---

Exhibit 99.3

IndependentAuditors
Report

To the Shareholders

We have audited the accompanying consolidated financial
statements of Tembec Inc., which comprise the consolidated balance sheets as at
September 24, 2011 and September 25, 2010, the consolidated statements of
operations and deficit and cash flows for the years then ended, and notes,
comprising a summary of significant accounting policies and other explanatory
information.

Managements Responsibility for the Consolidated Financial
StatementsManagement is responsible for the preparation and fair
presentation of these consolidated financial statements in accordance with
Canadian generally accepted accounting principles, and for such internal control
as management determines is necessary to enable the preparation of consolidated
financial statements that are free from material misstatement, whether due to
fraud or error.

Auditors ResponsibilityOur responsibility is to
express an opinion on these consolidated financial statements based on our
audits. We conducted our audits in accordance with Canadian generally accepted
auditing standards. Those standards require that we comply with ethical
requirements and plan and perform the audit to obtain reasonable assurance about
whether the consolidated financial statements are free from material
misstatement.

An audit involves performing procedures to obtain audit
evidence about the amounts and disclosures in the consolidated financial
statements. The procedures selected depend on our judgment, including the
assessment of the risks of material misstatement of the consolidated financial
statements, whether due to fraud or error. In making those risk assessments, we
consider internal control relevant to the entitys preparation and fair
presentation of the consolidated financial statements in order to design audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the entitys internal control. An
audit also includes evaluating the appropriateness of accounting policies used
and the reasonableness of accounting estimates made by management, as well as
evaluating the overall presentation of the consolidated financial statements.

We believe that the audit evidence we have obtained in our
audits is sufficient and appropriate to provide a basis for our audit
opinion.

OpinionIn our opinion, the consolidated financial
statements present fairly, in all material respects, the consolidated financial
position of Tembec Inc. as at September 24, 2011 and September 25, 2010, and its
consolidated results of operations and its consolidated cash flows for the years
then ended in accordance with Canadian generally accepted accounting
principles.

Montreal, Canada November 29, 2011

* CA Auditor permit no. 14114

Tembec Financial Report 2011 53

---

Consolidated Financial Statements

|CONSOLIDATED
      BALANCE SHEETS              
|-----------------------------------------------
|As at September 24, 2011 and September 25, 2010
|(in millions of Canadian dollars)              

|                                                 |   | 2011  |   |   | 2010  |  
|------------------------------------------------ | - | ----- | - | - | ----- | -
|ASSETS                                           |   |       |   |   |       |  
|Current assets:                                  |   |       |   |   |       |  
|Cash and cash equivalents                        | $ | 99    |   | $ | 68    |  
|Cash held in trust (note 11)                     |   | 6     |   |   | 6     |  
|Accounts receivable (notes 6 and 15)             |   | 182   |   |   | 209   |  
|Inventories (notes 3 and 6)                      |   | 261   |   |   | 255   |  
|Prepaid expenses                                 |   | 6     |   |   | 7     |  
|                                                 |   | 554   |   |   | 545   |  
|                                                 |   |       |   |   |       |  
|Fixed assets (note 4)                            |   | 493   |   |   | 498   |  
|Other assets (note 5)                            |   | 44    |   |   | 34    |  
|Future income
      taxes (note 13)              |   | 16    |   |   | 27    |  
|                                                 | $ | 1,107 |   | $ | 1,104 |  
|                                                 |   |       |   |   |       |  
|LIABILITIES AND SHAREHOLDERS EQUITY             |   |       |   |   |       |  
|Current liabilities:                             |   |       |   |   |       |  
|Operating bank loans (note 6)                    | $ | 6     |   | $ | 1     |  
|Accounts payable and accrued charges             |   | 254   |   |   | 238   |  
|Interest payable                                 |   | 8     |   |   | 3     |  
|Current portion of
      long-term debt (note 7) |   | 18    |   |   | 17    |  
|                                                 |   | 286   |   |   | 259   |  
|                                                 |   |       |   |   |       |  
|Long-term debt (note 7)                          |   | 271   |   |   | 271   |  
|Other long-term liabilities and credits (note 8) |   | 188   |   |   | 209   |  
|                                                 |   |       |   |   |       |  
|Shareholders equity:                            |   |       |   |   |       |  
|Share capital (note 9)                           |   | 570   |   |   | 570   |  
|Contributed surplus                              |   | 5     |   |   | 5     |  
|Deficit                                          |   | (213  | ) |   | (210  | )
|                                                 |   | 362   |   |   | 365   |  
|                                                 | $ | 1,107 |   | $ | 1,104 |  

Guarantees, commitments and contingencies (note 10)
Subsequent events (note 18) See accompanying notes to consolidated
financial statements.

On behalf of the Board:

|                      |                                      
|--------------------- | -------------------------------------
|James V. Continenza   | James M. Lopez                       
|Chairman of the Board | President and Chief Executive Officer

54Tembec Financial Report 2011

---

Consolidated Financial Statements

|CONSOLIDATED
      STATEMENTS OF OPERATIONS AND DEFICIT  
|---------------------------------------------------------
|Years ended September 24, 2011 and September 25, 2010    
|(in millions of Canadian dollars, unless otherwise noted)

|                                                                      |   | 2011  |   |   | 2010  |  
|--------------------------------------------------------------------- | - | ----- | - | - | ----- | -
|Sales                                                                 | $ | 1,743 |   | $ | 1,877 |  
|                                                                      |   |       |   |   |       |  
|Freight and other deductions                                          |   | 237   |   |   | 234   |  
|Lumber export taxes (note 10)                                         |   | 13    |   |   | 10    |  
|Cost of sales (excluding depreciation and amortization)               |   | 1,324 |   |   | 1,426 |  
|Selling, general and administrative                                   |   | 72    |   |   | 73    |  
|Share-based compensation (note 9)                                     |   | 2     |   |   | 2     |  
|Depreciation and amortization                                         |   | 45    |   |   | 56    |  
|Other items (note
      11)                                           |   | 1     |   |   | 13    |  
|Operating earnings                                                    |   | 49    |   |   | 63    |  
|                                                                      |   |       |   |   |       |  
|Interest, foreign exchange and other (note 12)                        |   | 32    |   |   | 51    |  
|                                                                      |   |       |   |   |       |  
|Exchange loss
      (gain) on long-term debt                          |   | 1     |   |   | (27   | )
|Earnings before income taxes and non-controlling interest             |   | 16    |   |   | 39    |  
|                                                                      |   |       |   |   |       |  
|Income tax expense (recovery) (note 13)                               |   | 19    |   |   | (15   | )
|                                                                      |   |       |   |   |       |  
|Non-controlling
      interest                                        |   |      |   |   | 2     |  
|Net earnings (loss) and comprehensive earnings (loss)                 |   | (3    | ) |   | 52    |  
|                                                                      |   |       |   |   |       |  
|Deficit, beginning
      of year                                      |   | (210  | ) |   | (262  | )
|Deficit, end of
      year                                            | $ | (213  | ) | $ | (210  | )
|Basic and diluted
      earnings (loss) in dollars per share (note 9) | $ | (0.03 | ) | $ | 0.52  |  

See accompanying notes to consolidated financial
statements.

Tembec Financial Report 2011 55

---

Consolidated Financial Statements

|CONSOLIDATED
      STATEMENTS OF CASH FLOWS          
|-----------------------------------------------------
|Years ended September 24, 2011 and September 25, 2010
|(in millions of Canadian dollars)                    

|                                                             |   | 2011 |   |   | 2010 |  
|------------------------------------------------------------ | - | ---- | - | - | ---- | -
|Cash flows from operating activities:                        |   |      |   |   |      |  
|Net earnings (loss)                                          | $ | (3   | ) | $ | 52   |  
|Adjustments for:                                             |   |      |   |   |      |  
|Depreciation and amortization                                |   | 45   |   |   | 56   |  
|Unrealized foreign exchange and other                        |   | (2   | ) |   | (1   | )
|Exchange loss (gain) on long-term debt                       |   | 1    |   |   | (27  | )
|Future income tax expense (recovery) (note 13)               |   | 11   |   |   | (15  | )
|Other items (note 11)                                        |   | (11  | ) |   | 13   |  
|Excess cash contributions over pension expense               |   | (20  | ) |   | (20  | )
|Other                                                        |   | (1   | ) |   |     |  
|                                                             |   | 20   |   |   | 58   |  
|Changes in non-cash working capital:                         |   |      |   |   |      |  
|Accounts receivable                                          |   | 33   |   |   | (41  | )
|Inventories                                                  |   | (6   | ) |   | 16   |  
|Prepaid expenses                                             |   | 1    |   |   | 5    |  
|Accounts payable,
      accrued charges and interest payable |   | 21   |   |   | 40   |  
|                                                             |   | 49   |   |   | 20   |  
|                                                             |   | 69   |   |   | 78   |  
|Cash flows from investing activities:                        |   |      |   |   |      |  
|Additions to fixed assets                                    |   | (55  | ) |   | (25  | )
|Proceeds on land sales and other                             |   | 17   |   |   | 7    |  
|Proceeds on sale of French mills (note 11)                   |   |     |   |   | 86   |  
|Other                                                        |   | (5   | ) |   | (1   | )
|                                                             |   | (43  | ) |   | 67   |  
|Cash flows from financing activities:                        |   |      |   |   |      |  
|Change in operating bank loans                               |   | 5    |   |   | (117 | )
|Cash held in trust (note 11)                                 |   |     |   |   | (6   | )
|Increase in long-term debt                                   |   | 8    |   |   | 272  |  
|Repayments of long-term debt                                 |   | (8   | ) |   | (318 | )
|Change in other long-term liabilities                        |   | (1   | ) |   | 2    |  
|Financing costs
      and other                              |   | 1    |   |   | (15  | )
|                                                             |   | 5    |   |   | (182 | )
|Net increase (decrease) in cash and cash equivalents         |   | 31   |   |   | (37  | )
|Cash and cash
      equivalents, beginning of year           |   | 68   |   |   | 105  |  
|Cash and cash
      equivalents, end of year                 | $ | 99   |   | $ | 68   |  

Interest paid in 2011 totalled $25 million ($29 million in
2010) and income taxes paid amounted to $1 million (nil in 2010). See
accompanying notes to consolidated financial statements.

56Tembec Financial Report 2011

---

Consolidated Financial Statements

|CONSOLIDATED
      BUSINESS SEGMENT INFORMATION      
|-----------------------------------------------------
|Years ended September 24, 2011 and September 25, 2010
|(in millions of Canadian dollars)                    

2011Forest
    
    
    Dissolving &
    
    
    High-Yield
    
    
    
    
    
    CorporateProducts
    
    
    Chemical Pulp
    
    
    Pulp
    
    
    Paper
    
    
    & Other
    
    
    ConsolidatedSales:External
    $
    375
    
    $
    681
    
    $
    348
    
    $
    339
    
    $
    
    
    $
    1,743Internal
    
    96
    
    
    12
    
    
    30
    
    
    
    
    
    7
    
    
    145471
    
    
    693
    
    
    378
    
    
    339
    
    
    7
    
    
    1,888Earnings (loss) before the following:
    
    (46
    )
    
    138
    
    
    (4
    )
    
    28
    
    
    (21
    )
    
    95Depreciation and amortization
    
    13
    
    
    18
    
    
    10
    
    
    3
    
    
    1
    
    
    45Other items (note
      11)
    
    4
    
    
    
    
    
    
    
    
    
    
    
    (3
    )
    
    1Operating earnings
      (loss)
    
    (63
    )
    
    120
    
    
    (14
    )
    
    25
    
    
    (19
    )
    
    49Net fixed asset
      additions
    
    10
    
    
    38
    
    
    3
    
    
    4
    
    
    
    
    
    55Identifiable assets  excluding cash and cash equivalents
    
    264
    
    
    437
    
    
    174
    
    
    119
    
    
    14
    
    
    1,008Cash and cash
      equivalents
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    99Total assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    1,107


2010Forest
    
    
    Dissolving &
    
    
    High-Yield
    
    
    
    
    
    CorporateProducts
    
    
    Chemical Pulp
    
    
    Pulp
    
    
    Paper
    
    
    & Other
    
    
    ConsolidatedSales:External
    $
    346
    
    $
    816
    
    $
    367
    
    $
    348
    
    $
    
    
    $
    1,877Internal
    
    88
    
    
    14
    
    
    28
    
    
    
