  |                   |  
|Gain on sale of Smooth Rock Falls hydro
      dam |  |                   |   |  |                   |  
|Costs for permanently idled facilities            |  | 6                  |   |  | 0.06               |  
|Net earnings (loss) excluding specific items      |  |                    |   |  |                    |  
|- not in accordance with GAAP                     |  | 19                 |   |  | 0.19               |  

Tembec Financial Report 2011 27

---

Managements Discussion and Analysis

Quarterly Financial Information(in
millions of dollars, except per share amounts)

2010
    
    
    2011Dec. 09
    
    
    March 10
    
    
    June 10
    
    
    Sept. 10
    
    
    Dec. 10
    
    
    March 11
    
    
    June 11
    
    
    Sept. 11Sales
    
    412
    
    
    476
    
    
    545
    
    
    444
    
    
    422
    
    
    452
    
    
    448
    
    
    421EBITDA
    
    4
    
    
    32
    
    
    60
    
    
    36
    
    
    11
    
    
    33
    
    
    32
    
    
    19Depreciation and amortization
    
    15
    
    
    15
    
    
    14
    
    
    12
    
    
    12
    
    
    11
    
    
    11
    
    
    11Other items
    
    (1
    )
    
    15
    
    
    (10
    )
    
    9
    
    
    3
    
    
    6
    
    
    (10
    )
    
    2Operating earnings (loss)
    
    (10
    )
    
    2
    
    
    56
    
    
    15
    
    
    (4
    )
    
    16
    
    
    31
    
    
    6Net earnings (loss) and comprehensive
      earnings (loss)
    
    (9
    )
    
    
    
    
    59
    
    
    2
    
    
    (12
    )
    
    7
    
    
    19
    
    
    (17
    )Basic and fully diluted net earnings (loss) in dollars per
      share
    
    (0.09
    )
    
    
    
    
    0.59
    
    
    0.02
    
    
    (0.12
    )
    
    0.07
    
    
    0.19
    
    
    (0.17
    )


|FOURTH QUARTER ANALYSIS
|-----------------------

The Company reported a net loss of $17 million or $0.17 per
share in the fourth quarter ended September 24, 2011, compared to net earnings
of $2 million or $0.02 per share in the same quarter of fiscal 2010. The
weighted average number of common shares outstanding was 100 million, unchanged
from the prior year.

Sales decreased by $23 million as compared to the same quarter
a year ago. Currency was unfavourable as the Canadian dollar averaged US $1.023,
a 6.3% increase from US $0.962 in the prior year quarter. Forest Products
segment sales increased by $8 million primarily as a result of higher shipments.
Dissolving and Chemical Pulp segment sales increased by $14 million due to
significantly higher prices. High-Yield Pulp segment sales decreased by $28
million due to lower shipments and prices. Paper segment sales decreased by $12
million due to lower shipments and prices.

EBITDA declined by $17 million over the prior year quarter.
Forest Products segment EBITDA declined by $5 million due primarily to higher
costs. Dissolving and Chemical Pulp segment EBITDA was unchanged, with higher
prices offsetting higher costs. High-Yield Pulp segment EBITDA declined by $22
million due mainly to lower prices. Paper segment EBITDA increased by $2 million because of lower costs. Corporate
expenses for the current quarter include a credit of $6 million relating to
share-based compensation. There was no charge for share-based compensation in
the prior year quarter.

The Company generated operating earnings of $6 million compared
to operating earnings of $15 million in the same quarter a year ago. The
previously noted decline in EBITDA was the main cause of the reduction in
operating earnings. The prior year quarter other items included a charge of
$7million related to the permanent closure of the Pine Falls, Manitoba,
newsprint mill. It also included a $2 million charge relating to legal costs,
site security and custodial costs for several permanently idled facilities. The
current year other items of $2million were also for costs related to
permanently idled facilities.

There were no significant interest variances. The expense
relates primarily to interest on the US $255 million senior secured notes
maturing in December 2018. Foreign exchange items relate primarily to gains or
losses on the translation of US$ net monetary assets. When the Canadian dollar
weakens versus the US dollar, as was the case during the current quarter, gains
are generated.

28Tembec Financial Report 2011

---

Managements Discussion and Analysis

During the September 2011 quarter, the Company recorded a loss
of $11 million on the translation of its US $ denominated debt as the relative
value of the Canadian dollar decreased from US $1.013 to US $0.971. The Company
did not record a gain or loss on the translation of its euro-denominated debt as
the relative value of the euro versus the Canadian dollar decreased from C
$1.399 to C $1.392.

During the September 2010 quarter, the Company recorded a gain
of $3 million on the translation of its US $ denominated debt as the relative
value of the Canadian dollar increased from US $0.965 to US $0.975. The Company
recorded a loss of $2million on the translation of its euro-denominated debt as
the relative value of the euro versus the Canadian dollar increased from C
$1.283 to C $1.384.

During the September 2011 quarter, the Company recorded an
income tax expense of $7 million on a loss before income taxes and
non-controlling interest of $10 million. The income tax expense reflected a $10
million unfavourable variance versus an anticipated income tax recovery of $3
million based on the Companys effective tax rate of 27.8%. The current quarter
absorbed a $6 million unfavourable change in valuation allowance. Based on past
financial performance, future income tax assets of the Companys Canadian
operations have not been recognized as it has not been determined that the
future realization of these assets is more likely than not to occur.

During the September 2010 quarter, the Company recorded an
income tax expense of $4 million on earnings before income taxes and
non-controlling interest of $6 million. The income tax expense reflected a $2
million unfavourable variance versus an anticipated income tax expense of $2
million based on the Companys effective tax rate of 29.8%. The prior year
quarter absorbed a $2 million unfavourable change in valuation allowance.

The fourth quarter 2011 interim MD&A issued on November15,
2011, provides a more extensive analysis of items having impacted the Companys
fourth quarter financial results.

|SUMMARY OF QUARTERLY RESULTS
|----------------------------

On a sequential quarterly basis, sales and margins were
negatively impacted by lower lumber prices. While US$ lumber reference prices
were fairly stable, the strengthening of the Canadian dollar versus the US
dollar, increasing from US$0.945 in the December 2009 quarter to US$1.023 in the
September 2011 quarter, resulted in declining prices and margins for the
Companys Forest Products segment. Demand remained weak and the lumber shipments
to capacity ratio ranged from 44% to 59% over the last eight quarters. By
contrast, the Dissolving and Chemical Pulp segment experienced price increases
over the last eight quarters, resulting in improved profitability and margins.
The High-Yield Pulp segment saw prices increase over the four quarters of
fiscal 2010 and then decline over the four quarters of fiscal 2011. Here again,
currency was a negative factor. High-yield pulp margins were negative in the
last two quarters of fiscal 2011. The Paper segment had improving results driven
by higher newsprint prices and lower manufacturing costs.

The Companys financial performance and that of its
Forest Products segment for the last eight quarters were negatively impacted by
export taxes on lumber shipped to the U.S. Total amount incurred over the last
two years was $23 million.

The Company generated EBITDA of $227 million in the last eight
quarters. This represents a margin of approximately 6% on sales of $3.6 billion.
Financial performance was adversely affected by the difficult lumber market.
Depreciation and amortization expense totalled $101 million during this period.
The Company recorded other items having a net unfavourable impact of $14 million
over the last eight quarters.

Due to the stronger Canadian dollar, the Company recorded a
gain of $26 million on the translation of its foreign-denominated debt over the
last two years. However, the impact of the quarterly debt translation gains and
losses added considerable volatility to the financial results, with the impact
ranging from a gain of $16 million in the December 2009 quarter to a loss of $11
million in the September 2011 quarter.

Tembec Financial Report 2011 29

---

Managements Discussion and Analysis

Financial Position and Liquidity

|FREE
      CASH FLOW                                           |  |      |   |  |      |  
|-------------------------------------------------------------- |  | ---- | - |  | ---- | -
|(in millions of dollars)                                       |  |      |   |  |      |  
|                                                               |  | 2010 |   |  | 2011 |  
|Cash flow from operations before working
      capital changes |  | 58   |   |  | 20   |  
|Net
      fixed asset additions                                |  | (25  | ) |  | (55  | )
|Free
      cash flow (negative)                                |  | 33   |   |  | (35  | )

Cash flow from operations before working capital changes in
fiscal 2011 was $20 million, compared to $58 million from the prior year. The
decline in EBITDA accounted for the decline in cash flow. In fiscal 2011,
non-cash working capital items generated $49 million as compared to $20 million generated in
the prior year. After allowing for net fixed asset additions of $55million, free
cash flow in fiscal 2011 was negative $35million compared to positive $33
million in the prior year.

