truths · tembec ar 08 - en editorial tembec annual report 2008 07 the strategic direction of the...

C1Tembec

AR 08 - EN COVERS

Truths.

TEMBEC2008 ANNUAL REPORT

20TembecAR 08 - EN EDITORIAL

1 INTROdUcTION

2 ThE TRUTh AbOUT Q1: A moment of truth.

3 ThE TRUTh AbOUT Q2: We faced the challenge head on.

4 ThE TRUTh AbOUT Q3: We found our feet.

5 ThE TRUTh AbOUT Q4: We forge ahead.

6 TRUE REsPONsIbILITy: Strategic direction

8 TRUE ENvIRONmENTAL LEAdERshIP: FSC certification and Greenhouse gas emissions

10 TRUE bALANcE: Vision, Mission, Principles and Guidelines

12 REPORT TO shAREhOLdERs

14 FINANcIAL hIghLIghTs

16 cORPORATE gOvERNANcE

19 mANAgEmENT’s dIscUssION ANd ANALysIs

52 mANAgEmENT’s REsPONsIbILITy

53 AUdITORs’ REPORT TO ThE shAREhOLdERs

54 cONsOLIdATEd FINANcIAL sTATEmENTs

61 NOTEs TO cONsOLIdATEd FINANcIAL sTATEmENTs

96 TEN-yEAR FINANcIAL REvIEw

98 dIREcTORs ANd OFFIcERs

99 shAREhOLdER INFORmATION

01Tembec

AR 08 - EN EDITORIAL

TEMBECAnnual Report 2008

01

A difficult period in the Canadian forestry industry has made us take stock of the strengths that define Tembec. In order to overcome challenges, we renewed our focus and learned that to be a strong competitor moving forward, we must rely on certain truths.


THE TRUTH ABOUT Q1

A moment of truth.ThE 1990s ANd EARLy yEARs OF ThE mILLENNIUm mARkEd A PERIOd OF UNPREcEdENTEd gROwTh FOR

TEmbEc. IT wAs A PERIOd OF OPPORTUNIsTIc AcQUIsITIONs, chEAP ENERgy, EAsy AccEss TO cAPITAL,

sTRONg mARkETs FOR mANy OF OUR PROdUcTs ANd AN UNdERvALUEd cANAdIAN dOLLAR.

OUR ExPANdEd cOmPANy, hOwEvER, REQUIREd ThE cONTINUATION OF ThEsE POsITIvE FAcTORs

TO sUPPORT ITs vIAbILITy. wITh mARkETs chANgINg, ThE cANAdIAN dOLLAR sURgINg ANd sOmE OF

OUR sITEs ILL-EQUIPPEd TO mAINTAIN ThEIR cOmPETITIvENEss, ThE NEEd FOR AggREssIvE AcTION

wAs cLEAR.

03Tembec



03THE TRUTH ABOUT Q2

We faced the challenge head on.IN REsPONsE TO ThIs “PERFEcT sTORm” OF FINANcIAL, cURRENcy ANd mARkET chALLENgEs, mANAgEmENT

ANd ThE ThEN bOARd OF dIREcTORs REcOgNIzEd ThE NEEd FOR dEcIsIvE AcTION. PRObLEms wERE

IdENTIFIEd, dIFFIcULT dEcIsIONs wERE mAdE ANd TOUgh AcTION wAs TAkEN, INcLUdINg sITE cLOsUREs.

mOsT sIgNIFIcANTLy, ThE chALLENgE OF A cRIPPLINg dEbT wAs FAcEd wITh ThE sUc cEssFUL

REcAPITALIzATION OF ThE cOmPANy. Us $1.2 bILLION OF dEbT wAs cONvERTEd INTO EQUITy ANd A NEw

Us $300 mILLION LOAN wAs PUT INTO PLAcE, PROvIdINg sIgNIFIcANT LIQUIdITy FOR TEmbEc.


THE TRUTH ABOUT Q3

We found our feet.wITh ThE REcAPITALIzATION cOmPLETEd, ThE NEw TEmbEc gAINEd FINANcIAL sTAbILITy – A vERy

dEsIRAbLE POsITION IN gENERAL, ANd IN ThE FOREsT PROdUcTs INdUsTRy IN PARTIcULAR. ThIs

REPOsITIONINg OF OUR cOmPANy ANd ThE cREATION OF ThE NEw TEmbEc wILL ALLOw ThE ENTIRE

ORgANIzATION TO AggREssIvELy PURsUE OPERATIONAL ANd cOmmERcIAL ExcELLENcE.

05Tembec



05THE TRUTH ABOUT Q4

We forge ahead.IN LIghT OF PREvAILINg mARkET cONdITIONs, mANAgEmENT Is AssEssINg ThE cOmPANy’s AssET mIx

TO REFOcUs ITs cAPITAL REsOURcEs TO ImPROvE OPERATINg mARgINs ANd mAxImIzE cAsh FLOw FROm

OPERATIONs. wE mOvE FORwARd wITh A cOmmITmENT OF RENEwEd FOcUs, dIscIPLINE ANd RIgOUR.