    
    
    5
    
    
    135434
    
    
    830
    
    
    395
    
    
    348
    
    
    5
    
    
    2,012Earnings (loss) before the following:
    
    (10
    )
    
    120
    
    
    47
    
    
    (2
    )
    
    (23
    )
    
    132Depreciation and amortization
    
    16
    
    
    27
    
    
    10
    
    
    3
    
    
    
    
    
    56Other items (note
      11)
    
    (2
    )
    
    (12
    )
    
    
    
    
    7
    
    
    20
    
    
    13Operating earnings
      (loss)
    
    (24
    )
    
    105
    
    
    37
    
    
    (12
    )
    
    (43
    )
    
    63Net fixed asset
      additions
    
    7
    
    
    12
    
    
    3
    
    
    3
    
    
    
    
    
    25Identifiable assets  excluding cash and cash equivalents
    
    241
    
    
    444
    
    
    213
    
    
    123
    
    
    15
    
    
    1,036Cash and cash
      equivalents
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    68Total assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    1,104


Tembec Financial Report 2011 57

---

Consolidated Financial Statements

|CONSOLIDATED
      GEOGRAPHIC AREA INFORMATION       
|-----------------------------------------------------
|Years ended September 24, 2011 and September 25, 2010
|(in millions of Canadian dollars)                    

2011Forest
    
    
    Dissolving &
    
    
    High-YieldProducts
    
    
    Chemical Pulp
    
    
    Pulp
    
    
    Paper
    
    
    ConsolidatedSales (by final destination):Canada
    $
    208
    
    $
    52
    
    $
    2
    
    $
    59
    
    $
    321United States
    
    146
    
    
    191
    
    
    2
    
    
    252
    
    
    591China
    
    15
    
    
    158
    
    
    170
    
    
    
    
    
    343European Union
    
    1
    
    
    195
    
    
    55
    
    
    11
    
    
    262Other
    
    5
    
    
    85
    
    
    119
    
    
    17
    
    
    226$
    375
    
    $
    681
    
    $
    348
    
    $
    339
    
    $
    1,743


2010Forest
    
    
    Dissolving &
    
    
    High-YieldProducts
    
    
    Chemical Pulp
    
    
    Pulp
    
    
    Paper
    
    
    ConsolidatedSales (by final destination):Canada
    $
    212
    
    $
    81
    
    $
    4
    
    $
    70
    
    $
    367United States
    
    126
    
    
    193
    
    
    4
    
    
    259
    
    
    582China
    
    4
    
    
    93
    
    
    211
    
    
    
    
    
    308European Union
    
    1
    
    
    338
    
    
    59
    
    
    6
    
    
    404Other
    
    3
    
    
    111
    
    
    89
    
    
    13
    
    
    216$
    346
    
    $
    816
    
    $
    367
    
    $
    348
    
    $
    1,8772011
    
    
    2010Fixed assets:Canada
    
    
    
    
    
    
    
    
    
    $
    402
    
    $
    419France
    
    
    
    
    
    
    
    
    
    
    89
    
    
    76Other
    
    
    
    
    
    
    
    
    
    
    2
    
    
    3$
    493
    
    $
    498


58Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements (in millions of
Canadian dollars, unless otherwise noted)

BUSINESS OF THE COMPANY

The Company operates an integrated forest products business.
The performance of each segment is evaluated by the management of the Company
against short-term and long-term financial objectives as well as environmental,
safety and other key criteria. During the December 2010 quarter, the Company
reorganized its internal reporting structure. Prior to the changes, the Company
had reported its financial results based on five reportable segments: Forest
Products, Pulp, Paper, Chemicals, and Corporate. The Pulp segment included six
pulp mills. Subsequent to the organizational changes, the Pulp segment has been
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
chemical product sales are related to byproducts generated by the two dissolving
pulp mills. The Forest Products, Paper and Corporate segments were unaffected by
the organizational changes. The Forest Products segment consists primarily of
forest and sawmill operations, which produce lumber and building materials. The
Dissolving and Chemical Pulp segment consists primarily of manufacturing and
marketing activities of dissolving and chemical pulps including the
transformation and sale of resins and pulp by-products. The High-Yield Pulp
segment includes the manufacturing and marketing activities of high-yield pulps.
The Paper segment consists primarily of production and sales of coated bleached
board and newsprint. Intersegment transfers of wood chips, pulp and other
services are recorded at transfer prices agreed to by the parties, which are
intended to approximate fair market value. The accounting policies used in these
business segments are the same as those described in Note 1. Comparative prior
period segment information has been restated to conform with the new segment
presentation.

|1. SIGNIFICANT ACCOUNTING POLICIES
|----------------------------------

BASIS OF CONSOLIDATION

These consolidated financial statements are prepared in
accordance with Canadian Generally Accepted Accounting Principles (GAAP) and
include the accounts of the Company, Tembec Inc. (the Corporation), and all
its subsidiaries (collectively Tembec or the Company). Investments over
which the Corporation has effective control are fully consolidated.

USE OF ESTIMATES

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

REVENUE

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

Tembec Financial Report 2011 59

---

Notes to Consolidated Financial Statements

|1. SIGNIFICANT ACCOUNTING POLICIES(CONTINUED)
|---------------------------------------------

FINANCIAL INSTRUMENTS

The Company classifies its cash and cash equivalents as
held-for-trading. Accounts receivable and long-term receivables are classified
as loans and receivables. Bank indebtedness, operating bank loans, accounts
payable and accrued charges, interest payable and long-term debt are classified
as other liabilities, all of which are measured at amortized cost. The Company
measures all derivatives and embedded derivatives at fair value and the Company
has maintained its policy not to use hedge accounting.

Transaction costs incurred upon the issuance of debt
instruments or modification of a financial liability are deducted from the
financial liability and are amortized using the effective interest method over
the expected life of the related liability.

In establishing the fair value of financial assets and
liabilities measured at fair value on a recurring basis, the Company uses a
hierarchy based on the following levels:

| | Level 1: defined as observable inputs such as quoted prices in active
  markets.                                                                         
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                          
| | Level 2: defined as inputs other than quoted prices in active markets that
  are either directly or indirectly observable.                               
| |                                                                                                                                                          
| | Level 3: defined as inputs that are based on little or no observable
  market data and, therefore, requiring entities to develop their own
  assumptions.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents, including cash on hand, demand
deposits, bankers acceptances and commercial paper with maturities of three
months or less from date of purchase, are recorded at fair value.

INVENTORIES

Finished goods, work in process, wood chips, logs and other raw
materials are valued at the lower of cost, determined on an average cost basis,
and net realizable value. For all raw materials to be used in the production of
finished goods, net realizable value is determined on an as converted to
finished goods basis. Operating, maintenance and spare parts inventories are
valued at lower of cost and net realizable value.

60Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|1. SIGNIFICANT ACCOUNTING POLICIES(CONTINUED)
|---------------------------------------------

FIXED ASSETS AND GOVERNMENT ASSISTANCE

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

Assets
    
    PeriodBuildings
    
    20  30 yearsProduction equipment:Pulp and paper
    
    20  30 yearsSawmill
    
    10  15 yearsForest access
      roads
    
    3  20 years


Assets under construction are recognized at cost and are not
depreciated as the assets are not available for use. Repairs and maintenance as
well as planned shutdown maintenance are charged to expense as incurred.

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

IMPAIRMENT OF LONG-LIVED ASSETS

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

ENVIRONMENTAL COSTS

The Company is subject to environmental laws and regulations
enacted by federal, provincial, state and local authorities. Environmental
expenditures that relate to current operations are expensed or capitalized as
appropriate. Expenditures that relate to an existing condition caused by past
operations and that are not expected to contribute to current or future
operations are expensed. Liabilities are recorded when environmental assessments
and/or remedial efforts are likely, and when the costs, based on a specific plan
of action in terms of the technology to be used and the extent of the corrective
action required, can be reasonably estimated.

ASSET RETIREMENT OBLIGATIONS

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

Tembec Financial Report 2011 61

---

Notes to Consolidated Financial Statements

|1. SIGNIFICANT ACCOUNTING POLICIES(CONTINUED)
|---------------------------------------------

EMPLOYEE FUTURE BENEFITS

Employee future benefits include pension plans and other
employee future benefit plans. Other employee future benefit plans include
post-retirement life insurance programs, healthcare and dental care benefits as
well as certain post-employment benefits provided to disabled employees.
Registered pension plans are funded in accordance with applicable legislation
and their assets are held by an independent trustee. The obligations of
non-registered pension plans and other employee future benefit plans are funded
by the Company as they become due.

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

| | The cost of employee future benefits provided in exchange for employees
  services rendered during the year;                                                                                                                                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | The interest cost on employee future benefit obligations;                                                                                                                                                                                                                                                                                                                                                                                   
| |                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | The expected return on pension fund assets based on the fair value of plan
  assets;                                                                                                                                                                                                                                                                                                                                                        
| |                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | Gains or losses on settlements or curtailments where, when the
  restructuring of a defined benefit plan gives rise to both a curtailment and a
  settlement of obligations, the curtailment is accounted for prior to the
  settlement;                                                                                                                                                                                                    
| |                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | The straight-line amortization of past service costs and plan amendments
  over the average remaining service period to full eligibility of the active
  employee group covered by the defined benefit plans or the average remaining
  lifetime of those entitled to benefits for plans covering only inactive
  participants; and                                                                                                         
| |                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | The amortization of cumulative unrecognized net actuarial gains and losses
  in excess of 10% of the greater of the accrued benefit obligation or fair
  value of plan assets at the beginning of the year, over the average remaining
  service period of the active employee group covered by the defined benefit
  plans or the average remaining lifetime of those entitled to benefits for
  plans covering only inactive participants.

The employee future benefit obligations are determined in
accordance with the projected benefit method prorated on services, which
incorporates managements best estimate of future salary levels, other cost
escalations, retirement ages of employees and actuarial factors.

TRANSLATION OF FOREIGN CURRENCIES

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

62Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|1. SIGNIFICANT ACCOUNTING POLICIES(CONTINUED)
|---------------------------------------------

INCOME TAXES

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

INVESTMENT TAX CREDITS AND GOVERNMENT ASSISTANCE

Amounts received resulting from government assistance programs,
including grants and investment tax credits for scientific research and
experimental development, are reflected as a reduction of the cost of the asset
or expense to which they relate at the time the eligible expenditure is
incurred. Government financial assistance is recorded when there is reasonable
assurance that the Company will comply with relevant conditions. Investment tax
credits are recognized when the Company has made the qualifying expenditures and
there is reasonable assurance that the credits will be realized.

SHARE-BASED COMPENSATION PLANS

The Company uses the fair value based approach of accounting
for all share options granted to its employees, whereby a compensation expense
is recognized over the vesting period of the options, with a corresponding
increase to contributed surplus. The Company bases the accruals of compensation
cost on the best available estimate of the number of options that are expected
to vest and revises that estimate if subsequent information indicates that
actual forfeitures are likely to differ from initial estimates. Any
consideration paid by plan participants in the exercise of share options or
purchase of shares is credited to share capital. The contributed surplus
component of share-based compensation is transferred to share capital upon the
issuance of common shares.

Deferred Share Units (DSU) are recognized in compensation
expense and accrued liabilities as they are awarded. DSUs are remeasured at each
reporting period, until settlement, using the trading price of the common shares
of the Company.

Performance Conditioned Restricted Share Units (PCRSU) are
recognized in compensation expense and accrued liabilities when it is likely
that the performance conditions attached to the unit will be met. Compensation
cost is prorated based on the underlying service period and the liability is
remeasured at each reporting period, until settlement, using the trading price
of the common shares of the Company.

Tembec Financial Report 2011 63

---

Notes to Consolidated Financial Statements

|1. SIGNIFICANT ACCOUNTING POLICIES(CONTINUED)
|---------------------------------------------

DERIVATIVE FINANCIAL INSTRUMENTS

The Company manages, from time to time, its foreign exchange
exposure on anticipated net cash inflows, principally US dollars and euros,
through the use of options and forward contracts.

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

The Company does not currently apply hedge accounting for these
derivative financial instruments. These are measured at fair value, with changes
in fair value recognized in earnings.