|CAPITAL SPENDING                         |  |      |  |  |      | 
|---------------------------------------- |  | ---- |  |  | ---- | 
|(in millions of dollars)                 |  |      |  |  |      | 
|                                         |  | 2010 |  |  | 2011 | 
|Forest Products                          |  | 7    |  |  | 10   | 
|Dissolving and Chemical Pulp             |  | 12   |  |  | 38   | 
|High-Yield Pulp                          |  | 3    |  |  | 3    | 
|Paper                                    |  | 3    |  |  | 4    | 
|Net
      fixed asset additions          |  | 25   |  |  | 55   | 
|As a % of total sales                    |  | 1.2% |  |  | 2.9% | 
|As a
      % of fixed asset depreciation |  | 45%  |  |  | 122% | 

In response to relatively low EBITDA and operating losses in
certain business segments brought on by challenging market conditions, the
Company has continued to limit capital expenditures. The Company estimates that
annual capital expenditures of $35 million to $40 million are required to
adequately maintain its current facilities. During fiscal 2011, net fixed asset
additions totalled $55 million compared to $25 million in the prior year. The
focus of the Companys capital expenditures was in the Dissolving and
Chemical Pulp segment, with all three mills benefiting from increased investment.
A total of $10 million was spent at the Tartas dissolving pulp mill to begin the installation of an 8-megawatt
electrical turbine. An additional $11 million will be spent in fiscal2012 to
complete the installation. Current start-up date is June2012. An amount of $6
million was spent at the Skookumchuck NBSK mill to effect a major repair on the
recovery boiler. The repairs are now complete and will result in higher
productivity at the mill in fiscal 2012. A further $4million was spent at the
Temiscaming dissolving pulp mill to erect a new brown stock tank. An estimated
$3 million will be spent in the first half of fiscal 2012 to complete the
project, with a forecast start-up date of April 2012.

30Tembec Financial Report 2011

---

Managements Discussion and Analysis

In October 2009, the Company was advised that it had qualified
for $24 million of credits under the federal governments Pulp and Paper Green
Transformation Program. The credits can be used to finance
capital projects that generate environmental benefits, including investments in
energy efficiency or the production of renewable energy from forest biomass. To
date, the Company has obtained approval for projects that will utilize the entire
$24million of available credits. The Company anticipates that it will spend the
full $24million within the programs specified time limits.

|ACQUISITIONS, INVESTMENTS AND DIVESTITURES
|------------------------------------------

On May 7, 2010, the Company announced that its European
subsidiary, Tembec SAS, had completed the sale of two kraft pulp mills located
in Tarascon and Saint-Gaudens, France. The purchaser paid the equivalent of
$86million in cash including preliminary working capital adjustments and assumed
$41million of debt, for total consideration of $127million. As a result of the
sale, the Company recorded a pre-tax gain of $12million in the fiscal2010
financial results.

On September 2, 2010, the Company announced the permanent
closure of its Pine Falls, Manitoba, newsprint mill. As a result, a charge of $7
million was recorded in the fiscal2010 financial results.

O n February 21, 2011, the Company announced the permanent
closure of its Taschereau, Quebec, SPF sawmill. As a result, a charge of $3
million was recorded in the fiscal 2011 financial results.

On March 29, 2011, the Company announced the sale of its
hydro-electric generating assets located in Smooth Rock Falls, Ontario. The
purchaser paid $16 million in cash for the assets. As a result, the Company
recorded a gain of $3 million in the fiscal 2011 financial results.

On April 25, 2011, the Company announced that its non-operating
U.S. subsidiary, Tembec USA LLC, had filed a petition seeking relief under
Chapter 7 of the Bankruptcy Code of the United States. As a result of the
filing, the Company recorded a gain of $8 million relating to the reduction in
its consolidated accrued benefit obligation in the fiscal 2011 financial
results.

On November 25, 2011, the Company sold its Toronto, Ontario,
flooring plant for proceeds of $13 million. Concurrently, the Company also
announced the closure of its Huntsville, Ontario, hardwood flooring plant. The
sale of the Toronto plant and the closure of the Huntsville plant will result in
a charge of $2 million that w ill be recorded in the Company s December 2011
quarterly financial results.

On November 28, 2011, the Company announced that it had reached
an agreement to sell its British Columbia sawmills and related forestry
operations for proceeds of $60 million. The transaction is expected to close in
the March 2012 quarter, at which time an estimated gain of $16 million will be
recorded.

|FINANCING ACTIVITIES
|--------------------

NET DEBT TO TOTAL CAPITALIZATION



Net debt to total capitalization stood at 27% at September2011,
a decrease of 1% from 28% at September 2010. As part of its long-term strategy,
the Company has resolved to maintain its percentage of net debt to total
capitalization to 40% or less. The objective of the plan is to keep a strong
balance sheet and maintain the ability of the Company to access capital markets
at favourable rates. The Company remains committed to this strategy.

Tembec Financial Report 2011 31

---

Managements Discussion and Analysis

|LONG-TERM DEBT                                                  |  |      |  |  |      | 
|--------------------------------------------------------------- |  | ---- |  |  | ---- | 
|(in millions of dollars)                                        |  |      |  |  |      | 
|                                                                |  | 2010 |  |  | 2011 | 
|Tembec Industries - US $255 million 11.25%
      senior secured |  |      |  |  |      | 
|notes due December 2018                                         |  | 261  |  |  | 262  | 
|Tembec Inc. - 6% unsecured notes - September
      2012         |  | 9    |  |  | 5    | 
|Tembec French operations                                        |  | 21   |  |  | 25   | 
|Kirkland Lake Engineered Wood Products Inc.                     |  | 8    |  |  | 8    | 
|Other debt                                                      |  | 2    |  |  | 2    | 
|Total long-term debt                                            |  | 301  |  |  | 302  | 
|Less
      unamortized financing costs                          |  | 13   |  |  | 13   | 
|                                                                |  | 288  |  |  | 289  | 
|Current portion included in above                               |  | 17   |  |  | 18   | 

As part of the financial recapitalization that occurred in
February 2008, the Company entered into a loan agreement with various lenders
for a non-revolving term loan of US $300million due February 28, 2012. The
facility was secured by a charge on the assets of the Companys material North
American operations, including a first priority charge on all assets except
receivables and inventories, where it had a second priority charge. In August
2010, the Company completed a private offering of US $255 million of 11.25%
senior secured notes maturing in December 2018. The notes were sold in a private
offering to qualified institutional buyers as defined in Rule 144A under the
U.S. Securities Act of 1933 and outside the U.S. in reliance on Regulation S
under the Securities Act. The notes were subsequently registered with the SEC on
March31, 2011. The notes are senior secured obligations of the Company, secured
by a first priority lien on the majority of the property and fixed assets of the
Company. They are secured by a second priority lien on accounts receivable,
inventories and certain intangibles. The net proceeds of the offering, together
with cash on hand, were used to repay all outstanding indebtedness under the
Companys existing US $300 million term loan facility maturing in February 2012,
including related fees, expenses and a 2% prepayment premium.

As part of the financial recapitalization of 2008, the Company
issued $18 million of 6% unsecured notes having a maturity of September 30,
2012. These notes are subject to an amortization schedule and an amount of $4
million was repaid in fiscal 2011, compared to $3 million in the prior year.

The debt of the French operations relates to the Companys
dissolving pulp mill. The increase in debt relates to new borrowings to install
an electrical turbine at the facility. The project was discussed previously in
the capital spending section.

Pursuant to the previously noted issuance of the 2018 senior
secured notes, Moodys Investors Service (Moodys) assigned a B3 rating to the
new long-term debt and the same level for the Companys corporate credit rating.
Standard and Poors (S&P) assigned a B- rating to the senior secured notes
as well as the Companys corporate credit rating. Both Moodys and S&P have
a stable outlook with respect to their ratings. There was no change in the
ratings in fiscal 2011.

At the end of September 2011, the Company had total cash of
$105 million (including cash held in trust) plus unused operating lines of $124
million. At the end of September 2010, the Company had total cash of $74 million
and unused operating lines of $100 million. The Company defines operating
lines to include loans of various durations, which are secured by charges on
accounts receivable and/or inventories. Operating lines are used primarily to
fund short-term requirements associated with both seasonal and cyclical
inventory increases, which can occur in the Companys business segments. The
Company would not normally draw on the operating lines to fund capital
expenditures or normal average working capital requirements. The operating lines
are established across multiple entities and jurisdictions to ensure they meet
the needs of the various operating units.