True Responsibility

ENVIRONMENTAL

REsPONsIbLE steward of resources

REsPONsIbLE employer

SOCIAL

Economically REsPONsIbLE

ECONOMIC

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07

THE STRATEgIC dIRECTION Of THE NEw TEMBEC IS BUILT UpON

A fOUNdATION Of RESpONSIBILITY. wE wILL BE:

An economically REsPONsIbLE company, achieving consistently superior •

financial results for the benefit of shareholders and other stakeholders by

maximizing the commercial benefit of the company’s positive initiatives and

programs in terms of market access and profitability.

A REsPONsIbLE steward of resources, demonstrating respect for nature •

through exemplary forest management practices and continuing to focus on

improving environmental performance of our manufacturing facilities, including

managing all aspects of our carbon footprint.

A REsPONsIbLE employer, promoting a safe, healthy and competitive working •

environment for employees.


True Environmental Leadership

fSC CERTIfICATION

back in 2001, Tembec was the first large-scale canadian forestry company to

seek third-party certification of all of its forest operations in accordance with

Forest stewardship council (Fsc) standards. Today, 100% of forests under our

management are certified and we are now working with external supply partners

to further extend the areas and volumes under certification.

Tembec offers the largest range of Fsc-certified products, including lumber, pulp,

newsprint and paperboard.

FSC CERTIFICATION(in millions of hectares)

0

2

4

6

8

10

12

2002 2003 2005 2006 20072004 2008

09Tembec



09

GREENHOUSE GAS EMISSIONS(in thousands of tonnes CO2 equivalent)

200

300

400

500

600

700

800

2003 2005 2006 20072004 2008

gREENHOUSE gAS EMISSIONS

Tembec has distinguished itself as an industry leader in environmental performance.

Our Impact zero® Environmental management Program is designed to minimize the

impact of manufacturing activities on the environment. Over the last three years our

energy and environmental policy commitments have resulted in greenhouse gas

emissions being cut by 35%. In the last six years, the reduction amounts to 56%.

Tembec intends to continue to pursue ghg reduction by focusing on green

energy production.


True Balance

VISION

Tembec is an efficient converter of forest resources, focused on achieving consistently

superior economic results and leading environmental stewardship.

MISSION

A team of people with an uncompromising focus on safety, efficiency, environ-

mental stewardship and quality, working to achieve consistently superior financial

performance within the forest industry. The success of our mission is built on the

strength of enduring partnerships with employees, customers, suppliers and the

communities in which we operate.

pRINCIpLES ANd gUIdELINES

The following principles and guidelines have been established to provide a

reference point and to support Tembec in accomplishing its mission:

create a safe and competitive working environment in which every employee •

can contribute.

manage the company efficiently and effectively to achieve consistently superior •

financial performance in the forest industry.

Remain a global leader in resource stewardship.•

Attain and maintain an operational regime focused on energy efficiency, •

minimum reliance on all forms of purchased energy and feasible reduction of

greenhouse gas emissions.

be a world-class manufacturing entity that consistently supplies high-quality •

products through its commitment to innovation and continuous improvement.

consider customers as long-term partners, anticipating and meeting their •

needs, including environmentally-friendly solutions, and provide them with

superior service.

Establish partnerships with suppliers that consistently meet the company’s •

quality, service and price requirements.

11Tembec



11

We are Tembec and these are the truths we believe in.


Report to Shareholders

In February of 2008, the company completed the recapit-

alization of its balance sheet. This was done only after an

extensive review was launched to explore a number of

refinancing alternatives with the assistance of its finan-

cial advisors. conditions for the company deteriorated

throughout this process due to negative changes in

external factors, including foreign exchange rates and

energy costs, leaving the company no choice but to

initiate a recapitalization of its balance sheet.

The critical elements of the recapitalization of the

company included the conversion of Us $1.2 billion of debt

and obtaining a Us $300-million loan which was used to

pay down the operating line and increase cash reserves.

while the result of this process was extremely dilutive

to existing shareholders, it provided the company with

an excellent balance sheet and liquidity position going

forward. with the benefit of hindsight, we can say that

the timing of the recapitalization was very good, since it

preceded the current credit crisis that is affecting virtually

every country and every region in the world, making credit

extremely difficult to obtain. without the Us $300-million

new loan, the company would not have its solid financial

footing to allow it to operate effectively as we go through

this period of economic uncertainty.

The credit crisis and the broader economic slowdown are

having an effect on the company’s key markets for each

of its business segments. An economic slowdown does

typically affect the demand for commodities and puts

pressure on prices, depending on how producers react.

On the other hand, the strengthening of the U.s. dollar and

reduction of key input costs, including energy, can provide

mitigation to some of the effects that the slowing economy

is having on the demand for the company’s products.

forest products

The situation in the U.s. housing market is more difficult

than anyone could have predicted. The subprime mortgage

problems have had the effect of reducing demand for

home purchases, and has put more homes on the market

due to foreclosures. The broader credit crisis and overall

economic uncertainty have had a further dampening effect

on demand for homes in the U.s., increasing the number

of homes for sale in an already oversupplied market. The

ultimate effect has been significant declines in the value of

homes throughout the United states.