FREIGHT AND OTHER DEDUCTIONS

Freight associated with shipping products to customer and
handling finished goods as well as discounts on prompt payment are included in
freight and other deductions in the consolidated statements of operations and
deficit.

|2. TRANSITION TO INTERNATIONAL FINANCIAL REPORTING
      STANDARDS
|------------------------------------------------------------------

On February 13, 2008, the Accounting Standards Board of Canada
(AcSB) confirmed that publicly accountable entities would be required to apply,
and report in accordance with International Financial Reporting Standards
(IFRS), in full and without modification, effective in 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 September 25, 2011 (the Changeover
date). In the Companys reporting in those periods following the Changeover
date, the Company will be required to present comparative data for equivalent
periods in the previous fiscal year, making September 26, 2010, the Transition
date for the Company.

The Company has identified those areas that will be impacted by
changes in accounting policy and made policy electionswhere they are
required to be made either specifically at the Transition date or on a
prospective basis. The areas that are most impacted for the Company are:
property, plant, and equipment; employee future benefits; biological assets;
warrants; provisions; and contributed surplus.

Management is finalizing the determination of the impact of the
application of IFRS on the financial statements.

64Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|3. INVENTORIES
|--------------

|                             |   | 2011 |  |   | 2010 | 
|---------------------------- | - | ---- |  | - | ---- | 
|Finished goods               | $ | 112  |  | $ | 111  | 
|Logs and wood chips          |   | 66   |  |   | 64   | 
|Supplies and
      materials |   | 83   |  |   | 80   | 
|                             | $ | 261  |  | $ | 255  | 

Cost of sales consists primarily of inventories recognized as
an expense for fiscal 2011 and fiscal 2010.

The provision for net realizable values relating to logs and
finished goods were as follows:

|                             |   | 2011 |  |   | 2010 | 
|---------------------------- | - | ---- |  | - | ---- | 
|Forest Products              | $ | 3    |  | $ | 4    | 
|Dissolving and Chemical Pulp |   |     |  |   |     | 
|High-Yield Pulp              |   | 1    |  |   |     | 
|Paper                        |   |     |  |   |     | 
|                             | $ | 4    |  | $ | 4    | 

|4. FIXED ASSETS
|---------------

2011
    
    
    
    
    
    
    
    
    2010Accumulated
    
    
    Net
    
    
    
    
    
    Accumulated
    
    
    NetCost
    
    
    depreciation
    
    
    book value
    
    
    Cost
    
    
    depreciation
    
    
    book valueLand
    $
    12
    
    $
    
    
    $
    12
    
    $
    12
    
    $
    
    
    $
    12Buildings
    
    79
    
    
    19
    
    
    60
    
    
    76
    
    
    13
    
    
    63Production equipment:Pulp and paper
    
    439
    
    
    102
    
    
    337
    
    
    441
    
    
    81
    
    
    360Sawmill
    
    92
    
    
    61
    
    
    31
    
    
    91
    
    
    50
    
    
    41Forest access roads
    
    17
    
    
    1
    
    
    16
    
    
    11
    
    
    
    
    
    11Assets under
      construction
    
    37
    
    
    
    
    
    37
    
    
    11
    
    
    
    
    
    11$
    676
    
    $
    183
    
    $
    493
    
    $
    642
    
    $
    144
    
    $
    498


Tembec Financial Report 2011 65

---

Notes to Consolidated Financial Statements

|5. OTHER ASSETS
|---------------

|                                 |   | 2011 |  |   | 2010 | 
|-------------------------------- | - | ---- |  | - | ---- | 
|Loan receivable  Temlam         | $ | 23   |  | $ | 23   | 
|Deferred pension costs (note 14) |   | 16   |  |   | 6    | 
|Long-term loans to employees     |   | 1    |  |   | 2    | 
|Notes receivable                 |   |     |  |   | 2    | 
|Other                            |   | 4    |  |   | 1    | 
|                                 | $ | 44   |  | $ | 34   | 

In October 2008, the Company assumed the rank of secured lender
to the Temlam LVL mill by effecting a payment of $22 million plus $1 million of
custodial fees. The Company retains a 50% ownership position in the LVL mill
that remains idle. Improvements in the U.S. housing market will be required
before operations can resume or the Company can monetize the loan.

|6. OPERATING BANK LOANS
|-----------------------

On March 4, 2011, the Company entered into a new $200 million
asset-based revolving five-year working capital facility expiring in February
2016. The new facility effectively replaces the prior $205 million revolving
working capital facility due to expire in December 2011. The new facility has a
first priority charge over the receivables and inventories of the Companys
Canadian operations. As at September 24, 2011, the amount available and unused,
based on eligible receivables and inventories, was $140million of which $34
million was reserved for letters of credit. Interest is calculated based either
on the BA Rate, the LIBOR, the Canadian Prime Rate or the U.S. Base Rate, as the
case may be, plus an applicable margin.

The French operations are supported by receivable factoring
agreements. As such, the borrowing base fluctuates periodically, depending on
shipments and cash receipts. At the end of September 2011, the amount available
was $18 million (2010 - $25million) net of borrowings of $6 million (2010 - $1
million).

66Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|7. LONG-TERM DEBT
|-----------------

|                                                                                                                                                                          |   | 2011 |  |   | 2010 | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | - | ---- |  | - | ---- | 
|Tembec Inc.                                                                                                                                                               |   |      |  |   |      | 
|6% unsecured notes, repayable in semi-annual instalments of
      $2 million beginning March 30, 2008, with the balance due on September 30,
      2012                   | $ | 5    |  | $ | 9    | 
|Other                                                                                                                                                                     |   | 2    |  |   | 2    | 
|                                                                                                                                                                          |   |      |  |   |      | 
|Tembec Industries Inc.                                                                                                                                                    |   |      |  |   |      | 
|11.25% senior secured notes US $255 million, due December
      15, 2018, with semi-annual interest payments due June 15 and December 15
      of each year               |   | 262  |  |   | 261  | 
|                                                                                                                                                                          |   |      |  |   |      | 
|Tembec Tartas SAS                                                                                                                                                         |   |      |  |   |      | 
|Secured term loans € 5 million, bearing interest at EURIBOR
      plus 2%, repayable in quarterly instalments beginning in March 2012 and
      maturing in December 2017 |   | 7    |  |   |     | 
|Unsecured term loans € 12 million, non-interest bearing,
      repayable and maturing at various dates from June 2014 to September 2020                                   |   | 17   |  |   | 12   | 
|Other                                                                                                                                                                     |   | 1    |  |   | 2    | 
|                                                                                                                                                                          |   |      |  |   |      | 
|Tembec Envirofinance SAS                                                                                                                                                  |   |     |  |   | 7    | 
|                                                                                                                                                                          |   |      |  |   |      | 
|Kirkland Lake
      Engineered Wood Products Inc.                                                                                                                         |   | 8    |  |   | 8    | 
|                                                                                                                                                                          | $ | 302  |  | $ | 301  | 
|                                                                                                                                                                          |   |      |  |   |      | 
|Less current portion                                                                                                                                                      |   | 18   |  |   | 17   | 
|Less unamortized
      financing costs                                                                                                                                    |   | 13   |  |   | 13   | 
|                                                                                                                                                                          | $ | 271  |  | $ | 271  | 

On August 17, 2010, the Company completed a private offering of
US $255 million in aggregate principal amount of 11.25% senior secured notes
(the Notes) due December 15, 2018. The notes are senior obligations secured by
a first priority lien on certain of the property and assets of the Company and
the guarantors of the notes, other than receivables, inventory and certain
intangibles upon which the note holders have a second priority lien. The notes
are guaranteed by the Company and certain of its subsidiaries. The proceeds from
the offering, together with cash on hand, were used to permanently repay all
outstanding indebtedness under the previous US $300 million term loan facility,
to pay prepayment premiums in connection therewith and to pay fees and expenses
related to the offering.

The Company entered into a registration rights agreement with
the initial purchasers pursuant to which they have agreed to use commercially
reasonable efforts to register with the SEC, new notes having substantially
identical terms as the Notes. The exchange offer and the registration of the new
notes with the SEC were completed on March 31, 2011.

Tembec Financial Report 2011 67

---

Notes to Consolidated Financial Statements

|7. LONG-TERM DEBT(CONTINUED)
|----------------------------

Instalments on consolidated long-term debt for the five years
following September 24, 2011, are as follows:

|2012 | $ | 18 | 
|---- | - | -- | 
|2013 | $ | 6  | 
|2014 | $ | 5  | 
|2015 | $ | 5  | 
|2016 | $ | 4  | 

|8. OTHER LONG-TERM LIABILITIES AND CREDITS
|------------------------------------------

|                                                            |   | 2011 |  |   | 2010 | 
|----------------------------------------------------------- | - | ---- |  | - | ---- | 
|Accrued benefit liability - pension benefit plans (note 14) | $ | 119  |  | $ | 130  | 
|Accrued benefit liability - other benefit plans (note 14)   |   | 50   |  |   | 57   | 
|Reforestation                                               |   | 9    |  |   | 9    | 
|Environmental and other asset retirement obligations        |   | 4    |  |   | 4    | 
|Other                                                       |   | 6    |  |   | 9    | 
|                                                            | $ | 188  |  | $ | 209  | 

|9. SHARE CAPITAL
|----------------

AUTHORIZED

Unlimited number of common voting shares, without par
value.

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

11,111,111 warrants convertible in equal amount of common
shares and expiring February 29, 2012. The warrants shall be deemed to be
exercised and shall be automatically converted into new common shares 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.

|(a) | Common shares and warrants
issued
|--- | ---------------------------------

| |                           |   | 2011 |  |   | 2010 | 
| | ------------------------- | - | ---- |  | - | ---- | 
| | Issued and fully paid:    |   |      |  |   |      | 
| | 100,000,000 common shares | $ | 564  |  | $ | 564  | 
| | 11,093,943
      warrants |   | 6    |  |   | 6    | 
| |                           | $ | 570  |  | $ | 570  | 

68Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|9. SHARE CAPITAL(CONTINUED)
|---------------------------

|(b) | Earnings (loss) per share                                                                                 
|--- | ----------------------------------------------------------------------------------------------------------
|    |                                                                                                           
|    | The following table provides the reconciliation between
      basic and diluted earnings (loss) per share:

| |                                                                    |   | 2011        |   |   | 2010        | 
| | ------------------------------------------------------------------ | - | ----------- | - | - | ----------- | 
| | Net earnings (loss)                                                | $ | (3          | ) | $ | 52          | 
| | Weighted average number of common shares outstanding               |   | 100,000,000 |   |   | 100,000,000 | 
| | Dilutive effect of employee share options and warrants             |   |            |   |   |            | 
| | Weighted average number of diluted common shares
      outstanding |   | 100,000,000 |   |   | 100,000,000 | 
| | Basic and diluted
      earnings (loss) in dollars per share       | $ | (0.03       | ) | $ | 0.52        | 

|    | The warrants and employees share options had no dilutive
      effect for the above periods; however, these securities could potentially
      dilute earnings per share in future periods.                                                                                                                                                                                                                                                                                                                                                              
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|(c) | Share-based compensation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|    | Under the prior Long-Term Incentive Plan, the Company
      had, from time to time, granted options to its employees. The plan
      provided for the issuance of common shares at an exercise price equal to
      the market price of the Companys common shares on the date of the grant.
      These options vest over a five-year period and expire ten years from the
      date of issue. No options have been granted since 2006. No compensation
      expense was recorded for the years ended September 24, 2011 and
      September25, 2010.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|    | The following table summarizes the changes in options
      outstanding and the impact on weighted average per share exercise price
      during the year:                                                                                                                                                                                                                                                                                                                                                                                               

| |                                |  |         |   |   | 2011           |  |  |         |   |   | 2010           | 
| | ------------------------------ |  | ------- | - | - | -------------- |  |  | ------- | - | - | -------------- | 
| |                                |  |         |   |   | Weighted       |  |  |         |   |   | Weighted       | 
| |                                |  |         |   |   | average        |  |  |         |   |   | average        | 
| |                                |  | Options |   |   | exercise price |  |  | Options |   |   | exercise price | 
| | Balance, beginning of year     |  | 161,123 |   | $ | 89.01          |  |  | 185,031 |   | $ | 105.17         | 
| | Options cancelled              |  | (39,103 | ) |   | 132.67         |  |  | (23,908 | ) |   | 214.07         | 
| | Balance, end of
      year     |  | 122,020 |   | $ | 75.01          |  |  | 161,123 |   | $ | 89.01          | 
| | Exercisable, end
      of year |  | 122,020 |   | $ | 75.01          |  |  | 151,470 |   | $ | 92.83          | 

Of the total 39,103 (2010  23,908)
options cancelled, 4,001 (2010  17,495) expired and 35,102 (2010  6,413) were
forfeited.