32Tembec Financial Report 2011

---

Managements Discussion and Analysis

The following table summarizes the unused operating lines at
the end of the last two fiscal years:

|OPERATING
      LINES            |  |      |   |  |      |  
|-------------------------------- |  | ---- | - |  | ---- | -
|(in millions of dollars)         |  |      |   |  |      |  
|                                 |  | 2010 |   |  | 2011 |  
|Borrowing base                   |  | 212  |   |  | 186  |  
|Less: availability
      reserve |  | (76  | ) |  | (22  | )
|Net availability                 |  | 136  |   |  | 164  |  
|Outstanding letters of credit    |  | (35  | ) |  | (34  | )
|Amount drawn                     |  | (1   | ) |  | (6   | )
|Unused amount                    |  | 100  |   |  | 124  |  

As part of the financial recapitalization that occurred in
February 2008, the Company negotiated a $205 million revolving working capital
or asset-based loan (ABL) facility maturing in December 2011. The ABL was
subject to a permanent availability reserve of $25 million. This amount would
increase to $35 million if the Companys trailing 12-month EBITDA fell below $80
million. The facility had a first priority charge over the receivables and
inventories and a second priority charge over the remainder of the assets of the
Companys significant North American operations. As part of the long-term debt
refinancing that occurred in August 2010, the ABL lenders sought and obtained an
increase of US$50million to the availability reserve. In March 2011, the Company
entered into a new five-year $200million ABL expiring in February 2016. The new
ABL effectively replaced the previously noted $205 million ABL. The new ABL has
a first priority charge over the receivables and inventories of the Companys
Canadian operations. The facility is subject to a permanent availability reserve
of $15 million. This amount is increased to $25 million if the Companys
trailing 12-month EBITDA falls below $60 million. There is also a variable
reserve, which totalled $7 million as at the end of fiscal 2011.

The outstanding letters of credit constitute security for
various operating items, principally the unfunded portion of supplementary
retirement plans, future landfill closure liabilities and performance guarantees
related to electricity generation agreements. The Company does not have any
other significant off-balance sheet arrangements.

The French operations are supported by receivable factoring
agreements. As such, the borrowing base fluctuates periodically, depending on
shipments and cash receipts.

|COMMON SHARES                      |      |     
|---------------------------------- | ---- | ----
|(in millions)                      |      |     
|                                   | 2010 | 2011
|Shares outstanding
      - opening | 100  | 100 
|Shares outstanding
      - ending  | 100  | 100 

There were no shares issued in fiscal 2010 and fiscal 2011.

There are currently 11,093,943 outstanding warrants
(unchanged from the prior year). The warrants are convertible into an equal
amount of common shares expiring February 29, 2012. They shall be deemed to be
exercised and shall be automatically converted into common shares of the Company
when the 20-day volume-weighted average trading price of a single common share
reaches or exceeds $12.00 or immediately prior to any transaction that would
constitute a change of control at a purchase price per common share equal to at
least $12.00.

In addition to the previously noted warrants, an additional
122,020 shares may be issued pursuant to options granted under the prior
Long-Term Incentive Plan (LTIP). The exercise price of the options ranges from
$16.61 per share to $248.29 per share with expiry dates from 2012 to 2016. As at
September 24, 2011, all of the options were exercisable.

Tembec Financial Report 2011 33

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Managements Discussion and Analysis

Financial Instruments and Contractual
Obligations

|FINANCIAL ASSETS
      AND LIABILITIES          |  |                    |  |  |            | 
|----------------------------------------------- |  | ------------------ |  |  | ---------- | 
|(in millions of dollars)                        |  |                    |  |  |            | 
|                                                |  | September 24, 2011 | 
|                                                |  | Carrying value     |  |  | Fair value | 
|Financial assets                                |  |                    |  |  |            | 
|Cash and cash equivalents                       |  | 99                 |  |  | 99         | 
|Cash held in trust                              |  | 6                  |  |  | 6          | 
|Accounts receivable                             |  | 182                |  |  | 182        | 
|Loans receivable                                |  | 24                 |  |  | 24         | 
|Financial liabilities                           |  |                    |  |  |            | 
|Operating bank loans                            |  | 6                  |  |  | 6          | 
|Accounts payable and accrued charges            |  | 254                |  |  | 254        | 
|Interest payable                                |  | 8                  |  |  | 8          | 
|Long-term debt (including current portion)      |  | 289                |  |  | 294        | 
|Pension and other
      benefit net liabilities |  | 153                |  |  | 208        | 

The carrying values for cash, cash equivalents, cash held in
trust, accounts receivable, loans receivable, operating bank loans, accounts
payable and accrued charges, and interest payable approximate their fair values
due to the near-term maturity of these instruments.

The fair value of the long-term debt is $5 million higher than
its carrying value. Unamortized financing costs increased the fair value by $13
million. This was partially offset by an $8 million decrease as the Companys US
$255 million senior secured notes were trading below par at year-end.

The $55 million difference in net liabilities of pension and
other benefit plans relates to $41 million of unamortized net actuarial losses,
$5 million of unamortized past service costs and $9million of employer
contributions made after June 30, 2011, the measurement date.

|FINANCIAL RISKS
|---------------

Credit risk

Credit risk arises from the possibility that entities to which
the Company sells products may experience financial difficulty and be unable to
fulfill their contractual obligations. The Company does not have a significant
exposure to any individual customer or counterparty. The Company reviews a new
customers credit history before extending credit and conducts regular reviews
of its existing customers credit performance. All credit limits are subject to
evaluation and revision at any time based on changes in levels of
creditworthiness and must be reviewed at least once per year. Sales orders
cannot be processed unless a credit limit has been properly approved. Bad debt
expense has not been significant in the past. The allowance for doubtful
accounts at September 2011 was nil, compared to $1 million at the end of the
prior year. The Company may require payment guarantees, such as letters of
credit, or obtain credit insurance coverage.

34Tembec Financial Report 2011

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Managements Discussion and Analysis

Liquidity risk

Liquidity risk arises from the possibility that the Company
will not be able to meet its financial obligations as they fall due. The Company
has an objective of maintaining liquidity equal to 12 months of maintenance
capital expenditures, interest and principal repayments and seasonal working
capital requirements, which would require approximately $150 million to $200
million of liquidity. As noted previously, the Company had total cash of $105
million plus unused operating lines of $124 million as at September 24,
2011.

Foreign currency risk

This item is discussed in detail in a subsequent section of the
MD&A, Significant Risks and Uncertainties.

Interest rate risk

Interest rate risk is the risk that the fair value or future
cash flows of a financial instrument will fluctuate because of changes in market
interest rates. This will have little impact on the Companys financial results
since the majority of the Companys debts are at fixed interest rates.

Commodity price and operational risk

These items are discussed in detail in a subsequent section of
the MD&A, Significant Risks and Uncertainties.

CONTRACTUAL
      OBLIGATIONS(in millions of dollars)Total
    
    
    Within 1
    
    
    2 - 3
    
    
    4 - 5
    
    
    After 5year
    
    
    years
    
    
    years
    
    
    yearsLong-term debt
    
    302
    
    
    9
    
    
    12
    
    
    12
    
    
    269Interest on long-term debt
    
    219
    
    
    31
    
    
    61
    
    
    60
    
    
    67Operating leases
    
    14
    
    
    5
    
    
    5
    
    
    3
    
    
    1Purchase obligations
    
    172
    
    
    78
    
    
    59
    
    
    31
    
    
    4Pension obligations:Normal cost
    
    116
    
    
    7
    
    
    14
    
    
    14
    
    
    81Contractual
    
    149
    
    
    30
    
    
    55
    
    
    33
    
    
    31972
    
    
    160
    
    
    206
    
    
    153
    
    
    453


The table above shows the Companys contractual obligations as
at September 24, 2011. The Company has long-term debt with contractual
maturities and applicable interest. The operating lease obligations relate
primarily to property and equipment rentals entered into in the normal course of
business. Purchase obligations relate to ongoing normal commercial commitments
to purchase timber, wood chips, energy, chemicals and other operating inputs. They also include
outstanding obligations relating to capital expenditures. Pension obligations
have two components. The normal cost obligations are limited to a 16-year period
and are based on estimated future employee service for existing registered
defined benefit plans. Contractual pension obligations include estimated
solvency and going concern amortization payments.

Tembec Financial Report 2011 35

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Managements Discussion and Analysis

2010 vs. 2009

|FINANCIAL SUMMARY                                            |  |       |   |  |       | 
|------------------------------------------------------------ |  | ----- | - |  | ----- | 
|(in millions of dollars, unless otherwise noted)             |  |       |   |  |       | 
|                                                             |  | 2009  |   |  | 2010  | 
|Sales                                                        |  | 1,786 |   |  | 1,877 | 
|EBITDA                                                       |  | (108  | ) |  | 132   | 
|Depreciation and amortization                                |  | 73    |   |  | 56    | 
|Other items                                                  |  | (3    | ) |  | 12    | 
|Operating earnings
      (loss)                              |  | (178  | ) |  | 64    | 
|Net earnings
      (loss)                                    |  | (214  | ) |  | 52    | 
|Basic and diluted
      earnings (loss) in dollars per share |  | (2.14 | ) |  | 0.52  | 
|Total assets (at
      year-end)                             |  | 1,366 |   |  | 1,104 | 
|Total long-term
      debt (at year-end) (1)                 |  | 402   |   |  | 288   | 

(1)includes current portion

Sales increased by $91 million as compared to fiscal 2009. The
increase was driven by higher pulp prices and shipments. Currency was
unfavourable as the Canadian dollar averaged US $0.960, a 13% increase from US
$0.850 in the prior year. Forest Products segment sales increased by $27 million
as a result of higher prices and shipments. Pulp segment sales increased by $142
million as a result of higher prices and shipments. Paper segment sales
decreased by $104 million due to lower shipments and prices.