The resulting reduction in housing starts and the poor

demand for lumber and other building products has

had a very negative effect on the financial results of the

company’s Forest Products business, which generated

negative EbITdA for the second year in a row due to very

poor selling prices. The company has adjusted to the poor

market situation by reducing production through a series

of permanent, indefinite and temporary sawmill closures,

accompanied by fixed cost reduction initiatives. however,

sawmills must be operated at a level sufficient to provide

wood chips and biomass to the company’s pulp and

paper mills.

The company intends to operate its Forest Products

business with the view that 2009 will be another

challenging year for housing in the U.s. The strategy will

be to operate the sawmills at a level that will generate the

best overall contribution rates throughout the internal

fibre supply chain.

pulp

The demand for paper pulp has been robust for the last

several years due to a strong global economy and the

installation of new, world-class paper, packaging and

tissue machines in Asia. many of the new machines are not

integrated with internal pulp capacity, requiring significant

purchases of market pulp. This trend, coupled with the

closure of older, uncompetitive integrated machines, has

driven the ratio of non-integrated to integrated capacity

to all-time highs. despite the construction and start-up of

very large pulp mills in the southern hemisphere, demand

for market pulp remained strong, and a very favourable

pricing environment existed for market pulp until late

summer of 2008.

Relatively high U.s. dollar prices for market pulp did not

translate into higher earnings for canadian pulp producers,

and Tembec was no exception. The weaker U.s. dollar versus

the canadian dollar and the euro, and escalating wood,

energy and chemical costs, clawed back most of the gains in

U.s. dollar pricing. This period did see the emergence of the

company’s high-yield pulp business as a superior performer

within the Pulp group. Time and resources spent in optimizing

the operational capabilities of the three high-yield pulp mills,

in addition to product and market development initiatives,

have made Tembec the world leader in high-yield pulps from

both a market share and a technology standpoint.

13Tembec



13

The markets for specialty dissolving pulps continued to

improve in the first half of 2008. The company used this

opportunity to optimize its product and customer mix

between its canadian and its French mills. more emphasis

was also placed on specialized product applications where

demand is more stable and pricing is less volatile than it

is for certain commodity dissolving pulps. while this

approach caused the company to miss peak commodity

pulp pricing in 2008, the strategy is expected to pay

dividends in the coming year as demand for all commodity

dissolving pulps is expected to decline.

The outlook for commodity paper and dissolving pulps

for the first half of 2009 is for slower demand due to

the weaker economy. Pricing will be highly dependent

on actions of pulp producers to balance supply with a

reduced demand level. specialty pulp pricing and demand

are expected to remain firm in the coming year.

paper

The demand for publishing papers in North America is

experiencing a structural shift, with both advertising and

content moving to other media. The extreme case is in the

newsprint sector where demand declines have been in the

double digits over the last several years. demand has been

further impacted by the economic slowdown that began in

the second half of 2008 and will carry over into 2009.

despite declining demand for newsprint in North America,

successive U.s. dollar price increases were obtained in

virtually every month in 2008 due to healthy overseas

shipments by some producers, coupled with significant

curtailments of newsprint capacity. This has kept supply

well balanced with demand and created opportunities

to increase prices. No reversal in the trend for newsprint

demand is anticipated in 2009, and pricing will be driven by

factors such as supply constraint, foreign exchange rates

and input cost for producers. The company’s newsprint

mills shifted to positive EbITdA in the september

2008 quarter.

The company’s coated bleached board mill went through a

transitional year in 2008 by shifting its grade mix to higher

value specialty grades. The new products are expected

to be important ingredients to the sales mix in 2009. This

operation should also benefit from a weaker canadian

dollar and lower pulp prices in the coming year.

Chemicals

The chemical Products group remains a small but

consistent contributor to the company’s earnings.

demand for resin products declined due to the declines

in demand by its Osb (oriented strand board) customers.

Osb is used mainly in new home construction. demand

for ethanol and lignin was stable for much of the year, but

we are now seeing the effects of the economic slowdown.

These trends are likely to continue into 2009.

Environment

Throughout the company’s financial challenges of the

past several years, Tembec has maintained its focus on

both Fsc certification of its forests under management

and greenhouse gas reductions. These were key elements

of the business plan that could not be compromised. Fsc

certification has now translated into commercial success

by assisting the company in obtaining key supply contracts

with large customers in the lumber, pulp and paper sectors.

while the greenhouse gas reduction efforts have not yet

directly provided expanded commercial opportunities,

they have resulted in significant reductions in purchased

fossil fuels at a critical period. The company will continue

to focus on these key elements of its environmental policy

to maintain its global environmental leadership position

within the forest products industry.

Conclusion

2008 was certainly a transformational year, starting with the

recapitalization which resulted in a significant improvement

in the company's balance sheet, a major change in the

company’s shareholder base and the formation of a new

board of directors. The recapitalization also put into place

a new Us $300-million loan to provide very good liquidity

levels that will not only allow the company to ride out

the current economic uncertainty, but will also provide

the flexibility to make changes in the company’s current

businesses. These changes will be necessary to improve

the financial results of the company.