Tembec Financial Report 2011 69

---

Notes to Consolidated Financial Statements

|9. SHARE CAPITAL(CONTINUED)
|---------------------------

|(c) | Share-based compensation(continued)                                                                                                                                                      
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                          
|    | The following table summarizes the weighted average per
      share exercise price and the weighted remaining contractual life of the
      options outstanding as at September 24, 2011:

| |              |  | Outstanding options and exercisable options | 
| | ------------ |  | ------------------------------------------- | 
| |              |  |                                             | 
| |              |  | Number of                                   | 
| | Year granted |  | options                                     | 
| | 2002         |  | 5,790                                       | 
| | 2003         |  | 4,696                                       | 
| | 2004         |  | 5,772                                       | 
| | 2005         |  | 57,792                                      | 
| | 2006         |  | 47,970                                      | 
| |              |  | 122,020                                     | 

|(d) | Other share-based compensation                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|    | During fiscal 2009, the Company established a
      Performance-Conditioned Restricted Share Units (PCRSU) plan for designated
      senior executives. Each PCRSU is equivalent in value to a common share of
      the Company and is notionally credited with dividends when shareholders
      receive dividends from the Company. Vesting of the PCRSUs is based on the
      attainment of performance objectives over a three-year period. PCRSUs will
      be settled in the form of cash.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|    | The following table summarizes the grant of PCRSUs that
      has occurred over the past two years:                                                                                                                                                                                                                                                                                                                                                                                                

| |                            |  | 2011      |   |  | 2010      |  
| | -------------------------- |  | --------- | - |  | --------- | -
| | Balance, beginning of year |  | 1,563,000 |   |  | 1,116,000 |  
| | Grants                     |  | 732,201   |   |  | 536,000   |  
| | Forfeitures                |  | (271,194  | ) |  | (89,000   | )
| | Balance, end of
      year |  | 2,024,007 |   |  | 1,563,000 |  
| | Vested, end of
      year  |  | 622,940   |   |  |          |  

Directors of the Company are given the
option to receive part of their annual retainer, meeting fees and awards under
the Directors Share Award Plan in the form of Deferred Share Units (DSU). Each
DSU is equivalent in value to a common share of the Company and is notionally
credited with dividends when shareholders receive dividends from the Company. A
DSU is paid to a director upon termination of Board service and is payable in
the form of cash.

70Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|9. SHARE CAPITAL(CONTINUED)
|---------------------------

|(d) | Other share-based compensation(continued)                                                        
|--- | -------------------------------------------------------------------------------------------------
|    |                                                                                                  
|    | The following table summarizes the grant of DSUs that has
      occurred over the past two years:

| |                            |  | 2011      |   |  | 2010    | 
| | -------------------------- |  | --------- | - |  | ------- | 
| | Balance, beginning of year |  | 411,222   |   |  | 411,222 | 
| | Grants                     |  | 750,999   |   |  |        | 
| | Paid                       |  | (42,385   | ) |  |        | 
| | Balance, end of
      year |  | 1,119,836 |   |  | 411,222 | 
| | Vested, end of
      year  |  | 619,170   |   |  | 411,222 | 

On November 17, 2010, under the
Directors Share Award Plan, non-executive members of the Board were granted
655,175DSUs, and on January 27, 2011, 95,824 additional DSUs were granted. These
DSUs are vesting in three equal amounts over the next three Annual General
Shareholders meetings beginning on January 27, 2011.

During fiscal 2006, the Predecessor of
the Company established a performance share units (PSU) plan for designated
senior executives. Under the terms of this plan, senior executives may be
eligible to an annual incentive remuneration paid to them in the form of PSUs.
Each PSU is equivalent in value to a common share of the Company and is
notionally credited with dividends when shareholders receive dividends from the
Company. A PSU is paid to an executive following a three-year vesting period and
is payable in the form of cash. As at September 24, 2011, no PSUs (2010 
40,523) were outstanding.

The following table summarizes the
details of share-based compensation expenses relating to its different
share-based compensation plans:

| |                                                    |   | 2011 |  |   | 2010 | 
| | -------------------------------------------------- | - | ---- |  | - | ---- | 
| | Performance-conditioned restricted share unit plan | $ | 2    |  | $ | 1    | 
| | Directors share award plan                        |   |     |  |   | 1    | 
| | Performance share
      unit plan                  |   |     |  |   |     | 
| |                                                    | $ | 2    |  | $ | 2    | 

Tembec Financial Report 2011 71

---

Notes to Consolidated Financial Statements

|10. GUARANTEES, COMMITMENTS AND CONTINGENCIES
|---------------------------------------------

GUARANTEES

The Company and certain of its subsidiaries have granted
irrevocable letters of credit, issued by high rated financial institutions, to
third parties to indemnify them in the event the Company does not perform its
contractual obligations. The Company has not recorded any additional liability
with respect to these guarantees, as the Company does not expect to make any
payments in excess of what is recorded in the Companys financial statements.
The letters of credit mature at various dates in fiscal 2012.

LUMBER EXPORT TAXES

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. The SLA had an effective date of October 12, 2006, at which time
the U.S. Department of Commerce (USDOC) revoked all existing countervailing and
antidumping duty orders on softwood lumber shipped to the U.S. from Canada.

COMMITMENTS

The Company has entered into operating leases for expected cash
outflows of $14 million. Outflows for the five years following September 24,
2011, are as follows:

|2012 | $ | 5 | 
|---- | - | - | 
|2013 | $ | 3 | 
|2014 | $ | 2 | 
|2015 | $ | 2 | 
|2016 | $ | 1 | 

CONTINGENCIES

The Company is party to claims and litigations arising in the
normal course of operations. The Company does not expect that the resolution of
these matters will have a material adverse effect on the Companys financial
condition, earnings or liquidity.

72Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|11. OTHER ITEMS
|---------------

2011

During the September 2011 quarter, the Company recorded a
charge of $2 million relating to several permanently idled facilities. The costs
relate to pension and healthcare benefits, legal costs, site security and
custodial costs. For the year ended September24, 2011, these charges amount to
$8 million.

During the June 2011 quarter, the Company finalized the sale of
its hydro-electric generating assets located in Smooth Rock Falls, Ontario, and
recorded a pre-tax gain of $3 million. Total consideration for the assets, which
had a capacity of 7.4 megawatts, was $16 million paid in cash.

During the June 2011 quarter, 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 determined that it no longer exercised control over
this investment. The Company recorded a gain of $8 million relating to the
deconsolidation of this subsidiary, arising primarily from the reduction in its
consolidated accrued benefit obligation.

During the March 2011 quarter, the Company announced the
permanent closure of the Taschereau, Quebec, sawmill. The facility had been
idled since October 2009. The Company recorded a charge of $3 million relating
to severance and other items.

During the March 2011 quarter, the Company recorded a charge of
$1 million for severance relating to the Cranbrook, British Columbia, planer mill
operation. The mill has been indefinitely idled since November 2007.

2010

During the September 2010 quarter, the Company incurred a net
charge of $7 million relating to the permanent closure of its newsprint mill
located in Pine Falls, Manitoba. The write-down of assets for $13 million and
the accrual for severances and other for $10 million were partially offset by
the recognition of a curtailment gain in employee future benefits totalling $16
million.

On May 7, 2010, the Company finalized the sale of the kraft
pulp mills located in Tarascon and Saint-Gaudens, France, to Paper Excellence
B.V. and recorded a gain of $12 million. Proceeds amounted to 66 million euros
($88 million) for the shares.Total proceeds of $88 million were reduced
by $2 million for cash balance left in the two mills. Approximately 4 million
euros ($6million) of this amount will be held in escrow with the Companys
counsel until May 2012 (changed from May 2011 under the terms of the escrow
agreement) to secure certain undertakings made by the Company. Paper Excellence
B.V. also assumed 31million euros ($41 million) of debt.

As a result of an order issued by the Ontario Ministry of the
Environment, the Company has had to undertake the removal ofblack liquor
from storage tanks and pipelines of the bankrupt Marathon, Ontario, pulp
facility. Costs for the September, June and March 2010 quarters amounted to $2
million, $2 million and $3 million, respectively.

Tembec Financial Report 2011 73

---

Notes to Consolidated Financial Statements

|11. OTHER ITEMS(CONTINUED)
|--------------------------

2010 (CONTINUED)

In April 2009, the Company sold the St. Francisville,
Louisiana, coated paper mill facility and related equipment to West Feliciana
Acquisition, LLC (WFA). The paper mill had been idle since July 2007. A portion
of the consideration received by the Company included two US $5 million interest
bearing notes. Principal payments on the notes were due on various dates
beginning in March2011 and ending in March 2016. On January 17, 2010, WFA filed
for relief under Chapter 11 of the U.S. Bankruptcy Code. It was unlikely that
the Company would recover any portion of the interest-bearing notes and, as a
result, a charge of $12million relating to these notes was recorded during the
March 2010 quarter. During the June 2010 quarter, the Company recorded a charge
of $1million relating to pension and healthcare benefits, which the Company has
continued to incur following the sale.

During the December 2009 and March 2010 quarters, the Company
completed the sale of a number of land properties and recorded a gain of $2
million.

The following table provides an analysis of the other items by
business segment of the Company:

2011Forest
    
    
    Dissolving &
    
    
    High-Yield
    
    
    
    
    
    CorporateProducts
    
    
    Chemical Pulp
    
    
    Pulp
    
    
    Paper
    
    
    & Other
    
    
    ConsolidatedGain on sale of assets
    $
    
    
    $
    
    
    $
    
    
    $
    
    
    $
    (3
    )
    $
    (3
    )Other
    
    1
    
    
    
    
    
    
    
    
    
    
    
    8
    
    
    9Severance, other
      labour-related and idling costs
    
    3
    
    
    
    
    
    
    
    
    
    
    
    (8
    )
    
    (5
    )$
    4
    
    $
    
    
    $
    
    
    $
    
    
    $
    (3
    )
    $
    1


2010Forest
    
    
    Dissolving &
    
    
    High-Yield
    
    
    
    
    
    CorporateProducts
    
    
    Chemical Pulp
    
    
    Pulp
    
    
    Paper
    
    
    & Other
    
    
    ConsolidatedGain on sales of assets
    $
    (2
    )
    $
    (12
    )
    $
    
    
    $
    
    
    $
    12
    
    $
    (2
    )Other
    
    
    
    
    
    
    
    
    
    
    11
    
    
    7
    
    
    18Severance, other
      labour-related and idling costs
    
    
    
    
    
    
    
    
    
    
    (4
    )
    
    1
    
    
    (3
    )$
    (2
    )
    $
    (12
    )
    $
    
    
    $
    7
    
    $
    20
    
    $
    13


74Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|12. INTEREST, FOREIGN EXCHANGE AND OTHER
|----------------------------------------

|                                                                                  |   | 2011 |   |   | 2010 |  
|--------------------------------------------------------------------------------- | - | ---- | - | - | ---- | -
|Interest on long-term debt                                                        | $ | 31   |   | $ | 27   |  
|Interest on
      operating bank loan                                             |   | 1    |   |   | 3    |  
|                                                                                  |   | 32   |   |   | 30   |  
|Exchange gain on conversion of integrated foreign
      subsidiaries              |   | (2   | ) |   | (1   | )
|Other foreign exchange items                                                      |   | 1    |   |   | 14   |  
|Fees - new revolving working capital facility                                     |   | 2    |   |   |     |  
|Term loan prepayment premium                                                      |   |     |   |   | 6    |  
|Bank charges and
      other                                                      |   | (1   | ) |   | 2    |  
|                                                                                  |   |     |   |   | 21   |  
|                                                                                  | $ | 32   |   | $ | 51   |  
|                                                                                  |   |      |   |   |      |  
|Foreign exchange items included in the financial statements
      are as follows: |   |      |   |   |      |  
|                                                                                  |   | 2011 |   |   | 2010 |  
|Exchange loss (gain) on long-term debt                                            | $ | 1    |   | $ | (27  | )
|Exchange gain on conversion of integrated foreign
      subsidiaries              |   | (2   | ) |   | (1   | )
|Other foreign
      exchange items                                                |   | 1    |   |   | 14   |  
|                                                                                  | $ |     |   | $ | (14  | )

|13. INCOME TAXES
|----------------

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

|                                                                                                              |   | 2011 |   |   | 2010 |  
|------------------------------------------------------------------------------------------------------------- | - | ---- | - | - | ---- | -
|Future income tax assets:                                                                                     |   |      |   |   |      |  
|Non-capital loss carry-forwards and pool of deductible
      scientific research and development expenditures | $ | 403  |   | $ | 386  |  
|Fixed assets                                                                                                  |   | 41   |   |   | 34   |  
|Employee future benefits                                                                                      |   | 41   |   |   | 49   |  
|Capital loss carry-forwards                                                                                   |   | 3    |   |   | 7    |  
|Financing charges                                                                                             |   |     |   |   | 7    |  
|Other                                                                                                         |   | 16   |   |   | 18   |  
|Valuation
      allowance                                                                                     |   | (486 | ) |   | (472 | )
|                                                                                                              |   | 18   |   |   | 29   |  
|Future income tax liabilities:                                                                                |   |      |   |   |      |  
|Other                                                                                                         |   | (2   | ) |   | (2   | )
|Net future income
      tax assets                                                                            | $ | 16   |   | $ | 27   |  