EBITDA improved by $240 million over fiscal 2009. The
Forest Products segment EBITDA improved by $57 million because of lower costs and
improved pricing. The Pulp segment EBITDA increased by $218 million due to lower
manufacturing costs and higher prices. The Paper segment EBITDA decreased by $29
million due to lower selling prices, with lower costs providing a partial
offset.

36Tembec Financial Report 2011

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Managements Discussion and Analysis

OPERATING EARNINGS
      (LOSS)(in millions of dollars)Depreciation &
    
    
    OtherTotal
    
    
    EBITDA
    
    
    amortization
    
    
    items2009
    
    
    2010
    
    
    variance
    
    
    variance
    
    
    variance
    
    
    varianceForest Products
    
    (88
    )
    
    (24
    )
    
    64
    
    
    57
    
    
    8
    
    
    (1
    )Pulp
    
    (101
    )
    
    134
    
    
    235
    
    
    218
    
    
    9
    
    
    8Paper
    
    22
    
    
    (12
    )
    
    (34
    )
    
    (29
    )
    
    
    
    
    (5
    )Chemicals
    
    7
    
    
    8
    
    
    1
    
    
    
    
    
    
    
    
    1Corporate
    
    (18
    )
    
    (42
    )
    
    (24
    )
    
    (6
    )
    
    
    
    
    (18
    )(178
    )
    
    64
    
    
    242
    
    
    240
    
    
    17
    
    
    (15
    )


The Company generated operating earnings of $64 million
compared to an operating loss of $178 million in fiscal 2009. The previously
noted improvement in EBITDA generated the majority of the increase in operating
results. The Pulp segment results included a $12 million gain relating to the
sale of two paper pulp mills located in Southern France. The Paper segment
results included a charge of $7 million related to the permanent closure of the
Pine Falls newsprint facility.

The fiscal 2010 Corporate segment results absorbed a charge of
$12 million relating to the write-down of notes receivable. As well, the Company
incurred expenses of $7 million covering legal costs, site security, and remedial actions relating to
the idled Marathon, Ontario, NBSK pulp mill. The Marathon mill was previously
owned by Marathon Pulp Inc., a joint venture in which the Company held a 50%
interest. In February 2009, the joint venture sought creditor protection and a
trustee in bankruptcy was appointed. The latter continued to operate the
facility for a period of time to liquidate inventories. In June2009, the
Ministry of Environment (MOE) of the province of Ontario directed the Company to
undertake certain actions on the site. While the Company contested the basis on
which the order was given, it complied with the various directives.

|INTEREST, FOREIGN
      EXCHANGE AND OTHER |  |      |   |  |      | 
|------------------------------------------ |  | ---- | - |  | ---- | 
|(in millions of dollars)                   |  |      |   |  |      | 
|                                           |  | 2009 |   |  | 2010 | 
|Interest on long-term debt                 |  | 33   |   |  | 27   | 
|Interest on operating bank loans           |  | 4    |   |  | 3    | 
|Debt prepayment premium                    |  |     |   |  | 6    | 
|Foreign exchange items                     |  | (16  | ) |  | 14   | 
|Bank charges and
      other               |  | 1    |   |  | 2    | 
|                                           |  | 22   |   |  | 52   | 

The $6 million decline in interest expense was primarily
foreign exchange related as the Canadian dollar averaged 13% higher versus the
US dollar. A term loan credit facility was repaid on August 17, 2010, and
required that the Company pay a debt prepayment premium of 2%. The Company
issued US$255million of senior secured notes maturing in December 2018. Foreign exchange items relate primarily to gains
or losses on the translation of US $ net monetary assets. When the Canadian
dollar strengthens versus the US dollar, as was the case during fiscal 2010,
losses are generated. If the Canadian dollar weakens, as was the case in fiscal
2009, gains are generated.

Tembec Financial Report 2011 37

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Managements Discussion and Analysis

During fiscal 2010, the Company recorded a gain of $19 million
on the translation of its US $ denominated debt as the relative value of the
Canadian dollar increased from US $0.916 to US$0.975. The Company recorded a
gain of $8 million on the translation of its euro-denominated debt as the
relative value of the euro versus the Canadian dollar decreased from C $1.602 to
C $1.384.

During fiscal 2009, the Company recorded a loss of $18 million
on the translation of its US $ denominated debt as the relative value of the
Canadian dollar decreased from US $0.968 to US$0.916. The Company recorded a
loss of $3 million on the translation of its euro-denominated debt as the
relative value of the euro versus the Canadian dollar increased from C $1.509 to
C $1.602.

During fiscal 2010, the Company recorded an income ta x recover
y of $15 million on earnings from continuing operations before income taxes and
non-controlling interests of $39 million. This income tax recovery reflected a
$27million favourable variance versus an anticipated income tax expense of $12
million based on the Companys effective tax rate of 29.8%. The change in
valuation allowance increased the recovery by $20 million. The most significant
item included in the above was a $19 million favourable adjustment relating to
the recognition of future tax assets of the Companys remaining operations in
France as it has been determined that the future realization of these assets is
more likely than not to occur. The non-taxable gain on consolidation of
foreign integrated subsidiaries increased the income tax recovery by $10
million.

During fiscal 2009, the Company recorded an income tax recovery
of $1 million on a loss from continuing operations before income ta xes and
non-controlling interests of $221million. The income tax recovery reflected a
$67 million unfavourable variance versus an anticipated income tax recovery of
$68million based on the Companys effective tax rate of 30.9%. The
non-recognition of period losses reduced the income tax recovery by $62 million.
Based on past financial performance, future income tax assets of the Companys
operations have been limited to the amount that is more likely than not to be
realized. The non-deductible portion of the loss on translation of
foreign-denominated debt reduced the income tax recovery by $2 million. The
non-deductible loss on consolidation of foreign integrated subsidiaries also
reduced the income tax recovery by $3 million.

The financial results of the St. Francisville paper mill have
been classified as discontinued operations. During fiscal 2010, the operations
did not impact the Companys financial results. A $2 million charge for pension
and post-retirement healthcare benefits was offset by a $2 million gain on the
translation of the US $ carrying values of the pension and post-retirement
healthcare obligations. Fiscal 2009 earnings of $5 million included a $12
million after-tax gain on the sale of the mill site and production equipment, a
$2 million loss on translation of the US $ carrying values of liabilities and a
charge of $5 million for custodial and legacy costs.

The Company generated net earnings of $52 million or $0.52 per
share for the year ended September 25, 2010, compared to a net loss of $214
million or $2.14 per share for the year ended September 26, 2009.

38Tembec Financial Report 2011

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Managements Discussion and Analysis

Critical Accounting Policies and
Estimates

Fixed asset depreciation

The Company records its fixed assets, primarily production
buildings and equipment, at cost. Interest costs are capitalized for projects in
excess of $1 million that have a duration in excess of one year. Investment tax
credits or capital assistance received reduce the cost of the related assets.
Fixed assets acquired as a result of a business acquisition are recorded at
their estimated fair value. Depreciation of fixed assets is provided over their
estimated useful lives, generally on a straight-line basis. The estimated useful
lives of fixed assets are based on judgement and the best currently available
information. Changes in circumstances can result in the actual useful lives
differing from our estimates. Revisions to the estimated useful lives of fixed
assets constitute a change in accounting estimate and are dealt with
prospectively by amending the amount of future depreciation expense. There were
no significant revisions to the estimated useful lives of fixed assets in fiscal
2011 and fiscal 2010.

Impairment of long-lived assets

The Company must review the carrying value of long-lived assets
when events or changes in circumstances indicate that the value may have been
impaired and is not recoverable through future operations and cash flows. To
estimate future cash flows, the Company uses operating and financial
assumptions, primarily those contained in its most recent multi-year operating
plan. This ensures that the assumptions are supported, where available, by
relevant independent information. There were no fixed asset impairment charges
in fiscal 2011 and fiscal 2010.

Employee future benefits

The Company contributes to several defined benefit pension
plans, primarily related to employees covered by collective bargaining
agreements. The Company also provides post-retirement benefits to retirees,
primarily healthcare related. For post-retirement benefits, funding of
disbursements is done on a pay as you go basis. The Company uses independent
actuarial firms to quantify the amount of pension and post-retirement
obligations. The Company, based on its own experience and recommendations from
its actuarial firms, evaluates the underlying assumptions on an annual basis.