JAMES M. LOpEzPresident and chief Executive Officer

JAMES V. CONTINENzAchairman of the board

James m. Lopez James v. continenza Tembec's board of directors


FinancialHighlights

2004 2005 2006 2007Combined

2008

(1)

OPERATIONs (in millions of dollars)

sales $ 3,171 $ 3,109 $ 3,016 $ 2,750 $ 2,376

EbITdA 142 13 42 65 21

EbITdA margin 4.5 % 0.4 % 1.4 % 2.4 % 0.9 %

Operating earnings (loss) (106) (410) (325) 119 (77)

Net earnings (loss) 46 (300) (292) (49) (150)

Net fixed assets additions 143 144 82 71 63

FINANcIAL POsITION (in millions of dollars)

working capital (excluding cash and short-term debt) $ 417 $ 512 $ 482 $ 430 $ 426

Total capitalization 3,093 2,903 2,580 2,255 1,128

Net debt 1,485 1,681 1,663 1,415 342

shareholders’ equity 1,206 905 615 566 522

Net debt to total capitalization 48 % 59 % 65 % 63 % 30 %

cOmmON shAREs OUTsTANdINg (in millions) 85.9 85.6 85.6 85.6 100.0

PER cOmmON shARE ($)

Net earnings (loss) from continuing operations 0.89 (2.20) (3.45) 1.75 (1.55)

Net earnings (loss) 0.53 (3.50) (3.41) (0.58) (1.67)

diluted earnings (loss) 0.53 (3.50) (3.41) (0.58) (1.67)

book value 14.05 10.57 7.18 6.61 5.22

OThER dATA

Employees at year-end 10,047 9,583 8,608 7,661 6,727

Annual payroll and benefits (in millions of dollars) 771 728 697 597 508

(1) The 2008 annual financial results ("combined") include those of the Predecessor for the five-month period ended February 29, 2008, and of the company for the seven-month period ended september 27, 2008. The comparative figures have been restated to reflect the effect of the adoption of certain canadian Institute of chartered Accountants recommendations. From 2002, the comparative figures have been reclassified to exclude the oriented strand board and the coated paper results from the continuing operations.

15Tembec



15

Performance against long-term financial objectives

EBITDA MARGINS(in percentage)

0

5

10

15

2004

4.6%

1.0%

2006

0.9%

2008

1.2%

2007

0.7%

2005

1.7%

5-yearaverage

Actual

Objective > 14%

FREE CASH FLOW(in millions of dollars)

-200

-100

-50

-150

0

50

100

150

2004

93

(179)

2006

(113)

2008

71

2007

(158)

2005

(57)

5-yearaverage

Actual

Objective – minimum of $100 million

RETURN ON CAPITAL EMPLOYED (ROCE)(in percentage)

-10

-5

0

5

10

15

2004

4.0%

(7.8)%

2006

(6.5)%

2008

1.4%

2007

(7.0)%

2005

(3.2)%

5-yearaverage

Actual

Objective > 10%

RETURN ON SHAREHOLDERS’ EQUITY(in percentage)

-50

-30

-20

-10

-40

0

10

20

2004

3.2%

(41.5)%

2006

(27.8)%

(8.6)%

20082007

(29.3)%

2005

(20.8)%

5-yearaverage

Actual

Objective > 14%


Corporate Governance

BOARd Of dIRECTORS

The board of directors is responsible for the overall

stewardship of the corporation and has full power and

authority to manage and control the affairs and busi-

ness of the corporation. It establishes the overall policies

and standards for the corporation. while delegating

certain of its authority and responsibilities to its commit-

tees and management of the corporation, it retains full

effective control over the corporation and monitors senior

management. The directors are kept informed of the

corporation’s operations at meetings of the board, of its

committees and through reports, analyses and discussions

with management.

The board of directors has a formal written mandate which

describes its principal functions, a copy of which can be

found on the corporation’s website at www.tembec.com.

The mandate provides that the board will consider recom-

mendations made by the officers of the corporation who

are responsible for the general day-to-day manage-

ment of the corporation. The board is also responsible

for overseeing the formulation by management of long-

term strategic, financial and organizational and related

objectives. The mandate of the board also establishes a

requirement that it implement structures and procedures

to ensure that it functions independently of management,

such as the board’s practice of conducting in-camera

sessions as part of each regularly scheduled meeting.

Composition of the Board of directors

The board of directors currently consists of nine members.

It believes that such number of directors is large enough

to allow the directors to benefit from a wide variety of

ideas and viewpoints without compromising communi-

cation among the directors, and between the directors

and management.

Independence of directors

The corporation considers that a majority of the

board of directors qualified as independent directors

throughout the last financial year, and all Audit committee

members qualified as independent within the meaning of

Multilateral Instrument 52‑110 – Audit Committees.

COMMITTEES

The board of directors has established three standing

committees, each of which is constituted by its own charter,

to which the board has delegated certain of its authority

and responsibilities, as well as certain advisory func-

tions and power to make recommendations and reports

to the board. The standing committees of the board

are the corporate governance and human Resources

committee, the Audit committee and the Environment,

health and safety committee. with the exception of

the Environment, health and safety committee, where

mr. James m. Lopez, President and chief Executive Officer

of the corporation and mr. Luc Rossignol, President,

Local 233, communications, Energy and Paperworkers

Union are members, all committees of the board of

directors are composed of independent directors.