Tembec Financial Report 2011 75

---

Notes to Consolidated Financial Statements

|13. INCOME TAXES(CONTINUED)
|---------------------------

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

|                                                                          |   | Amounts |  |  | Expiring dates | 
|------------------------------------------------------------------------- | - | ------- |  |  | -------------- | 
|Non-capital loss carried forward for:                                     |   |         |  |  |                | 
|Canadian subsidiaries                                                     | $ | 1,106   |  |  | 2014 to 2031   | 
|U.S. subsidiaries                                                         | $ | 18      |  |  | 2028 to 2031   | 
|French subsidiaries                                                       | $ | 32      |  |  | Unlimited      | 
|Pool of deductible
      scientific research and experimental development | $ | 370     |  |  | Unlimited      | 

The reconciliation of income taxes calculated at the statutory
rate to the actual tax provision is as follows:

|                                                                                                                 |   | 2011 |   |   | 2010 |  
|---------------------------------------------------------------------------------------------------------------- | - | ---- | - | - | ---- | -
|Earnings before
      income taxes and non-controlling interest                                                  | $ | 16   |   | $ | 39   |  
|Income tax expense
      based on combined federal and provincial income tax rates of 27.8% (2010 
      29.8%) | $ | 4    |   | $ | 12   |  
|Increase (decrease) resulting from:                                                                              |   |      |   |   |      |  
|Future income tax adjustment due to rate enactments                                                              |   |     |   |   | 2    |  
|Change in valuation allowance                                                                                    |   | 11   |   |   | (20  | )
|Difference in statutory income tax rate                                                                          |   | 5    |   |   | 4    |  
|Permanent differences:                                                                                           |   |      |   |   |      |  
|Non-taxable portion of exchange gain on long-term debt                                                           |   |     |   |   | (3   | )
|Non-taxable exchange gain on conversion of integrated
      foreign subsidiaries                                 |   |     |   |   | (10  | )
|Other permanent
      differences                                                                                |   | (1   | ) |   |     |  
|                                                                                                                 |   | 15   |   |   | (27  | )
|Income tax expense
      (recovery)                                                                              | $ | 19   |   | $ | (15  | )
|Income taxes                                                                                                     |   |      |   |   |      |  
|Current                                                                                                          | $ | 8    |   | $ |     |  
|Future                                                                                                           |   | 11   |   |   | (15  | )
|Income tax expense
      (recovery)                                                                              | $ | 19   |   | $ | (15  | )

76Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|14. EMPLOYEE FUTURE BENEFITS
|----------------------------

DEFINED CONTRIBUTION PENSION PLANS

The Company contributes to defined contribution pension plans,
provincial and labour sponsored pension plans, group registered retirement
savings plans, deferred profit sharing plans, and 401(k) plans. The pension
expense of $11 million (2010  $9 million) under these plans is equal to the
Companys contribution.

DEFINED BENEFIT PENSION PLANS

The Company has several defined benefit pension plans.
Non-unionized employees in Canada joining the Company after January1, 2000,
participate in defined contribution pension plans. Some of the defined benefit
pension plans are contributory. The pension expense and the obligation related
to the defined benefit pension plans are actuarially determined using
managements most probable assumptions.

OTHER FUTURE BENEFIT PLANS

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

The post-retirement and post-employment benefit expenses and
the obligations related to other future benefit plans are actuarially determined
using managements most probable assumptions.

Actuarial valuations of these plans for accounting purposes are
conducted on a triennial basis unless there are significant changes affecting
the plans. The latest actuarial valuations were conducted as at January 1, 2010
or May 1, 2009.

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

COMPANY CONTRIBUTIONS

Total cash payments for employee future benefits consist of
cash contributed by the Company to its funded pension plans, cash payments
directly to beneficiaries for its unfunded benefit plans and cash contributed to
its defined contribution plans including multi-employer pension plans. The
Company contributions were $44 million for fiscal 2011 and 2010.

DESCRIPTION OF FUND ASSETS

The assets of the registered defined benefit pension plans are
held by an independent trustee and accounted for separately in the Companys
pension funds. Based on the fair value of assets held at June 30, 2011, the
defined benefit pension plan assets were comprised of 1% (1% in 2010) in cash
and short-term investments, 5% (5% in 2010) in real estate, 44% (45% in 2010) in
bonds and 50% (49% in 2010) in Canadian, U.S. and foreign equity.

Tembec Financial Report 2011 77

---

Notes to Consolidated Financial Statements

|14. EMPLOYEE FUTURE BENEFITS(CONTINUED)
|---------------------------------------

FUNDING POLICY

The Companys funding policy for registered defined benefit
pension plans is to contribute annually the amount required to provide for
benefits earned in the year and to fund past service obligations over periods
not exceeding those permitted by the applicable regulatory authorities.
Actuarial valuations for funding purposes are conducted on a triennial basis,
unless required earlier by pension legislation or as deemed appropriate by
management from time to time. The latest funding actuarial valuations were
conducted for two plans on January 1, 2011, 10 plans on December 31, 2010, one
plan on December 31, 2009, and three plans on December 31, 2008.

INVESTMENT POLICY

The Company follows a disciplined investment strategy, which
provides diversification of investments by asset class, foreign currency, sector
and company. The Corporate Governance and Human Resources Committee of the Board
of Directors has approved an investment policy that establishes long-term asset
mix targets based on a review of historical returns achieved by world-wide
investment markets. Investment managers may deviate from these targets to the
extent permitted by the investment policy. Their performance is evaluated in
relation to the market performance on the target mix.

INFORMATION ABOUT THE COMPANYS DEFINED BENEFIT PLANS IN
AGGREGATE

The Company measures its accrued benefit obligation and the
fair value of plan assets for accounting purposes as at June 30 of each
year.

During fiscal 2011, significant lump sum payments to employees
were paid from the Pine Falls and Taschereau pension plans having for effect of
reducing benefit obligations (obligations being settled) by $4 million and
benefit plan assets (settlement payments) by $3 million. In fiscal 2010,
significant lump sum payments to employees were paid from the Pine Falls pension
plans having for effect of reducing benefit obligations by $18 million and
benefit plan assets by $15 million. In fiscal 2010, benefit obligations were
also reduced by $45 million relating to the purchase of annuities for a partial
windup group. As a result, benefit plan assets were reduced by $42 million.

78Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|14. EMPLOYEE FUTURE BENEFITS(CONTINUED)
|---------------------------------------

INFORMATION ABOUT THE COMPANYS DEFINED BENEFIT PLANS IN
AGGREGATE(CONTINUED)

The following tables present the change in the accrued benefit
obligation for the defined benefit plans as calculated by independent actuaries
and the change in the fair value of plan assets:

Change in accrued benefit obligations for defined benefit
plans:

|                                                   |   | Pension plans |   |   | Other benefit plans |  
|-------------------------------------------------- | - | ------------- | - | - | ------------------- | -
|                                                   |   | 2011          |   |   | 2010                |  
|Accrued benefit obligation, at beginning of year   | $ | 786           |   | $ | 828                 |  
|Current service cost                               |   | 8             |   |   | 11                  |  
|Interest cost                                      |   | 39            |   |   | 46                  |  
|Employee contributions                             |   | 2             |   |   | 2                   |  
|Benefits paid                                      |   | (44           | ) |   | (48                 | )
|Divestitures                                       |   |              |   |   | (9                  | )
|Plan amendments                                    |   | 1             |   |   | 1                   |  
|Actuarial loss (gain)                              |   | 16            |   |   | 54                  |  
|Foreign exchange rate changes and other adjusments |   | 1             |   |   | (9                  | )
|Decrease in obligation due to curtailment          |   |              |   |   | (24                 | )
|Obligations being
      settled                    |   | (5            | ) |   | (66                 | )
|Accrued benefit
      obligation, at end of year   | $ | 804           |   | $ | 786                 |  

Change in fair value of plan assets for defined benefit
plans:

|                                                                      |   | Pension plans |   |   | Other benefit plans |  
|--------------------------------------------------------------------- | - | ------------- | - | - | ------------------- | -
|                                                                      |   | 2011          |   |   | 2010                |  
|Fair value of defined benefit plan assets, at beginning of
      year | $ | 580           |   | $ | 606                 |  
|Actual return on plan assets                                          |   | 75            |   |   | 57                  |  
|Employer contributions                                                |   | 31            |   |   | 28                  |  
|Employee contributions                                                |   | 2             |   |   | 2                   |  
|Benefits paid                                                         |   | (44           | ) |   | (48                 | )
|Foreign exchange rate changes and other adjusments                    |   | 1             |   |   | (5                  | )
|Settlement
      payments                                             |   | (4            | ) |   | (60                 | )
|Fair value of
      defined benefit plan assets, at end of year       | $ | 641           |   | $ | 580                 |  

Tembec Financial Report 2011 79

---

Notes to Consolidated Financial Statements

|14. EMPLOYEE FUTURE BENEFITS(CONTINUED)
|---------------------------------------

FUNDED STATUS

The following table presents the difference between the fair
value of plan assets and the actuarially determined accrued benefit obligation
as at June 30, 2011 and June 30, 2010, for defined benefit plans. This
difference is also referred to as either the deficit or surplus, as the case may
be, or the funded status of the plans.

The table further reconciles the amount of the surplus or
deficit (funded status) to the net amount recognized in the consolidated balance
sheets. The difference between the funded status and the net amount recognized
in the consolidated balance sheets, in accordance with Canadian GAAP, represents
the portion of the surplus or deficit not yet recognized for accounting
purposes. This approach allows for a gradual recognition of changes in accrued
benefit obligations and plan performance as described in Note 1.