Changes in estimates or assumptions can have a substantial
impact on the amount of pension and post-retirement benefit expense, the
carrying values on the balance sheet, and, in the case of defined benefit plans,
the amount of plan surplus or deficit. At June 30, 2011, (the measurement
date), the fair value of defined benefit plan assets was $641 million, an amount
equal to 80% of the estimated accrued benefit obligation of $804 million,
generating a deficit of $163 million. The plan deficit was $206 million at the
prior measurement date, June 30, 2010. The deficit decrease of $43 million that
occurred over the 12-month period was due to several items. The deficit was
decreased by $38 million as the return on plan assets exceeded the assumed rate
of return. The deficit was further reduced by $23 million as employer
contributions of $31million exceeded the current service cost of $8 million.
These favourable items were partially offset by an actuarial loss of $16 million
that increased the obligations at the measurement date. This item was caused by
a decrease in the applicable discount rate from 5.12% to 4.94%. The discount
rate is tied to rates applicable to high-quality corporate bonds (AA or higher)
in effect at the measurement date. Pension expense in fiscal 2011 was $11
million, as compared to nil in the prior year. Based on current assumptions
under IFRS, employer contributions and pension expense in fiscal 2012 are
expected to be approximately $44 million and $5 million, respectively. There is
no assurance that current assumptions will materialize in future periods. The
defined benefit pension plans may be unable to earn the assumed rate of return.
Market driven changes to discount rates and other variables may result in
changes to anticipated Company contribution amounts.

With regard to other employee future benefit plans, the accrued
benefit obligation at the measurement date was $45million, a decrease from $49
million in the prior year. Employer contributions were $2 million, compared to
$3 million in the prior year. In fiscal 2011, the Company recognized an expense
of $3 million, unchanged from the prior year. Based on current assumptions under
IFRS, the amount of employer contributions and the amount of expense to be
recognized in fiscal 2012 are expected to be approximately $2 million and
$4million, respectively.

Tembec Financial Report 2011 39

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Managements Discussion and Analysis

Future income taxes

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

Use of Non-GAAP Financial Measures

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

EBITDA refers to earnings before interest, income taxes,
depreciation and amortization. EBITDA does not have any standardized meaning
according to GAAP. The Company defines EBITDA as sales less cost of sales and
selling, general and administrative expenses, meaning it represents operating
earnings before depreciation, amortization and other specific or non-recurring
items. The Company considers EBITDA to be a useful indicator of the financial
performance of the Company, the business segments and the individual business
units. The most comparable Canadian GAAP financial measure is operating
earnings. The following table is a reconciliation of operating earnings to the
Companys definition of EBITDA.

|(in millions of
      dollars) |  | 2010 |  |  | 2011 | 
|------------------------------ |  | ---- |  |  | ---- | 
|Operating earnings             |  | 64   |  |  | 49   | 
|Depreciation and amortization  |  | 56   |  |  | 45   | 
|Other items                    |  | 12   |  |  | 1    | 
|EBITDA                         |  | 132  |  |  | 95   | 

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

Net debt refers to debt less cash, cash equivalents and cash
held in trust.

Total capitalization refers to net debt plus future income
taxes, other long-term liabilities and credits, and shareholders equity.

Net debt to total capitalization is used by the Company to
measure its financial leverage.

|(in millions of
      dollars)               |  | 2010 |   |  | 2011 |  
|-------------------------------------------- |  | ---- | - |  | ---- | -
|Long-term debt                               |  | 271  |   |  | 271  |  
|Unamortized financing costs                  |  | 13   |   |  | 13   |  
|Current portion of long-term debt            |  | 17   |   |  | 18   |  
|Operating bank loans                         |  | 1    |   |  | 6    |  
|Less: total cash                             |  | (74  | ) |  | (105 | )
|Net debt                                     |  | 228  |   |  | 203  |  
|Other long-term liabilities and credits      |  | 209  |   |  | 188  |  
|Shareholders
      equity                   |  | 365  |   |  | 362  |  
|Total
      capitalization                   |  | 802  |   |  | 753  |  
|Net debt to total
      capitalization ratio |  | 28%  |   |  | 27%  |  

40Tembec Financial Report 2011

---

Managements Discussion and Analysis

Changes in Accounting Policies and
Estimates

During the year ended September 24, 2011, there have been no
new standards issued by the CICA that had an impact on the Companys
consolidated financial statements.

Impact of Accounting Pronouncementson Future Reporting Periods

International Financial Reporting Standards (IFRS) will replace
Canadian GAAP for publicly accountable entities for financial periods beginning
on or after January 1, 2011. Accordingly, the conversion from Canadian GAAP to
IFRS will be applicable to the Companys reporting for the first quarter of
fiscal2012 for which current and comparative information will be prepared
under IFRS. The Company has evaluated the impact of the conversion to IFRS and
presented its evaluation under Conversion to International Financial Reporting
Standards below.

Conversion to International Financial Reporting
Standards

|CONVERSION PROGRESS
|-------------------

In 2005, the Accounting Standards Board of Canada (AcSB)
announced that accounting standards in Canada are to converge with International
Financial Reporting Standards (IFRS). On February 13, 2008, the AcSB confirmed
that publicly accountable entities will be required to prepare financial
statements in accordance with IFRS, in full and without modification, for
interim and annual financial statements for fiscal years beginning on or after
January 1, 2011, which in the case of the Company, represents interim and fiscal
year-end periods beginning on or after September 25, 2011 (the Changeover
date). In the Companys reporting for those periods following the Changeover
date, comparative data for equivalent periods in the previous fiscal year will
be required, making September 26, 2010, the Transition date for the
Company.

The Companys transition to full implementation of IFRS
consists of five phases:

| | Preliminary study phase  This phase involves performing
      a high-level assessment to identify key areas of accounting differences
      and their impact (high, medium or low priority) that may arise from the
      transition to IFRS.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Project set-up phase  This phase includes the
      identification of a project team and IFRS Steering Committee, the
      development of a detailed conversion plan, a change management plan, as
      well as other key conversion processes and tools.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | Component evaluations and issues resolution phase  In
      this phase, the Company completes a detailed assessment of all accounting
      differences, including those identified in the preliminary study phase,
      and their impact on the Company. It involves specification of changes
      required to existing accounting policies, information systems and business
      processes, together with an analysis of policy alternatives allowed under
      IFRS and impacts on drafting of financial statements under IFRS. The
      analysis and decisions made during this phase are included in IFRS
      Accounting Policy Choice Memos challenged and approved by the IFRS
      Steering Committee and External Auditors, which are then submitted to the
      Audit Committee.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | Conversion phase  This phase includes execution of
      changes to information systems, business processes and accounting
      policies. It also involves the development of a communication and training
      program for the Companys finance and other staff, as
  necessary.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

Tembec Financial Report 2011 41

---

Managements Discussion and Analysis

| | Embedding phase  The project will culminate in the
      collection of financial information necessary to compile IFRS-compliant
      financial statements, embedding IFRS in business processes, eliminating
      unnecessar y data collection processes and submitting IFRS financial statements to the Audit
      Committee for approval.
      Implementation also involves further training of staff as revised systems
      begin to take effect.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

To ensure adequate management of this process, the Company has
established a project team and an IFRS Steering Committee, both of which are
comprised of finance and accounting senior management as well as representatives
from various areas of the organization, as deemed appropriate. Progress
reporting to the Audit Committee on the status of the IFRS implementation
project has been instituted. The Company completed the Preliminary Study Phase
in July 2008, the Project Set-up Phase in January 2009, the Component
Evaluations and Issues Resolution Phase in September 2009 and the Conversion
Phase in September 2010. The IFRS team is currently completing the Embedding
Phase.

|POTENTIAL
      IMPACT OF IMPLEMENTATION ON THE COMPANY
|-------------------------------------------------------

The transition to IFRS requires the Company to apply IFRS1, First-Time Adoption of International Financial Repor ting
Standards, which applies only at the time of changeover and includes a
requirement for retrospective application of each IFRS standard. IFRS 1 also
mandates certain exceptions to retrospective application and provides a series
of optional exemptions from retrospective application to ease the transition to
the full set of IFRSs.

IFRS 1  Mandatory exceptions

The mandatory IFRS 1 exception that is relevant to the Company
relates to the use of estimates. Specifically, hindsight cannot be used to
create or revise estimates previously made under Canadian GAAP, except where
necessary to reflect any difference in accounting policies or where there is
objective evidence that those estimates were in error.