Corporate governance and

Human Resources Committee

The corporate governance and human Resources

committee is responsible for developing the corporation’s

approach to corporate governance issues. It reviews

and reports to the board annually on what ought to be

the size, composition, profile and compensation of the

board of directors. It also recommends candidates to be

nominated for election or appointment as directors and

evaluates the board’s performance. It also evaluates the

performance of the board’s committees and the contri-

bution of members of the board and its committees. The

committee also reviews, on an annual basis, the board/

management relationship and recommends to the board

structures and procedures to ensure that the board

functions independently of management.

The committee is also responsible for reviewing matters

of remuneration for senior executive positions, including

that of the President and chief Executive Officer, and

making recommendations to the board of directors

thereon. It is also responsible for reviewing and making

recommendations to the board for the appointment of

persons to senior executive positions, for considering their

terms of employment and for succession planning. The

committee recommends awards under the corporation’s

THE BOARd Of dIRECTORS ANd MANAgEMENT Of THE CORpORATION CONSIdER gOOd CORpORATE gOVERNANCE

TO BE CENTRAL TO THE EffECTIVE OpERATION ANd SUCCESS Of THE CORpORATION. IN ORdER TO ENSURE

pROpER ANd CURRENT CORpORATE gOVERNANCE pRACTICES, THE BOARd Of dIRECTORS ANd MANAgEMENT

REgULARLY COMpARE THE CORpORATION’S pRACTICES ANd pROCEdURES wITH THE gUIdELINES SET OUT IN

NatioNal iNstrumeNt 58‑201 – Corporate GoverNaNCe GuideliNes, THE pROpOSALS Of VARIOUS OTHER

REgULATORY AUTHORITIES, AS wELL AS THE pRACTICES AdOpTEd BY ITS pEERS.

17Tembec



17

long-term and short-term incentive plans, employee profit

sharing plans and oversees the design and funding of the

corporation’s pension plans. It assumes the role of admin-

istrator for the corporate-sponsored registered pension

plans, supervising the administration of such retirement

plans and monitoring the investment performance of the

trust funds for the corporation’s retirement plans. It also

makes sure that these are in compliance with applicable

legislation and investment policies. Finally, the committee

annually reviews and approves the remuneration of

corporate and divisional officers and the remuneration of

all other employees on an aggregate basis.

The responsibilities of the corporate governance and

human Resources committee, including those respon-

sibilities described above, are reviewed by the board of

directors annually.

Audit Committee

The Audit committee meets on a regular basis with the

financial officers of the corporation and the independent

auditors to, among other things, review and inquire into:

(a) matters affecting financial reporting; (b) the adequacy

of internal controls and procedures for financial reporting

and accounting; (c) the audit procedures and audit plans;

and (d) the financial and business risks or exposures of

the corporation and the steps that management has taken

to control such risks. It also recommends to the board of

directors the external auditors to be appointed and their

remuneration. The Audit committee annually reviews the

independence of the external auditors.

The Audit committee reviews and recommends to the

board, for its approval: (a) the interim unaudited financial

statements and management’s discussion and Analysis

contained therein; (b) the audited annual financial state-

ments and management’s discussion and Analysis

contained therein; (c) prospectuses and other offering

memoranda; and (d) the annual and interim earnings press

releases and other public disclosure documents containing

audited or unaudited financial information required by

regulatory authorities.

The responsibilities of the Audit committee, including

those responsibilities described above, are reviewed by the

board of directors annually. All the members of the Audit

committee are financially literate as defined in applicable

securities legislation.

Environment, Health and Safety Committee

The Environment, health and safety committee is respon-

sible for reviewing and making recommendations and

reports to the board of directors relating to the policies,

standards, practices and programs of the corporation on

matters pertaining to both the environment and occu-

pational health and safety. The committee monitors the

corporation’s performance in relation to its own policies,

as well as in relation to applicable legislation pertaining

to both the environment and occupational health and

safety. It also reviews and reports to the board of directors

on the corporation’s state of readiness to respond to

crisis situations.

The responsibilities of the Environment, health and safety

committee, including those responsibilities described

above, are reviewed by the board of directors annu-

ally. All of the above board committees have a written

charter, which may be found on the corporation’s website

at www.tembec.com.

COdE Of ETHICS ANd BUSINESS CONdUCT

The corporation has adopted a written code of Ethics

and business conduct (the “code of conduct”), which

provides guidelines to ensure that all directors, officers

and employees of the corporation and its subsidiaries and

all consultants, suppliers and other persons working with

or on behalf of the corporation abide by its commitment

to conduct business relationships with respect, openness

and integrity. The corporation believes that its success is

contingent on its values, which include integrity, account-

ability, trust, transparency and teamwork. The corporation

is committed to conducting its business in compliance

with applicable laws, statutes and regulations.

The board of directors monitors compliance with the code

of conduct and is responsible for granting any waivers

from compliance. compliance with the code of conduct

is also reviewed by the Audit committee as part of the

corporation’s internal audit process and by the corporate

governance and human Resources committee in relation

to board members. The code of conduct is available on

the corporation’s website at www.tembec.com.

SHAREHOLdER/INVESTOR COMMUNICATION

The board of directors considers and reviews the means

by which shareholders can communicate with the

corporation, including the opportunity to do so at the

Annual meeting and through the corporation’s website,

as well as the adequacy of resources available within the

corporation to respond to shareholders through the office

of the secretary or otherwise.