Reconciliation of funded status for defined benefit plans:

|                                                       |   | Pension plans |   |   | Other benefit plans |  
|------------------------------------------------------ | - | ------------- | - | - | ------------------- | -
|                                                       |   | 2011          |   |   | 2010                |  
|Fair value of plan assets                              | $ | 641           |   | $ | 580                 |  
|Accrued benefit
      obligation                       |   | (804          | ) |   | (786                | )
|Plan deficit                                           |   | (163          | ) |   | (206                | )
|Employer contribution after measurement date (June 30) |   | 9             |   |   | 8                   |  
|Unamortized past service costs                         |   | 2             |   |   | 1                   |  
|Unamortized net
      actuarial loss (gain)            |   | 49            |   |   | 73                  |  
|Net benefit
      liability                            | $ | (103          | ) | $ | (124                | )

Amounts recognized in the consolidated balance sheets for
defined benefit plans:

|                                |   | Pension plans |   |   | Other benefit plans |  
|------------------------------- | - | ------------- | - | - | ------------------- | -
|                                |   | 2011          |   |   | 2010                |  
|Deferred pension costs          | $ | 16            |   | $ | 6                   |  
|Accrued benefit
      liability |   | (119          | ) |   | (130                | )
|Net benefit
      liability     | $ | (103          | ) | $ | (124                | )

The accrued benefit obligations in excess of fair value of plan
assets at the end of the year with respect to defined benefit plans that are not
fully funded are as follows:

|                                 |   | Pension plans |   |   | Other benefit plans |  
|-------------------------------- | - | ------------- | - | - | ------------------- | -
|                                 |   | 2011          |   |   | 2010                |  
|Fair value of plan assets        | $ | 636           |   | $ | 579                 |  
|Accrued benefit
      obligation |   | (800          | ) |   | (785                | )
|Plan deficit                     | $ | (164          | ) | $ | (206                | )

80Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|14. EMPLOYEE FUTURE BENEFITS(CONTINUED)
|---------------------------------------

COMPONENTS OF NET PERIODIC BENEFIT COST FOR DEFINED BENEFIT
PENSION PLANS

|                                                                                                                       |   | 2011 |   |   | 2010 |  
|---------------------------------------------------------------------------------------------------------------------- | - | ---- | - | - | ---- | -
|Current service cost                                                                                                   | $ | 8    |   | $ | 11   |  
|Interest cost                                                                                                          |   | 39   |   |   | 46   |  
|Actual return on plan assets                                                                                           |   | (75  | ) |   | (57  | )
|Actuarial loss                                                                                                         |   | 16   |   |   | 54   |  
|Curtailment gain                                                                                                       |   |     |   |   | (15  | )
|Settlement gain                                                                                                        |   | (1   | ) |   | (2   | )
|Plan amendments
      and other                                                                                        |   | 1    |   |   | 1    |  
|                                                                                                                       |   |      |   |   |      |  
|Net expense (income) before adjustments to recognize the
      long-term nature of the plans                           |   | (12  | ) |   | 38   |  
|                                                                                                                       |   |      |   |   |      |  
|Difference between expected and actual return on plan
      assets                                                     |   | 38   |   |   | 17   |  
|Difference between net actuarial gain and actuarial gain                                                               |   | (14  | ) |   | (54  | )
|Difference between
      amortization of past service costs for the year and actual plan amendments
      for the year |   | (1   | ) |   | (1   | )
|Net periodic
      benefit cost                                                                                        | $ | 11   |   | $ |     |  

COMPONENTS OF NET PERIODIC BENEFIT COST FOR OTHER FUTURE
BENEFIT PLANS

|                                                                                                                 |   | 2011 |   |   | 2010 |  
|---------------------------------------------------------------------------------------------------------------- | - | ---- | - | - | ---- | -
|Current service cost                                                                                             | $ | 1    |   | $ | 1    |  
|Interest cost                                                                                                    |   | 2    |   |   | 3    |  
|Curtailment gain                                                                                                 |   |     |   |   | (1   | )
|Actuarial gain                                                                                                   |   | (2   | ) |   | (3   | )
|Net expense before adjustments to recognize the long-term
      nature of the plans                              |   | 1    |   |   |     |  
|                                                                                                                 |   |      |   |   |      |  
|Difference between amortization of past service costs for
      the year and actual plan amendments for the year |   | 1    |   |   | 1    |  
|Difference between
      net actuarial loss and actuarial loss                                                   |   | 1    |   |   | 2    |  
|Net periodic
      benefit cost                                                                                  | $ | 3    |   | $ | 3    |  

Tembec Financial Report 2011 81

---

Notes to Consolidated Financial Statements

|14. EMPLOYEE FUTURE BENEFITS(CONTINUED)
|---------------------------------------

ASSUMPTIONS

Significant assumptions for defined benefit pension plans
(weighted average):

|                                                                                 |   | 2011  |   |   | 2010  |  
|-------------------------------------------------------------------------------- | - | ----- | - | - | ----- | -
|Accrued benefit obligation at end of year:                                       |   |       |   |   |       |  
|Discount rate                                                                    |   | 4.94% |   |   | 5.12% |  
|Rate of compensation increase                                                    |   | 2.50% |   |   | 2.50% |  
|                                                                                 |   |       |   |   |       |  
|Net periodic benefit cost for the year:                                          |   |       |   |   |       |  
|Discount rate                                                                    |   | 5.12% |   |   | 5.73% |  
|Rate of compensation increase                                                    |   | 2.50% |   |   | 2.61% |  
|Expected long-term
      return on assets                                        |   | 6.52% |   |   | 6.88% |  
|                                                                                 |   |       |   |   |       |  
|Significant assumptions for other future benefit plans
      (weighted average): |   |       |   |   |       |  
|                                                                                 |   |       |   |   |       |  
|                                                                                 |   | 2011  |   |   | 2010  |  
|Accrued benefit obligation at end of year:                                       |   |       |   |   |       |  
|Discount rate                                                                    |   | 4.91% |   |   | 5.12% |  
|Rate of compensation increase                                                    |   | 2.50% |   |   | 2.50% |  
|                                                                                 |   |       |   |   |       |  
|Net periodic benefit cost for the year:                                          |   |       |   |   |       |  
|Discount rate                                                                    |   | 5.12% |   |   | 5.48% |  
|Rate of compensation increase                                                    |   | 2.50% |   |   | 2.50% |  
|                                                                                 |   |       |   |   |       |  
|Assumed healthcare cost trend rate at end of year:                               |   |       |   |   |       |  
|Initial healthcare cost trend                                                    |   | 7.50% |   |   | 8.00% |  
|Annual rate of decline in trend rate                                             |   | 0.50% |   |   | 0.50% |  
|Ultimate healthcare cost trend rate                                              |   | 5.00% |   |   | 5.00% |  
|                                                                                 |   |       |   |   |       |  
|Effect of change in healthcare cost trend rate (1%
      increase):              |   |       |   |   |       |  
|Total of service cost and interest cost                                          | $ |      |   | $ |      |  
|Accrued benefit obligation                                                       | $ | 3     |   | $ | 3     |  
|                                                                                 |   |       |   |   |       |  
|Effect of change in healthcare cost trend rate (1%
      decrease):              |   |       |   |   |       |  
|Total of service cost and interest cost                                          | $ |      |   | $ |      |  
|Accrued benefit
      obligation                                                 | $ | (3    | ) | $ | (3    | )

82Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|15. FINANCIAL INSTRUMENTS
|-------------------------

FAIR VALUE

The carrying amount of cash and cash equivalents, cash held in
trust, derivative financial instruments, accounts receivable, bank indebtedness,
operating bank loans, accounts payable and accrued charges, and interest payable
approximates their fair values because of the near-term maturity of those
instruments. The carrying value of the long-term loans receivable also
approximates their fair values.

The carrying value and the fair value of long-term debt are as
follows:

|               |   | 2011 |  |   | 2010 | 
|-------------- | - | ---- |  | - | ---- | 
|Carrying value | $ | 289  |  | $ | 288  | 
|Fair value     | $ | 294  |  | $ | 301  | 

Cash and cash equivalents, cash held in trust and the
derivative financial instruments are the only financial instruments of the
Company measured at fair value on a recurring basis and have been valued in
accordance with Level 1 of the fair value hierarchy, which is based on
unadjusted quoted prices in an active market.

FINANCIAL RISK MANAGEMENT

|Overview                                                                              
|--------------------------------------------------------------------------------------
|The Company has exposure to the following risks from its use of
financial instruments:
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      
|                                                                                      

The Board of Directors has overall responsibility for the
establishment and oversight of the Companys risk management policy. The policy
defines the method by which the Company manages its risk through properly and
prudently administering the Companys financial assets, liabilities and
derivatives. Internal Audit measures the adequacy of the business control
systems through the execution of an Internal Audit Plan approved by the Audit
Committee.

CREDIT RISK MANAGEMENT

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. As required in the Risk
Management Policy, 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. The Company may require payment guarantees, such as
letters of credit, or obtain credit insurance coverage. Bad debt expense has not
been significant in the past. The allowance for doubtful accounts for the
Company, as at September 24, 2011, was nil (2010  $1 million).

Tembec Financial Report 2011 83

---

Notes to Consolidated Financial Statements

|15. FINANCIAL INSTRUMENTS(CONTINUED)
|------------------------------------

EXPOSURE TO CREDIT RISK

The carrying amount of financial assets represents the maximum
credit exposure. The maximum exposure to credit risk at the reporting date
was:

|                                                    |   | 2011 |  |   | 2010 | 
|--------------------------------------------------- | - | ---- |  | - | ---- | 
|Loans and receivables                               | $ | 206  |  | $ | 236  | 
|Cash, cash
      equivalents and cash held in trust | $ | 105  |  | $ | 74   | 

The maximum exposure to credit risk for trade accounts
receivable as at September 24, 2011 and September 25, 2010, by geographical
region was as follows:

|                                                    |   | 2011 |  |   | 2010 |  
|--------------------------------------------------- | - | ---- |  | - | ---- | -
|Canada                                              | $ | 27   |  | $ | 23   |  
|United States                                       |   | 69   |  |   | 65   |  
|Pacific Rim and India                               |   | 19   |  |   | 27   |  
|United Kingdom,
      Europe and other              |   | 18   |  |   | 48   |  
|                                                    |   | 133  |  |   | 163  |  
|Allowance for
      doubtful accounts               |   |     |  |   | (1   | )
|Net trade receivables                               |   | 133  |  |   | 162  |  
|Other receivables
      including input tax credits |   | 49   |  |   | 47   |  
|Accounts
      receivable                           | $ | 182  |  | $ | 209  |  

The aging of trade accounts receivable was as follows:

|                    |   |       |  |   | 2011      |  |   |       |  |   | 2010      | 
|------------------- | - | ----- |  | - | --------- |  | - | ----- |  | - | --------- | 
|                    |   | Gross |  |   | Allowance |  |   | Gross |  |   | Allowance | 
|Not past due        | $ | 125   |  | $ |          |  | $ | 150   |  | $ |          | 
|Past due 030 days  |   | 6     |  |   |          |  |   | 8     |  |   |          | 
|Past due 3160 days |   | 2     |  |   |          |  |   |      |  |   |          | 
|Past due 6190 days |   |      |  |   |          |  |   | 3     |  |   |          | 
|More than 90 days   |   |      |  |   |          |  |   | 2     |  |   | 1         | 
|                    | $ | 133   |  | $ |          |  | $ | 163   |  | $ | 1         | 

The movement in the allowance for doubtful accounts receivable
in respect to trade accounts receivable was as follows:

|                           |   | 2011 |   |   | 2010 |  
|-------------------------- | - | ---- | - | - | ---- | -
|Balance, beginning of year | $ | 1    |   | $ | 2    |  
|Bad debt written
      off |   | (1   | ) |   | (1   | )
|Balance, end of
      year | $ |     |   | $ | 1    |  

84Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|15. FINANCIAL INSTRUMENTS(CONTINUED)
|------------------------------------

LIQUIDITY RISK MANAGEMENT

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.

EXPOSURE TO LIQUIDITY RISK

A liquidity reserve in the form of cash and undrawn revolving
credit facilities is maintained to assist in the solvency and financial
flexibility of the Company. Liquidity reserves as at September 24, 2011,
totalled $229 million (2010  $174 million). Repayment of amounts due within one
year may also be funded by normal collection of current trade accounts
receivable and cash on hand.

The following are the contractual maturities of financial
liabilities, including interest payments and excluding the impact of netting
agreements:

2011Carrying
    
    
    **Contractual**
    
    
    6 months
    
    
    612
    
    
    12
    
    
    25
    
    
    More thanamount
    
    
    cash flows
    
    
    or less
    
    
    months
    
    
    years
    
    
    years
    
    
    5 yearsSecured bank loans
    $
    278
    
    $
    494
    
    $
    15
    
    $
    16
    
    $
    31
    
    $
    98
    
    $
    334Unsecured loans
    
    24
    
    
    27
    
    
    4
    
    
    5
    
    
    5
    
    
    11
    
    
    2Operating bank loans
    
    6
    
    
    6
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    Trade and others
    
    262
    
    
    262
    
    
    262
    
    
    
    
    
    
    
    
    
    
    
    $
    570
    
    $
    789
    
    $
    287
    
    $
    21
    
    $
    36
    
    $
    109
    
    $
    336


The Company had no derivative financial liabilities at
September 24, 2011. It is not expected that the cash flows included in the
maturity analysis could occur significantly earlier, or, excluding the effects
of foreign exchange fluctuations on US dollar liabilities, at significantly
different amounts.

FOREIGN CURRENCY RATE RISK MANAGEMENT

The Company is exposed to currency risk on sales, purchases and
long-term debt that are denominated in a currency other than the Canadian
dollar. The currencies in which these transactions are primarily denominated are
Canadian dollar, US dollar and euro.

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 and the euro relative to the Canadian dollar 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.