IFRS 1  Optional exemptions

IFRS 1, First-Time Adoption of International Financial
Reporting Standards, provides entities adopting IFRS for the first time with
a number of optional exemptions and mandatory exceptions, in certain areas, to
the general requirement for full retrospective application of IFRS. Following a
detailed analysis of the various optional exemptions, the Company has elected to
apply the following:

| | Business combinations exemption  IFRS 1 provides the
      option to apply IFRS 3, Business Combinations,retrospectively or
      prospectively  either from the Transition date or a particular date prior
      to the Transition date. The Company has elected to apply IFRS 3
      prospectively on business combinations that occur after the Transition
      date. Accordingly, business combinations prior to this date have not been
      restated.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | Event driven fair value of property, plant and equipment
      as deemed cost  IFRS does not provide specific guidance on the accounting
      by entities subject to a financial reorganization. Instead, usual
      requirements of IFRS apply. In particular, fresh start accounting is not
      permitted in such circumstances. In order to mitigate the impact of this
      accounting difference, IFRS 1 provides the choice of recording assets and
      liabilities based on a deemed cost, which can be an event driven valuation
      where some or all of the assets and liabilities were valued and recognized
      at fair value. The Company has elected to apply this exemption and
      therefore, the difference between Canadian GAAP and IFRS regarding fresh
      start accounting is not expected to impact the accounting measurement of
      the assets and liabilities that were revalued on February 29,
  2008.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | Employee benefits exemption  IFRS 1 provides the option
      to retrospectively apply International Accounting Standard (IAS) 19,
      Employee Benefits,for the recognition of unamortized actuarial
      gains and losses, past service costs and transitional obligations and
      assets or to recognize these balances previously deferred under Canadian
      GAAP in opening retained earnings at the Transition date. The Company has
      elected to recognize all unamortized cumulative actuarial losses and past
      ser vice costs at the Transition date as an adjustment to opening retained
      earnings for all of its employee benefit plans.                                                                                                                                                                                                                                                                          

42Tembec Financial Report 2011

---

Managements Discussion and Analysis

| | Share-based payment transaction exemption  IFRS1
      provides an optional exemption to the application of IFRS2, Share-based
      Payment,for those share options granted subsequent to November 7,
      2002, that have fully vested as at September 26, 2010. The Company has
      elected this exemption and will exclude all such share options from the
      application of IFRS 2.                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | Borrowing costs  IAS 23, Borrowing Costs,requires an entity to capitalize borrowing costs related to all
      qualifying assets for which the commencement date for capitalization is on
      or after January 1, 2009. IFRS 1 permits all borrowing costs prior to its
      Transition date to be expensed. The Company has elected to apply this
      exemption and will expense all borrowing costs on qualifying assets prior
      to September 26, 2010.

There are additional optional exemptions under IFRS 1. However,
the Company does not expect any other exemptions to be significant to the
Companys adoption of IFRS.

|IFRS ACCOUNTING POLICIES
|------------------------

While the conceptual framework of IFRS is similar to
Canadian GAAP, significant differences exist in certain matters of recognition,
measurement and disclosure. The Company has identified specific areas where
changes in accounting policies are expected to impact the Companys consolidated
balance sheet and statement of comprehensive income. The adoption of IFRS is not
expected to have a material impact on the Companys cash flow from operations.
The significant IFRS accounting policies to be applied by the Company upon
adoption of IFRS and which are expected to have a significant impact on its
balance sheet and comprehensive income are as follows:

|(a) | Property, plant and equipment                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|    | Consistent with Canadian GAAP, IFRS requires separable
      components of property, plant and equipment to be recognized initially at
      cost. Under IAS 16, Property, Plant and Equipment,an entity is
      required to choose to account for each class of property, plant and
      equipment, using either the cost model or the revaluation model. The cost
      model is generally consistent with Canadian GAAP where an
  item of property, plant and equipment is carried at its cost
      less accumulated depreciation and accumulated impairment losses. Under the
      revaluation model, an item of property, plant and equipment is carried at
      its revalued amount, being its fair value at the date of the revaluation
      less any accumulated depreciation and accumulated impairment losses. The
      Company expects to use the cost model to account for all classes of
      property, plant and equipment.

|    | Unlike Canadian GAAP, which is silent on these matters,
      IFRS specifically requires capitalization of major replacement costs,
      major inspection costs and borrowing costs of qualifying assets.
      Management is currently quantifying the effects of additional
      capitalization required and expects an increase in proper ty, plant and
      equipment and a corresponding decrease of the accumulated deficit as at
      September 26, 2010.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(b) | Actuarial gains and losses                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|    | IAS 19, Employee Benefits,permits an entity to
      recognize actuarial gains and losses in profit or loss, or alternatively
      immediately in other comprehensive income. Under Canadian GAAP, the
      Company recognized actuarial gains and losses in profit or loss using the
      corridor approach where an entity recognizes amortization of actuarial
      gains and losses in a period in which, as of the beginning of the period,
      the unamortized net actuarial gain or loss exceeded 10% of the greater of:
      (a) the accrued benefit obligation at the beginning of the year; and (b) the
      fair value, or market-related value, of the plan assets at the beginning
      of the year. The Company has selected a policy to recognize the actuarial
      gains and losses immediately in other comprehensive income, thereby
      allowing pension assets and liabilities to be reflected at their fair
      values. The election of IFRS1 to clear all unamortized actuarial gains and
      losses against retained earnings results in an increase of the accumulated
      deficit of approximately $67 million on September 26,
2010.

Tembec Financial Report 2011 43

---

Management’s Discussion and Analysis

|(c) | Biological assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|    | IAS 41, Agriculture,specifically addresses biological assets. The timber component of the Company’s private timberlands (freeholds) will qualify as a biological asset under the scope of IAS 41. This timber will be
recorded at fair value less cost to sell and shown as a separate line item on the Company’s balance sheet. The fair value of biological assets for the Company will be measured by discounting expected cash flows from the sale of standing timber
at a current market determined rate. This value will include not only the harvest value, but would also include a value for potential future growth. All gains and losses from changes in fair value are recognized in profit and loss. The agricultural
produce (logs) from the biological asset are measured at fair value less costs to sell, which becomes the deemed cost for the purpose of subsequent accounting under the IAS 2, Inventories,standard.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|    | The Company currently expects an increase to this asset category of approximately $7 million at September 26, 2010, with a corresponding decrease of the accumulated deficit. Future changes in fair value of these biological
assets will be recognized in the Company’s profit and loss going forward.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(d) | Warrants                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|    | IAS 32, Financial Instruments: Presentation,requires an entity to classify a financial instrument as a financial liability if the Company does not have the unconditional right to avoid delivering cash or another financial
asset on settlement. Although Canadian GAAP classified the warrants as equity, the contingent settlement provision of the warrants requires the Company to classify them as financial liabilities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|    | The classification of the warrants as a financial liability will result in an increase of $5 million to long-term debt with a decrease of $6 million to share capital. The difference represents a change in fair value of the
warrants from their date of issue to the Transition date and will reduce the accumulated deficit by $1 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

|(e) | Provisions                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    | IAS 37, Provisions, Contingent Liabilities and Contingent Assets,requires a provision to be recognized when: there is a present obligation as a result of a past transaction or event; it is probable that an outflow of
resources will be required to settle the obligation; and a reliable estimate can be made of the obligation. “Probable” in this context means more likely than not. Under Canadian GAAP, the criterion for recognition in the financial
statements is “likely”, which is a higher threshold than “probable”. Therefore, it is possible that there may be some provisions or contingent liabilities, which would meet the recognition criteria under IFRS that were not
recognized under Canadian GAAP. Other differences between IFRS and Canadian GAAP exist in relation to the measurement of provisions, such as the methodology for determining the best estimate where there is a range of equally possible outcomes (IFRS
uses the mid-point of the range, whereas Canadian GAAP uses the low-end of the range), and the requirement under IFRS for provisions to be discounted where material.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    | As a result of the discounting requirement, the Company expects a decrease to the reforestation provision as calculated under Canadian GAAP at the Transition date of approximately $2 million with a corresponding decrease of
the accumulated deficit.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|(f) | Contributed surplus                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    | Canadian GAAP requires that a future income tax asset that was not recognized at the date of a comprehensive revaluation as a result of a financial reorganization be subsequently recognized first as a reduction of any unamortized
intangible asset and then in a manner consistent with the revaluation adjustment recorded at the date of the comprehensive revaluation. Under IFRS, this recognition of a future income tax asset is adjusted to profit and loss.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    | Consequently, the Company expects to eliminate contributed surplus of $5 million with a corresponding decrease of the accumulated deficit.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

The Company will continue to review all proposed and ongoing projects of the International Accounting Standards Board (IASB) and assess their impact on its conversion process.

44Tembec Financial Report 2011

---

Managements Discussion and Analysis

Reconciliation tables

The following tables provide a reconciliation of the
shareholders equity and the balance sheet as at September 26, 2010:

|SHAREHOLDERS
      EQUITY RECONCILIATION
|-----------------------------------------
|$ millions (unaudited)                   

|                                                 |  |       |  |  | As at              |  
|------------------------------------------------ |  | ----- |  |  | ------------------ | -
|                                                 |  |       |  |  | September 26, 2010 |  
|                                                 |  | Notes |  |  | (Transition date)  |  
|Equity reported under Canadian GAAP              |  |       |  |  | 365                |  
|Opening balance sheet adjustments                |  |       |  |  |                    |  
|Property, plant and equipment
      amortization |  | (a)   |  |  | (2                 | )
|Employee future benefits                         |  | (b)   |  |  | (67                | )
|Biological assets                                |  | (c)   |  |  | 7                  |  
|Warrants                                         |  | (d)   |  |  | (5                 | )
|Reforestation provision                          |  | (e)   |  |  | 2                  |  
|Deferred taxes on above items                    |  |       |  |  |                   |  
|                                                 |  |       |  |  | (65                | )
|Equity reported under IFRS                       |  |       |  |  | 300                |  