18TembecAR 08 - EN MD&A

19Tembec

AR 08 - EN MD&A


19

Management’s Discussion and Analysis as at November 28, 2008

THE MANAgEMENT’S dISCUSSION ANd ANALYSIS (Md&A) SECTION pROVIdES A REVIEw Of THE SIgNIfICANT

dEVELOpMENTS ANd ISSUES THAT INfLUENCEd TEMBEC INC.’S fINANCIAL pERfORMANCE dURINg THE fISCAL

YEAR ENdEd SEpTEMBER 27, 2008, AS COMpAREd TO THE fISCAL YEAR ENdEd SEpTEMBER 29, 2007. THE Md&A

SHOULd BE REAd IN CONJUNCTION wITH THE AUdITEd CONSOLIdATEd fINANCIAL STATEMENTS fOR THE fISCAL

YEAR ENdEd SEpTEMBER 27, 2008. ALL REfERENCES TO QUARTERLY OR COMpANY INfORMATION RELATE TO

TEMBEC INC.’S fISCAL QUARTERS. EBITdA, NET dEBT, TOTAL CApITALIzATION, fREE CASH fLOw ANd CERTAIN

OTHER fINANCIAL MEASURES UTILIzEd IN THE Md&A ARE NON-gAAp (gENERALLY ACCEpTEd ACCOUNTINg

pRINCIpLES) fINANCIAL MEASURES. AS THEY HAVE NO STANdARdIzEd MEANINg pRESCRIBEd BY gAAp, THEY

MAY NOT BE COMpARABLE TO SIMILAR MEASURES pRESENTEd BY OTHER COMpANIES.

The md&A includes “forward-looking statements” within the meaning of securities laws. such statements relate to the company’s or management’s objectives, projections, estimates, expectations or predictions of the future and can be identified by words such as “anticipate”, “estimate”, “expect”, “will” and “project” or variations of such words. These statements are based on certain assumptions and analyses made by the company in light of its experience and its perception of future developments. such state-ments are subject to a number of risks and uncertainties, including, but not limited to, changes in foreign exchange rates, product selling prices, raw material and operating costs and other factors identified in our periodic filings with securities regulatory authorities. many of these risks are beyond the control of the company and, therefore, may cause actual actions or results to materially differ from those expressed or implied herein. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The infor-mation in the md&A is at November 28, 2008. disclosure contained in this document is current to that date, unless otherwise stated.

Throughout the md&A, “Tembec” or “company” means Tembec Inc. and its consolidated subsidiaries and invest-ments. “Av cell” refers to the company’s participation in Av cell Inc. which operates a dissolving pulp mill located in Atholville, New brunswick. On september 30, 2007, the Aditya birla group purchased additional equity of Av cell Inc. As the company did not purchase additional equity, the percentage ownership of the Aditya birla group increased from 50% to 75% and the company’s ownership declined from 50% to 25%. As a result, the company ceased applying the proportionate consolidation accounting method to its investment in Av cell Inc. and began applying the equity accounting method. “marathon” refers to the

company’s 50% participation in marathon Pulp Inc., which operates a northern bleached softwood kraft (Nbsk) pulp mill in marathon, Ontario. This investment is accounted for by the proportionate consolidation method. “Temlam” refers to the company’s 50% participation in Temlam Inc., which operates laminated veneer lumber (LvL) plants in ville-marie and Amos, Quebec, and wood I-beam manu-facturing plants in calgary, Alberta, bolton, Ontario, and blainville, Quebec. On september 15, 2008, Temlam Inc. and Jager building systems Inc., a wholly-owned subsidiary of Temlam Inc., made voluntary assignments in bankruptcy. As a result of these filings, the company concluded that, based on canadian gAAP, it had lost joint control over Temlam Inc. and ceased to apply the propor-tionate consolidation method to account for its 50% interest in Temlam Inc. “Temrex” refers to the company’s 50% participation in Produits Forestiers Temrex Limited Partnership, which operates two sawmills in the gaspé region of Quebec. This investment is accounted for by the proportionate consolidation method.

Tembec’s operations consist of four reportable business segments: Forest Products, Pulp, Paper, and chemicals. On september 27, 2008 Tembec had approximately 7,000 employees, as compared to 8,000 at the end of the prior fiscal year. The company operated manufacturing facilities in Quebec, Ontario, manitoba, british columbia, the states of Louisiana and Ohio, as well as in southern France. Principal facilities are described in the subsequent sections of the md&A.

In July 2007, the company indefinitely idled its coated paper facility in st. Francisville, Louisiana. despite efforts to restructure the operation, the mill’s financial perform-ance remained relatively poor. As a result of the change in circumstances, the company recorded an asset impair-ment charge of $173 million in fiscal 2007. The company


management’s discussion and Analysis

has not identified a feasible restructuring plan to resume operations at the facility. As well, the company has retained the services of an outside party to actively seek the sale of the site. As this operation is the only coated paper facility owned by the company, its fiscal 2007 financial results were reclassified as discontinued operations. comparative figures were also reclassified to exclude the coated paper results from the company’s continuing operations. For certain non-gAAP financial measures, the amounts presented still reflect the actual reported results in fiscal 2007. In those circumstances, a footnote indicates that they include the results of the coated paper operations.