Tembec Financial Report 2011 85

---

Notes to Consolidated Financial Statements

|15. FINANCIAL INSTRUMENTS(CONTINUED)
|------------------------------------

FOREIGN CURRENCY RATE SENSITIVITY ANALYSIS

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:

|Sales increase                           | $ | 13 | 
|---------------------------------------- | - | -- | 
|Cost of sales
      increase             |   | 3  | 
|Gross margin                             |   | 10 | 
|Loss on US dollar
      debt translation |   | 3  | 
|Pre-tax earnings
      increase          | $ | 7  | 

Direct US $ purchases of raw materials, supplies and services
provided 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.

Interest expense on the Companys US $ denominated debt
provides a small offset to its US $ exposure. To further reduce the impact of
fluctuations in the value of the US dollar, the Company has adopted a policy,
which allows for hedging up to 50% of its anticipated US $ receipts for up to 36
months in duration. As at September 24, 2011, the Company does not hold any
foreign exchange contracts.

INTEREST RATE RISK MANAGEMENT

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.

INTEREST RATE SENSITIVITY ANALYSIS

Fluctuations of market interest rates have little impact on the
Companys financial results since the majority of the Companys debts are fixed
rate debts.

COMMODITY PRICE AND OPERATIONAL RISK MANAGEMENT

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. The Company may
periodically purchase lumber, pulp and newsprint price derivative commodity
contracts to mitigate the impact of price volatility. The Company did not hold
any significant product price derivative commodity contracts at September 24,
2011 and September 25, 2010.

The manufacturing activities conducted by the Companys
operations are subject to a number of risks, including availability and price of
fibre and competitive prices for purchased energy and raw materials. To mitigate
the impact of price fluctuations, the Company may periodically purchase
derivative commodity contracts. The Company does not currently hold any
significant derivative commodity contracts.

86Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|16. CAPITAL MANAGEMENT
|----------------------

It is the Companys objective to manage its capital to ensure
adequate capital resources exist to support operations while maintaining its
business growth. The Company sets the amount of capital in proportion to risk.
The Company manages the capital structure and makes adjustments to it in light
of changes in economic conditions and the risk of characteristics of the
underlying assets.

The Company monitors capital on the basis of net debt to total
capitalization ratio. Net debt is calculated as a total debt (long-term debt
plus bank indebtedness and operating bank loans) less cash, cash equivalents and
cash held in trust. Total capitalization includes net debt plus future income
taxes, other long-term liabilities and credits, and shareholders equity.

The Companys strategy is to maintain the net debt to total
capitalization ratio at 40% or less. The objective is to keep a strong balance
sheet and maintain the ability of the Company to access capital markets at
favourable rates. The net debt to total capitalization ratio for the Company as
at September 24, 2011 and September 25, 2010, were at 27% and 28%,
respectively.

|17. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL
      INFORMATION
|--------------------------------------------------------------------

The following condensed consolidating financial information has
been included in these consolidated financial statements in compliance with
National Instrument 51-102  Continuous Disclosure Obligations under
Canadian securities laws.

The senior secured notes (the Notes) of Tembec Industries
Inc. (the Subsidiary Issuer) are fully and unconditionally guaranteed on a
joint and several basis by Tembec Inc. (the Parent Company) and most of the
Subsidiary Issuers subsidiaries located in Canada (the Guarantor
Subsidiaries). The Subsidiary Issuer and each of the Guarantor Subsidiaries are
100% owned by the Parent Company. The Notes are not guaranteed by the Companys
other subsidiaries (the Other Subsidiaries).

The following supplemental condensed consolidating financial
information sets forth, on an unconsolidated basis, the balance sheets as at
September 24, 2011 and September 25, 2010, and the statements of operations and
deficit, and the statement of cash flows for the years ended September 24, 2011
and September 25, 2010, for the Parent Company and for the Subsidiary Issuer. It
also provides the same information on a combined basis for the Guarantor
Subsidiaries and the Other Subsidiaries.

The supplemental condensed consolidating financial information,
which has been prepared in accordance with Canadian GAAP, reflects the
investments of the Parent Company in the Subsidiary Issuer using the equity
method. Investments of the Subsidiary Issuer in the Guarantor Subsidiaries and
Other Subsidiaries are also accounted for using this method.

Tembec Financial Report 2011 87

---

Notes to Consolidated Financial Statements

|17. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL
      INFORMATION(CONTINUED)
|-------------------------------------------------------------------------------

CONDENSED CONSOLIDATED BALANCE SHEETS UNDER CANADIAN
GAAP

Year ended September 24, 2011Parent
    
    
    **Subsidiary**
    
    
    Guarantor
    
    
    Other
    
    
    **Consolidation**Company
    
    
    Issuer
    
    
    **Subsidiaries**
    
    
    **Subsidiaries**
    
    
    Adjustments
    
    
    **Consolidated**ASSETSCurrent assets:Cash and cash equivalents
    $
    
    
    $
    
    
    $
    40
    
    $
    59
    
    $
    
    
    $
    99Cash held in trust
    
    
    
    
    
    
    
    
    
    
    6
    
    
    
    
    
    6Accounts receivable
    
    35
    
    
    299
    
    
    140
    
    
    49
    
    
    (341
    )
    
    182Inventories
    
    
    
    
    
    
    
    232
    
    
    29
    
    
    
    
    
    261Prepaid expenses
    
    
    
    
    1
    
    
    5
    
    
    
    
    
    
    
    
    635
    
    
    300
    
    
    417
    
    
    143
    
    
    (341
    )
    
    554Investments
    
    333
    
    
    647
    
    
    
    
    
    
    
    
    (980
    )
    
    Fixed assets
    
    
    
    
    5
    
    
    389
    
    
    99
    
    
    
    
    
    493Other assets
    
    
    
    
    29
    
    
    13
    
    
    2
    
    
    
    
    
    44Future income
      taxes
    
    1
    
    
    
    
    
    
    
    
    15
    
    
    
    
    
    16$
    369
    
    $
    981
    
    $
    819
    
    $
    259
    
    $
    (1,321
    )
    $
    1,107LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Operating bank loans
    $
    
    
    $
    
    
    $
    
    
    $
    6
    
    $
    
    
    $
    6Accounts payable and accrued charges
    
    
    
    
    194
    
    
    319
    
    
    88
    
    
    (347
    )
    
    254Interest payable
    
    
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    8Current portion of
      long-term debt
    
    5
    
    
    
    
    
    
    
    
    13
    
    
    
    
    
    185
    
    
    202
    
    
    319
    
    
    107
    
    
    (347
    )
    
    286Long-term debt
    
    2
    
    
    249
    
    
    
    
    
    26
    
    
    (6
    )
    
    271Other long-term liabilities and credits
    
    
    
    
    127
    
    
    46
    
    
    15
    
    
    
    
    
    188Future income taxes
    
    
    
    
    61
    
    
    (60
    )
    
    (1
    )
    
    
    
    
    Shareholders equity:Share capital
    
    570
    
    
    555
    
    
    668
    
    
    34
    
    
    (1,257
    )
    
    570Contributed surplus
    
    5
    
    
    5
    
    
    
    
    
    5
    
    
    (10
    )
    
    5Retained earnings
      (deficit)
    
    (213
    )
    
    (218
    )
    
    (154
    )
    
    73
    
    
    299
    
    
    (213
    )362
    
    
    342
    
    
    514
    
    
    112
    
    
    (968
    )
    
    362$
    369
    
    $
    981
    
    $
    819
    
    $
    259
    
    $
    (1,321
    )
    $
    1,107


88Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|17. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL
      INFORMATION(CONTINUED)
|-------------------------------------------------------------------------------

CONDENSED CONSOLIDATED BALANCE SHEETS UNDER CANADIAN GAAP(CONTINUED)

Year
      ended September 25, 2010Parent
    
    
    Subsidiary
    
    
    Guarantor
    
    
    Other
    
    
    ConsolidationCompany
    
    
    Issuer
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Adjustments
    
    
    ConsolidatedASSETSCurrent assets:Cash and cash equivalents
    $
    
    
    $
    1
    
    $
    24
    
    $
    43
    
    $
    
    
    $
    68Cash held in trust
    
    
    
    
    
    
    
    
    
    
    6
    
    
    
    
    
    6Accounts receivable
    
    38
    
    
    350
    
    
    175
    
    
    41
    
    
    (395
    )
    
    209Inventories
    
    
    
    
    
    
    
    231
    
    
    24
    
    
    
    
    
    255Prepaid expenses
    
    
    
    
    1
    
    
    5
    
    
    1
    
    
    
    
    
    738
    
    
    352
    
    
    435
    
    
    115
    
    
    (395
    )
    
    545Investments
    
    337
    
    
    565
    
    
    
    
    
    
    
    
    (902
    )
    
    Fixed assets
    
    
    
    
    5
    
    
    404
    
    
    89
    
    
    
    
    
    498Other assets
    
    
    
    
    27
    
    
    6
    
    
    1
    
    
    
    
    
    34Future income taxes
    
    1
    
    
    
    
    
    
    
    
    26
    
    
    
    
    
    27$
    376
    
    $
    949
    
    $
    845
    
    $
    231
    
    $
    (1,297
    )
    $
    1,104LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Operating bank loans
    $
    
    
    $
    
    
    $
    
    
    $
    1
    
    $
    
    
    $
    1Accounts payable and accrued charges
    
    
    
    
    170
    
    
    305
    
    
    157
    
    
    (394
    )
    
    238Interest payable
    
    
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    3Current portion of long-term debt
    
    5
    
    
    
    
    
    
    
    
    12
    
    
    
    
    
    175
    
    
    173
    
    
    305
    
    
    170
    
    
    (394
    )
    
    259Long-term debt
    
    6
    
    
    248
    
    
    
    
    
    23
    
    
    (6
    )
    
    271Other long-term liabilities and credits
    
    
    
    
    133
    
    
    48
    
    
    28
    
    
    
    
    
    209Future income taxes
    
    
    
    
    54
    
    
    (53
    )
    
    (1
    )
    
    
    
    
    Shareholders equity:Share capital
    
    570
    
    
    551
    
    
    669
    
    
    (27
    )
    
    (1,193
    )
    
    570Contributed surplus
    
    5
    
    
    5
    
    
    
    
    
    5
    
    
    (10
    )
    
    5Retained earnings (deficit)
    
    (210
    )
    
    (215
    )
    
    (124
    )
    
    33
    
    
    306
    
    
    (210
    )365
    
    
    341
    
    
    545
    
    
    11
    
    
    (897
    )
    
    365$
    376
    
    $
    949
    
    $
    845
    
    $
    231
    
    $
    (1,297
    )
    $
    1,104


Tembec Financial Report 2011 89

---

Notes to Consolidated Financial Statements

|17. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL
      INFORMATION(CONTINUED)
|-------------------------------------------------------------------------------

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND DEFICIT
UNDER CANADIAN GAAP

Year ended September 24, 2011Parent
    
    
    **Subsidiary**
    
    
    Guarantor
    
    
    Other
    
    
    **Consolidation**Company
    
    
    Issuer
    
    
    **Subsidiaries**
    
    
    **Subsidiaries**
    
    
    Adjustments
    
    
    **Consolidated**Sales
    $
    
    
    $
    3
    
    $
    1,503
    
    $
    255
    
    $
    (18
    )
    $
    1,743Freight and other deductions
    
    
    
    
    
    
    
    224
    
    
    19
    
    
    (6
    )
    
    237Lumber export taxes
    
    
    
    
    
    
    
    13
    
    
    
    
    
    
    
    
    13Cost of sales
    
    
    
    
    
    
    
    1,176
    
    
    160
    
    
    (12
    )
    
    1,324Selling, general and administrative
    
    (1
    )
    
    10
    
    
    56
    
    
    7
    
    
    
    
    
    72Share-based compensation
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    2Depreciation and amortization
    
    
    
    
    1
    
    
    38
    
    
    6
    
    
    
    
    
    45Other items
    
    
    
    
    4
    
    
    4
    
    
    (7
    )
    
    
    
    
    1Operating earnings (loss)
    
    1
    
    
    (14
    )
    
    (8
    )
    
    70
    
    
    
    
    
    49Interest, foreign exchange and other
    
    
    
    
    1
    
    
    29
    
    
    2
    
    
    
    
    
    32Exchange loss
      (gain) on long-term debt
    
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1Earnings (loss) before income taxes and non-controlling
      interest
    
    1
    
    
    (16
    )
    