Tembec Financial Report 2011 45

---

Managements Discussion and Analysis

Estimated adjustments to the balance sheet on adoption of IFRS
as at September 26, 2010:

|BALANCE SHEET RECONCILIATION               |  |       |  |  |       |   |  |            |   |  |       |  
|------------------------------------------ |  | ----- |  |  | ----- | - |  | ---------- | - |  | ----- | -
|$ millions (unaudited)                     |  |       |  |  |       |   |  |            |   |  |       |  
|                                           |  |       |  |  |       |   |  |            |   |  |       |  
|                                           |  | Notes |  |  | GAAP  |   |  | Adjustment |   |  | IFRS  |  
|Assets                                     |  |       |  |  |       |   |  |            |   |  |       |  
|Current assets:                            |  |       |  |  |       |   |  |            |   |  |       |  
|Cash and cash equivalents                  |  |       |  |  | 68    |   |  |           |   |  | 68    |  
|Cash held in trust                         |  |       |  |  | 6     |   |  |           |   |  | 6     |  
|Trade and other receivables                |  |       |  |  | 209   |   |  |           |   |  | 209   |  
|Inventories                                |  |       |  |  | 255   |   |  |           |   |  | 255   |  
|Biological assets                          |  | (c)   |  |  |      |   |  | 1          |   |  | 1     |  
|Prepaid expenses                           |  |       |  |  | 7     |   |  |           |   |  | 7     |  
|                                           |  |       |  |  | 545   |   |  | 1          |   |  | 546   |  
|Property, plant and equipment              |  | (a)   |  |  | 498   |   |  | (2         | ) |  | 496   |  
|Biological assets                          |  | (c)   |  |  |      |   |  | 6          |   |  | 6     |  
|Other assets                               |  | (b)   |  |  | 34    |   |  | (6         | ) |  | 28    |  
|Deferred income taxes                      |  |       |  |  | 27    |   |  |           |   |  | 27    |  
|Total assets                               |  |       |  |  | 1,104 |   |  | (1         | ) |  | 1,103 |  
|                                           |  |       |  |  |       |   |  |            |   |  |       |  
|Liabilities and Shareholders Equity       |  |       |  |  |       |   |  |            |   |  |       |  
|Current liabilities:                       |  |       |  |  |       |   |  |            |   |  |       |  
|Operating bank loans                       |  |       |  |  | 1     |   |  |           |   |  | 1     |  
|Trade and other payables                   |  |       |  |  | 233   |   |  |           |   |  | 233   |  
|Interest payable                           |  |       |  |  | 3     |   |  |           |   |  | 3     |  
|Provisions                                 |  |       |  |  | 5     |   |  |           |   |  | 5     |  
|Current portion of long-term debt          |  |       |  |  | 17    |   |  |           |   |  | 17    |  
|                                           |  |       |  |  | 259   |   |  |           |   |  | 259   |  
|Long-term debt                             |  | (d)   |  |  | 271   |   |  | 5          |   |  | 276   |  
|Provisions                                 |  | (e)   |  |  | 13    |   |  | (2         | ) |  | 11    |  
|Accrued benefit liability                  |  | (b)   |  |  | 187   |   |  | 61         |   |  | 248   |  
|Other long-term liabilities and credits    |  |       |  |  | 9     |   |  |           |   |  | 9     |  
|                                           |  |       |  |  | 480   |   |  | 64         |   |  | 544   |  
|Shareholders equity:                      |  |       |  |  |       |   |  |            |   |  |       |  
|Share capital                              |  | (d)   |  |  | 570   |   |  | (6         | ) |  | 564   |  
|Contributed surplus                        |  |       |  |  | 5     |   |  | (5         | ) |  |      |  
|Deficit                                    |  |       |  |  | (210  | ) |  | (54        | ) |  | (264  | )
|Total shareholders equity                 |  |       |  |  | 365   |   |  | (65        | ) |  | 300   |  
|Total liabilities and shareholders equity |  |       |  |  | 1,104 |   |  | (1         | ) |  | 1,103 |  

46Tembec Financial Report 2011

---

Managements Discussion and Analysis

Disclosure of entity-specific Internal Control over
Financial Reporting and Disclosure Controls and Procedures

Management has made the appropriate changes to ensure the
integrity of internal control over financial reporting (ICFR) and disclosure
controls and procedures (DC&P). The changes address accounting policies
required for first-time adoption as well as ongoing IFRS reporting. Management
has not identified any significant changes to ICFR or DC&P.

Disclosure of entity-specific Financial Reporting
Expertise

The Company has identified the resource requirements to
establish appropriate IFRS financial reporting expertise at all levels of the
business. Training of finance and other staff has been completed.

The IFRS Conversion Project Manager meets with the Audit
Committee quarterly and informs the Committee on specifics of the project as
well as developments in IFRS. The Committee members follow the progress very
closely and have been informed of the timeline for implementation, expected
impacts of different accounting policies as well as costs of conversion.

Disclosure of entity-specific Business Activities

The Company is party to many contracts with suppliers and
customers. Following a detailed review of all contracts, it is not expected that
the conversion to IFRS will have a significant impact on any of these contracts.
The Company has no significant contracts, which include financial covenants.

As previously mentioned, IAS 21, The Effects of Changes in
Foreign Exchange Rates, will have an impact on the translation of the
Companys foreign operations to the presentation currency. Under Canadian GAAP,
certain foreign operations situated in Europe and the U.S. were considered to be
fully integrated entities with the Canadian dollar as their functional currency.
Under IFRS, the Company has determined that these foreign operations functional
currency is the euro or the US dollar. The change in functional currency will
have an impact on the consolidated balance sheet and statement of
operations.

Disclosure of entity-specific Information Technology and
Data Systems

The Company completed a detailed assessment of its IT systems
and has determined that the current systems are adequate for proper reporting
under IFRS. The systems allow the Company to track and report on all financial
information required under Canadian GAAP (required until September 24, 2011),
under IFRS (required as of September 25, 2011) and for the compilation of a
comparative year of financial information beginning September 26, 2010.

Tembec Financial Report 2011 47

---

Managements Discussion and Analysis

Significant Risks and Uncertainties

|PRODUCT PRICES
|--------------

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

Based on 2012 planned sales volumes, the following table
illustrates the approximate annual impact of changes to average Canadian dollar
selling prices on after-tax earnings:

|SELLING
      PRICE SENSITIVITY                   |  |                    |  | 
|------------------------------------------------- |  | ------------------ |  | 
|                                                  |  | Impact on          |  | 
|                                                  |  | after-tax earnings |  | 
|                                                  |  | ($ millions)       |  | 
|                                                  |  |                    |  | 
|Pulp - $25/tonne                                  |  | 22                 |  | 
|SPF lumber - $10/mbf                              |  | 8                  |  | 
|Paper and coated
      bleached board - $25/tonne |  | 7                  |  | 

The Companys strategy is to mitigate price volatility by
maintaining operations in three core sectors, namely wood products, pulp and
paper; maintaining low cost, high-quality flexible production facilities;
establishing and developing long-term relationships with its customers;
developing specialty niche products where possible. In addition, the Company may
periodically purchase lumber, pulp and newsprint derivative commodity contracts
to mitigate the impact of price volatility. At September 24, 2011, the Company
did not hold any significant product derivative commodity contracts, unchanged
from the prior year-end.

|FOREIGN EXCHANGE
|----------------

The Companys revenues for most of its products are affected by
fluctuations in the relative exchange rates of the Canadian dollar, the US dollar
and the euro. The prices for many products, including those sold in Canada and
Europe are generally driven by US $ reference prices of similar products. The
Company generates approximately $1.3 billion of US$ denominated sales annually
from its Canadian operations. As a result, any decrease in the value of the US
dollar relative to the Canadian dollar and the euro reduces the amount of
revenues realized on sales in local currency. In addition, since business units
purchase the majority of their production inputs in local currency, fluctuations
in foreign exchange can significantly affect the units relative cost position
when compared to competing manufacturing sites in other currency
jurisdictions.

Based on 2012 planned sales volumes and prices, the following
table illustrates the impact of a 1% change in the value of the US dollar versus
the Canadian dollar and the euro. For illustrative purposes, an increase of 1%
in the value of the US dollar is assumed. A decrease would have the opposite
effects of those shown below:

|FOREIGN EXCHANGE
      SENSITIVITY  |  |    | 
|----------------------------------- |  | -- | 
|(in millions of dollars)            |  |    | 
|Sales increase                      |  | 13 | 
|Cost of sales
      increase        |  | 3  | 
|EBITDA increase                     |  | 10 | 
|Interest expense
      increase     |  |   | 
|Cash flow increase                  |  | 10 | 
|Loss on US $ debt
      translation |  | 3  | 
|Pre-tax earnings increase           |  | 7  | 
|Tax expense
      increase          |  | 2  | 
|Net earnings
      increase         |  | 5  | 

48Tembec Financial Report 2011

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Managements Discussion and Analysis

Direct US $ purchases of raw materials, supplies and services
provide a partial offset to the impact on sales. This does not include the
potential indirect impact of currency on the cost of items purchased in the
local currency.