On February 29, 2008, the company completed a major financial recapitalization of its balance sheet. The prin-cipal element of the recapitalization was the conversion of Us $1.2 billion of senior unsecured notes into 95% of the common equity of the company. In accordance with section 1625 of the canadian Institute of chartered Accountants (cIcA), Comprehensive Revaluation of Assets and Liabilities, Tembec applied fresh start accounting as at February 29, 2008. For purposes of the md&A, reported sales and EbITdA were relatively unaffected and remain directly comparable to prior periods, as the company’s physical operations were not impacted by the financial recapitalization. however, a $804 million reduction in the carrying value of fixed assets did lead to a reduction of approximately $33 million in fiscal 2008 depreciation expense, decreasing the reported operating loss by the same amount. The impact of this reduction on each of the company’s business segments is outlined in subsequent sections of the md&A. details regarding the financial recapitalization are included in note 1 of the audited consolidated financial statements.

CHANgES IN ACCOUNTINg pOLICIES ANd ESTIMATES

As part of the application of fresh start accounting in February 2008 and the requirement to effect a compre-hensive revaluation of the company’s fixed assets, a review of the estimated remaining useful life of certain fixed assets was also undertaken. The review indicated that the estimated useful life of several Pulp segment fixed assets was longer than originally anticipated and periodic future depreciation expense should be reduced. The implementation of these changes in estimates reduced Pulp segment depreciation expense by $4 million in the september 2008 quarter.

Effective march 2008, the company adopted the new standards of the cIcA handbook section 3031, Inventories. The new section requires that inventories be measured at the lower of cost and net realizable value. Prior to the adoption of this section, the company did not apply net realizable value standards to its log inventories. during

fiscal 2008, the Forest Products segment benefited from an $18 million favourable adjustment to the carrying values of its log inventories.

Effective march 2008, the company adopted the new standards of the cIcA handbook section 3862, Financial Instruments – Disclosures and section 3863, Financial Instruments – Presentation. These new sections are effective for interim and annual financial statements begin-ning on or after October 1, 2007. section 3862 requires an increased emphasis on disclosing the nature and the extent of risk arising from financial instruments and how the company manages those risks. section 3863, estab-lishes standards for presentation of financial instruments and non- financial derivatives. sections 3862 and 3863 replaced section 3861, Financial Instruments – Disclosures and Presentation. The adoption of these new standards did not impact the company’s financial results.

Effective march 2008, the company adopted the new stan-dards of cIcA handbook section 1535, Capital Disclosures. section 1535 requires the company to disclose informa-tion to enable users of its financial statements to evaluate the company’s objectives, policies and processes for managing capital. The adoption of these new standards did not impact the company’s financial results.

Effective October 1, 2007, the company adopted the revised standards of the cIcA handbook section 1506, Accounting Changes. The revised section provides addi-tional guidance in determining when it is impracticable to give retrospective application to a change in accounting policy. The adoption of the revised standards did not impact the company’s financial results.

Effective march 1, 2008, the company adopted the accounting treatment prescribed by Emerging Issues Committee’s EIC‑166 of the cIcA handbook with respect to transaction costs when it acquires a financial asset or incurs a financial liability. EIc-166 concluded that the same accounting policy choice should be made for all similar financial instruments classified as other than held for trading, but that a different accounting policy choice might be made for financial instruments that are not similar. The adoption of EIc-166 did not impact the company’s financial results.

Effective march 15, 2008, the company adopted the accounting treatment prescribed by Emerging Issues Committee’s EIC‑169 of the cIcA handbook with respect to contracts that are routinely denominated in a single currency. EIc-169 provides guidance on the interpreta-tion of the term “routinely denominated” and identifies factors that can be used to determine whether a contract for the purchase or sale of a non-financial item is routinely denominated in a particular currency in commercial trans-actions around the world. The adoption of EIc-169 did not impact the company’s financial results.

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IMpACT Of ACCOUNTINg pRONOUNCEMENTS ON fUTURE REpORTINg pERIOdS

The cIcA revised handbook section 1400, General Standards of Financial Statement Presentation. The revision to this section provides additional guidance related to management’s assessment of the company’s ability to continue as a going concern. This revision will become effective for the fiscal year beginning on October, 1, 2008. The company does not anticipate any substantial change to its disclosure as a result of the adop-tion of the revised standards.

The cIcA has released handbook section 3064, Goodwill and Intangible Assets. This section establishes standards for the recognition, measurement, presentation and disclosure of goodwill and intangible assets. These new standards will become effective for the fiscal years begin-ning on or after October 1, 2008. The company does not anticipate any substantial change to its disclosure as a result of the adoption of the new standards.

On February 13, 2008, the Accounting standards board confirmed that publicly accountable entities will be required to prepare financial statements in accordance with International Financial Reporting standards (“IFRs”) for interim and annual financial statements for fiscal years beginning on or after January 1, 2011. The company is currently in the process of developing a conversion imple-mentation plan, has appointed a project manager and is assessing the impacts of the conversion on its consoli-dated financial statements and disclosure.