    (37
    )
    
    68
    
    
    
    
    
    16Income tax expense (recovery)
    
    
    
    
    7
    
    
    (7
    )
    
    19
    
    
    
    
    
    19Share of results of significantly influenced companies
    
    4
    
    
    (20
    )
    
    
    
    
    
    
    
    16
    
    
    Non-controlling
      interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net earnings (loss) and comprehensive earnings (loss)
    
    (3
    )
    
    (3
    )
    
    (30
    )
    
    49
    
    
    (16
    )
    
    (3
    )Wind-up of subsidiary
    
    
    
    
    
    
    
    
    
    
    (9
    )
    
    9
    
    
    Retained earnings
      (deficit), beginning of period
    
    (210
    )
    
    (215
    )
    
    (124
    )
    
    33
    
    
    306
    
    
    (210
    )Retained earnings
      (deficit), end of period
    $
    (213
    )
    $
    (218
    )
    $
    (154
    )
    $
    73
    
    $
    299
    
    $
    (213
    )Basic and diluted
      earnings (loss) in dollars per share
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (0.03
    )


90Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|17. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL
      INFORMATION(CONTINUED)
|-------------------------------------------------------------------------------

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND DEFICIT
UNDER CANADIAN GAAP(CONTINUED)

Year
      ended September 25, 2010Parent
    
    
    Subsidiary
    
    
    Guarantor
    
    
    Other
    
    
    ConsolidationCompany
    
    
    Issuer
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Adjustments
    
    
    ConsolidatedSales
    $
    
    
    $
    1
    
    $
    1,484
    
    $
    409
    
    $
    (17
    )
    $
    1,877Freight and other deductions
    
    
    
    
    
    
    
    210
    
    
    30
    
    
    (6
    )
    
    234Lumber export taxes
    
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    
    10Cost of sales
    
    
    
    
    
    
    
    1,132
    
    
    305
    
    
    (11
    )
    
    1,426Selling, general and administrative
    
    
    
    
    5
    
    
    58
    
    
    10
    
    
    
    
    
    73Share-based compensation
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    2Depreciation and amortization
    
    
    
    
    
    
    
    43
    
    
    13
    
    
    
    
    
    56Other items
    
    
    
    
    19
    
    
    6
    
    
    (12
    )
    
    
    
    
    13Operating earnings (loss)
    
    
    
    
    (25
    )
    
    25
    
    
    63
    
    
    
    
    
    63Interest, foreign exchange and other
    
    1
    
    
    35
    
    
    31
    
    
    (16
    )
    
    
    
    
    51Exchange loss
      (gain) on long-term debt
    
    
    
    
    (19
    )
    
    
    
    
    (8
    )
    
    
    
    
    (27
    )Earnings (loss) before income taxes and non-controlling
      interest
    
    (1
    )
    
    (41
    )
    
    (6
    )
    
    87
    
    
    
    
    
    39Income tax expense (recovery)
    
    (1
    )
    
    15
    
    
    (15
    )
    
    (14
    )
    
    
    
    
    (15
    )Share of results of significantly influenced companies
    
    (52
    )
    
    (101
    )
    
    
    
    
    
    
    
    153
    
    
    Non-controlling
      interest
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    
    
    2Net earnings (loss) and comprehensive earnings (loss)
    
    52
    
    
    45
    
    
    9
    
    
    99
    
    
    (153
    )
    
    52Wind-up of subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Retained earnings
      (deficit), beginning of period
    
    (262
    )
    
    (260
    )
    
    (133
    )
    
    (66
    )
    
    459
    
    
    (262
    )Retained earnings
      (deficit), end of period
    $
    (210
    )
    $
    (215
    )
    $
    (124
    )
    $
    33
    
    $
    306
    
    $
    (210
    )Basic and diluted
      earnings (loss) in dollars per share
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    0.52


Tembec Financial Report 2011 91

---

Notes to Consolidated Financial Statements

|17. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL
      INFORMATION(CONTINUED)
|-------------------------------------------------------------------------------

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS UNDER
CANADIAN GAAP

Year ended September 24, 2011Parent
    
    
    **Subsidiary**
    
    
    Guarantor
    
    
    Other
    
    
    ConsolidationCompany
    
    
    Issuer
    
    
    **Subsidiaries**
    
    
    Subsidiaries
    
    
    Adjustments
    
    
    **Consolidated**Cash flows from operating activities:Net earnings (loss)
    $
    (3
    )
    $
    (3
    )
    $
    (30
    )
    $
    49
    
    $
    (16
    )
    $
    (3
    )Adjustments for:Depreciation and amortization
    
    
    
    
    1
    
    
    38
    
    
    6
    
    
    
    
    
    45Unrealized foreign exchange and other
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    (2
    )Exchange loss (gain) on long-term debt
    
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1Future income tax expense (recovery)
    
    
    
    
    7
    
    
    (7
    )
    
    11
    
    
    
    
    
    11Other items
    
    
    
    
    
    
    
    (3
    )
    
    (8
    )
    
    
    
    
    (11
    )Excess cash contributions over pension expense
    
    
    
    
    (8
    )
    
    (8
    )
    
    (4
    )
    
    
    
    
    (20
    )Share of results of significantly influenced companies
    
    4
    
    
    (20
    )
    
    
    
    
    
    
    
    16
    
    
    Other
    
    
    
    
    1
    
    
    (2
    )
    
    
    
    
    
    
    
    (1
    )1
    
    
    (21
    )
    
    (12
    )
    
    52
    
    
    
    
    
    20Changes in non-cash working capital:Accounts receivable
    
    3
    
    
    25
    
    
    43
    
    
    (38
    )
    
    
    
    
    33Inventories
    
    
    
    
    
    
    
    (2
    )
    
    (4
    )
    
    
    
    
    (6
    )Prepaid expenses
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    
    
    1Accounts payable,
      accrued charges and interest payable
    
    
    
    
    (8
    )
    
    12
    
    
    17
    
    
    
    
    
    213
    
    
    17
    
    
    53
    
    
    (24
    )
    
    
    
    
    494
    
    
    (4
    )
    
    41
    
    
    28
    
    
    
    
    
    69Cash flows from investing activities:Additions to fixed assets
    
    
    
    
    
    
    
    (37
    )
    
    (18
    )
    
    
    
    
    (55
    )Proceeds on land sales and other
    
    
    
    
    
    
    
    17
    
    
    
    
    
    
    
    
    17Proceeds on sale of French mills
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    
    
    4
    
    
    (5
    )
    
    (4
    )
    
    
    
    
    (5
    )
    
    
    4
    
    
    (25
    )
    
    (22
    )
    
    
    
    
    (43
    )Cash flows from financing activities:Change in operating bank loans
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    
    
    5Cash held in trust
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Increase in long-term debt
    
    
    
    
    
    
    
    
    
    
    8
    
    
    
    
    
    8Repayments of long-term debt
    
    (4
    )
    
    
    
    
    
    
    
    (4
    )
    
    
    
    
    (8
    )Change in other long-term liabilities
    
    
    
    
    (2
    )
    
    
    
    
    1
    
    
    
    
    
    (1
    )Other
    
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1(4
    )
    
    (1
    )
    
    
    
    
    10
    
    
    
    
    
    5Net increase (decrease) in cash and cash equivalents
    
    
    
    
    (1
    )
    
    16
    
    
    16
    
    
    
    
    
    31Cash and cash
      equivalents, beginning of period
    
    
    
    
    1
    
    
    24
    
    
    43
    
    
    
    
    
    68Cash and cash
      equivalents, end of period
    $
    
    
    $
    
    
    $
    40
    
    $
    59
    
    $
    
    
    $
    99Supplemental information:Interest paid
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    25Income tax paid
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    1


92Tembec Financial Report 2011

---

Notes to Consolidated Financial Statements

|17. SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL
      INFORMATION(CONTINUED)
|-------------------------------------------------------------------------------

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS UNDER
CANADIAN GAAP(CONTINUED)

Year
      ended September 25, 2010Parent
    
    
    Subsidiary
    
    
    Guarantor
    
    
    Other
    
    
    ConsolidationCompany
    
    
    Issuer
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Adjustments
    
    
    ConsolidatedCash flows from operating activities:Net earnings (loss)
    $
    52
    
    $
    45
    
    $
    9
    
    $
    99
    
    $
    (153
    )
    $
    52Adjustments for:Depreciation and amortization
    
    
    
    
    
    
    
    43
    
    
    13
    
    
    
    
    
    56Unrealized foreign exchange and other
    
    
    
    
    1
    
    
    
    
    
    (2
    )
    
    
    
    
    (1
    )Exchange loss (gain) on long-term debt
    
    
    
    
    (19
    )
    
    
    
    
    (8
    )
    
    
    
    
    (27
    )Future income tax expense (recovery)
    
    
    
    
    15
    
    
    (15
    )
    
    (15
    )
    
    
    
    
    (15
    )Other items
    
    
    
    
    19
    
    
    6
    
    
    (12
    )
    
    
    
    
    13Excess cash contributions over pension expense
    
    
    
    
    (9
    )
    
    (3
    )
    
    (8
    )
    
    
    
    
    (20
    )Share of results of significanlty influenced companies
    
    (52
    )
    
    (101
    )
    
    
    
    
    
    
    
    153
    
    
    Other
    
    
    
    
    (1
    )
    
    (1
    )
    
    2
    
    
    
    
    
    
    
    
    (50
    )
    
    39
    
    
    69
    
    
    
    
    
    58Changes in non-cash working capital:Accounts receivable
    
    4
    
    
    97
    
    
    (37
    )
    
    (105
    )
    
    
    
    
    (41
    )Inventories
    
    
    
    
    
    
    
    12
    
    
    4
    
    
    
    
    
    16Prepaid expenses
    
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    
    5Accounts payable,
      accrued charges and interest payable
    
    
    
    
    (3
    )
    
    34
    
    
    9
    
    
    
    
    
    404
    
    
    94
    
    
    14
    
    
    (92
    )
    
    
    
    
    204
    
    
    44
    
    
    53
    
    
    (23
    )
    
    
    
    
    78Cash flows from investing activities:Additions to fixed assets
    
    
    
    
    
    
    
    (18
    )
    
    (7
    )
    
    
    
    
    (25
    )Proceeds on land sales and other
    
    
    
    
    3
    
    
    2
    
    
    2
    
    
    
    
    
    7Proceeds on sale of French mills
    
    
    
    
    
    
    
    
    
    
    86
    
    
    
    
    
    86Other
    
    
    
    
    
    
    
    2
    
    
    (3
    )
    
    
    
    
    (1
    )
    
    
    3
    
    
    (14
    )
    
    78
    
    
    
    
    
    67Cash flows from financing activities:Change in operating bank loans
    
    
    
    
    
    
    
    (96
    )
    
    (21
    )
    
    
    
    
    (117
    )Cash held in trust
    
    
    
    
    
    
    
    
    
    
    (6
    )
    
    
    
    
    (6
    )Increase in long-term debt
    
    
    
    
    263
    
    
    
    
    
    9
    
    
    
    
    
    272Repayments of long-term debt
    
    (4
    )
    
    (309
    )
    
    
    
    
    (5
    )
    
    
    
    
    (318
    )Change in other long-term liabilities
    
    
    
    
    
    
    
    1
    
    
    1
    
    
    
    
    
    2Other
    
    
    
    
    (14
    )
    
    (3
    )
    
    2
    
    
    
    
    
    (15
    )(4
    )
    
    (60
    )
    
    (98
    )
    
    (20
    )
    
    
    
    
    (182
    )Net increase (decrease) in cash and cash equivalents
    
    
    
    
    (13
    )
    
    (59
    )
    
    35
    
    
    
    
    
    (37
    )Cash and cash
      equivalents, beginning of period
    
    
    
    
    14
    
    
    83
    
    
    8
    
    
    
    
    
    105Cash and cash
      equivalents, end of period
    $
    
    
    $
    1
    
    $
    24
    
    $
    43
    
    $
    
    
    $
    68Supplemental information:Interest paid
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    29Income tax paid
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    


Tembec Financial Report 2011 93

---

Notes to Consolidated Financial Statements

|18. SUBSEQUENT EVENTS
|---------------------

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 will 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.

|19. COMPARATIVE FIGURES
|-----------------------

Certain comparative figures have been reclassified to conform
with the financial statement presentation adopted in the current year.

94Tembec Financial Report 2011

---