To potentially further reduce the impact of fluctuations in the
value of the US dollar, the Company has a policy, which permits hedging up to
50% of its anticipated US $ receipts for up to 36months in duration. At
September 24, 2011 and September 25, 2010, the Company did not hold any foreign
exchange contracts.

|OPERATIONAL RISKS
|-----------------

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

Fibre represents the Companys major raw material in the
production of wood products, pulp and paper. In Canada, virgin fibre or timber
is sourced primarily by agreements with provincial governments. The agreements
are granted for various terms from five to 25 years and are generally subject to
regular renewals every five years. The agreements incorporate commitments with
respect to sustainable forest management, silvicultural work, forest and soil
renewal, as well as cooperation with other forest users. In addition, the
Company has undertaken, on a voluntary basis, to have its timber harvesting
certified by the Forest Stewardship Council (FSC). The Company expects the
agreements to be extended as they come up for renewal. Aboriginal groups have
claimed substantial portions of land in various provinces over which they claim
aboriginal title or in which they have a traditional interest and for which they
are seeking compensation from various levels of government. The Company has
taken a proactive approach to enhance the economic participation of First Nations in its operations wherever feasible. The
Companys operation in France sources its fibre requirements from various
private sources, primarily through long-term supply arrangements.

Energy is an important component of mill costs, especially for
high-yield pulp mills and newsprint mills. In 2011, purchased energy costs
totalled approximately $130 million, 62% of which was electricity. Electrical
purchases are made primarily from large public utilities, at rates set by
regulating bodies. In certain jurisdictions, electricity is deregulated, which
can lead to greater price volatility. To mitigate the effect of price
fluctuations on its financial performance, the Company employs several tactics,
including the securing of longer term supply agreements, the purchase of
derivative commodity contracts and operational curtailments in periods of high
prices (load shedding). At September 2011 and September 2010, the Company did
not hold any derivative commodity contracts relating to purchased electricity.
Fossil fuels, primarily natural gas, are purchased at market rates. The Company
periodically purchases derivative commodity contracts to reduce its exposure. At
September 24, 2011 and September 25, 2010, the Company did not hold any natural
gas derivative commodity contracts.

Nearly all the Companys manufacturing units have a unionized
workforce. Over the past 30 years, the Company has successfully negotiated new
collective agreements in nearly all instances, with relatively few work
stoppages. At many of the Companys facilities, as well as those of the North
American industry as a whole, we have seen reductions in employment levels
resulting from technological and process improvements resulting in a workforce
with more years of service. This increases the relative costs of pensions and
benefits. At September 2011, the Company had approximately 3,250employees
covered by collective bargaining agreements. At September 24, 2011, there were
15 agreements covering 975employees that had expired. During fiscal2012, a total
of three agreements covering 375employees will expire. The remaining contracts
expire at various dates up to February2016. The Company anticipates it will
reach satisfactory agreements on contracts currently under active negotiations
and those expiring in the future.

Tembec Financial Report 2011 49

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Managements Discussion and Analysis

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

The production of lumber, pulp and paper is capital intensive.
The Company estimates that it must invest approximately $35million to $40
million per year on capital expenditures to avoid degradation of its current
operations. As the majority of the funding is provided by cash flow from
operations, there can be no assurance that the funds will be available to meet
all of the Companys capital expenditure needs. Failure to reinvest can lead to
older equipment that is less productive, less reliable and more costly to
maintain and operate. The risk of technological obsolescence also increases.
Capital expenditure projects can be large in scale, requiring the Company to
maintain and/or acquire expertise in the design, planning and execution of major
capital projects. There are inherent risks in the capital expenditure process,
including the potential for project cost overruns, new equipment that does not
perform to anticipated or projected levels, a lengthy start-up period and
disruptions to normal operations. Due to relatively low operating cash flow
generation over the last several years, the Company has limited capital
expenditures. This has led to a backlog of capital expenditure projects in
many operating facilities. The Company recently unveiled a large and
comprehensive capital expenditure program of approximately $500 million to be
spent over the next four to five years to modernize its facilities. As the
majority of the funding for the program is to be provided by operating cash
flows, there is a risk that the Company may experience delays in executing the
various projects or may not be able to complete all the projects included in the
program.

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

|TRADE RESTRICTIONS / LUMBER EXPORT TAXES
|----------------------------------------

The Companys manufacturing operations are located primarily in
Canada. However, sales into the Canadian market represented only 18% of
consolidated sales in 2011. As such, the Companys financial results are highly
dependent on its ability to sell its products into the export markets. Tariffs
and trade barriers that reduce or prohibit the movement of our products across
international borders constitute an ongoing risk. The agreement between Canada
and the United States over softwood lumber is a case in point. On October 12,
2006, Canada and the United States entered into an agreement to govern the
shipment of Canadian softwood lumber into the United States. The outcome was
less than satisfactory. Through a combination of quotas and export taxes, the
agreement will ensure that Canadian producers of softwood lumber will remain at
a competitive disadvantage versus U.S. producers when it comes to accessing the
U.S. market.

|FINANCIAL RISKS / DEBT SERVICE
|------------------------------

Of the total long-term debt of $302 million, 87% relates to the
US $255 million senior secured notes maturing December2018. The notes do not
require periodic payments for principal amortization. Since the entire principal
amount will become due on the maturity date, it is possible the Company will not
have the required funds/liquidity to repay the principal due. The Company may
require access to the public or private debt markets to issue new debt
instruments to replace or partially replace the notes. There is no assurance
that the Company will be able to refinance the notes on commercially acceptable
terms. The Companys objective is to maintain a relatively low debt level.

50Tembec Financial Report 2011

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Managements Discussion and Analysis

Evaluation of Disclosure Controls and
Procedures

The Companys President and Chief Executive Officer and the
Companys Executive Vice President, Finance and Chief Financial Officer have
designed, or caused to be designed under their supervision, disclosure controls
and procedures to provide reasonable assurance that material information
relating to the Company has been made known to them and that information
required to be disclosed in the Companys annual filings, interim filings or
other reports filed by it or submitted by it under securities legislation is
recorded, processed, summarized and reported within the time periods specified by
applicable securities legislation. The Companys President and Chief Executive
Officer and the Companys Executive Vice President, Finance and Chief Financial
Officer have evaluated, or caused to be evaluated under their supervision, the
effectiveness of the Companys disclosure controls and procedures and have
determined, based on that evaluation, that such disclosure controls and
procedures are effective at the financial year-end.

Internal Control Over Financial
Reporting

The Companys President and Chief Executive Officer and the
Companys Executive Vice President, Finance and Chief Financial Officer have
designed, or have caused to be designed under their supervision, internal
control over financial reporting as defined under National Instrument 52-109 
Certification of Disclosure in Issuers Annual and Interim Filings, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
GAAP. The Companys President and Chief Executive Officer and the Companys Executive Vice
President, Finance and Chief Financial Officer have evaluated, or caused to be
evaluated under their super vision, the effectiveness of the Companys internal
control over financial reporting and have determined, based on the criteria
established in Enterprise Risk Management  Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and on this
evaluation, that such internal controls over financial reporting are effective
at the financial year-end.

Changes in Internal Controls

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

Oversight Role of Audit Committee and Board of
Directors

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

Additional Information

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

Tembec Financial Report 2011 51

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ManagementResponsibility

The consolidated financial statements and all information in
the Financial Report are the responsibility of the Companys management. The
consolidated financial statements have been prepared by management in accordance
with Canadian Generally Accepted Accounting Principles (GAAP) and, where
necessary, include amounts which are based on best estimates and judgement.
Financial information presented throughout the Financial Report is consistent
with the data presented in the consolidated financial statements.

A system of internal accounting and administrative controls is
maintained by management in order to provide reasonable assurance that
transactions are appropriately authorized, assets are safeguarded and financial
records are properly maintained to provide accurate and reliable financial
statements.

The Companys external auditors are responsible for auditing
the consolidated financial statements and giving an opinion thereon. The
external auditor also reports any internal control weaknesses identified during
the course of the quarterly reviews and the annual audit. In addition, the
Company employs internal auditors to evaluate the effectiveness of its systems,
policies and procedures.

The Board of Directors has appointed an Audit Committee,
consisting solely of independent directors, which reviews the consolidated
financial statements and recommends their approval to the Board of Directors.
The Committee meets periodically with the external auditors, the internal
auditors and management to review their respective activities and the discharge
of each of their responsibilities. Both the external and internal auditors have
direct access to the Committee to discuss the scope of their audit work and the
adequacy of internal control systems and financial reporting procedures.

The accompanying consolidated financial statements have been
audited by the external auditors, KPMG LLP, whose report follows.

|                                      |                                                                    
|------------------------------------- | -------------------------------------------------------------------
|JAMES M. LOPEZ                        | MICHEL J. DUMAS                                                    
|President and Chief Executive Officer | Executive Vice President, Finance and Chief
      Financial Officer

November 29, 2011



52Tembec Financial Report 2011

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