CRITICAL ACCOUNTINg pOLICIES ANd ESTIMATES

fixed asset depreciationThe company records its fixed assets, primarily production buildings and equipment, at cost. Interest costs are capital-ized for projects in excess of $1 million that have a duration in excess of one year. Investment tax credits or capital assistance received reduce the cost of the related assets. Fixed assets acquired as a result of a business acquisition are recorded at their estimated fair value. depreciation of fixed assets is provided over their estimated useful lives, generally on a straight-line basis. Forest access roads are depreciated on the basis of harvested volumes and certain equipment is depreciated using the unit of produc-tion method. The estimated useful lives of fixed assets are based on judgement and the best currently available infor-mation. changes in circumstances can result in the actual useful lives differing from our estimates. Revisions to the estimated useful lives of fixed assets constitute a change in accounting estimate and are dealt with prospectively by

amending the amount of future depreciation expense. In fiscal 2008, a review of the estimated useful life of several Pulp segment fixed assets indicated that their estimated useful life was longer than originally anticipated and periodic future depreciation expense should be reduced. The implementation of these changes in estimates will reduce annual Pulp segment depreciation expense by $20 million, with approximately $4 million being recorded in fiscal 2008. There were no significant adjustments to depreciation rates in fiscal 2007.

Impairment of goodwillAccounting standards require that goodwill no longer be amortized to earnings, but be annually tested for impair-ment. The company uses certain operating and financial assumptions to conduct its impairment test, principally those contained in its most recent multi-year operating plan. This ensures that assumptions are supported, where available, by relevant independent information. There was no goodwill impairment in fiscal 2007. As a result of the financial recapitalization undertaken on February 29, 2008, the carrying value of goodwill was reduced from $3 million to nil.

Impairment of long-lived assetsThe company must review the carrying value of long-lived assets when events or changes in circumstances indi-cate that the value may have been impaired and is not recoverable through future operations and cash flows. To estimate future cash flows, the company uses operating and financial assumptions, primarily those contained in its most recent multi-year operating plan. This ensures that the assumptions are supported, where available, by relevant independent information. The work conducted in fiscal 2007 indicated a fixed asset impairment charge of $1 million relating to a specialty hardwood sawmill. The charge to income was included in depreciation and amor-tization expense. There were no fixed asset impairment charges in fiscal 2008.

Employee future benefitsTembec contributes to several defined benefit pension plans, primarily related to employees covered by collective bargaining agreements. The company also provides post-retirement benefits to certain retirees, primarily health-care related. For post-retirement benefits, funding of disbursements is done on a “pay as you go” basis. The company uses independent actuarial firms to quantify the amount of pension and post-retirement obligations. The company, based on its own experience and recommendations from its actuarial firms, evaluates the underlying assumptions on an annual basis. changes in estimates or assumptions can have a substantial impact on the amount of pension and post-retirement benefit expense, the carrying values on the balance sheet, and, in the case of defined benefit plans, the amount of plan surplus or deficit. At June 30, 2008, (“the measurement date”), the fair value of defined benefit plan assets was



$736 million, an amount equal to 81% of the estimated accrued benefit obligation of $907 million, generating a deficit of $171 million. The plan deficit was $131 million at the prior measurement date, June 30, 2007. The deficit increase of $40 million that occurred over the 12-month period was caused by several items. The deficit was reduced by $22 million as employer contributions of $38 million exceeded the current service cost of $16 million. This favourable item was more than offset by two unfavourable items. The deficit was increased by $47 million as the return on plan assets of $2 million (less than 1%) was less than the implied interest cost of $49 million. An actuarial loss of $10 million increased the obligation at the measurement date. This item was caused primarily by updated mortality tables. The discount rate is tied to the rates applicable to high-quality corporate bonds (AA or higher) in effect at the measurement date. Pension expense in fiscal 2008 was $14 million, as compared to $39 million in the prior year. based on current assumptions, employer contributions and pension expense in fiscal 2009 are expected to be approximately $47 million and $16 million respectively. Eight of the company’s defined benefit pension plans, representing approximately $505 million in solvency liabilities, will be valued as of december 31, 2008, as required by pension legislation. because of the severe market correction in 2008, these valuations are expected to increase fiscal 2009 funding requirements by $8 million versus fiscal 2008. There is no assurance that current assumptions will materialize in future periods. The defined benefit pension plans may be unable to earn the assumed rate of return. market driven changes to discount rates and other variables may result in significant changes to anticipated company contribution amounts.

with regard to other employee future benefit plans, the accrued benefit obligation at the measurement date was $59 million, an increase from $53 million in the prior year. Employer contributions were $2 million, down from $3 million in the prior year. In fiscal 2008, the company recognized an expense of $5 million versus a credit of $1 million in fiscal 2007. The prior year was favourably impacted by a $7 million curtailment gain relating to the indefinite idling of the st. Francisville paper mill. based on current assumptions, the amount of employer contribu-tions and the amount of expense to be recognized in fiscal 2009 are expected to be approximately $4 million and $6 million respectively.

future income taxesFuture income tax is provided for using the asset and liability method and recognizes temporary differences between the tax values and the financial statement carrying amounts of balance sheet items as well as certain carry-forward items. The company only recognizes a

future income tax asset to the extent that, in its opinion, it is more likely than not that the future income tax asset will be realized. This opinion is based on estimates and assumptions as to the future financial performance of the various taxable legal entities in the various tax jurisdic-tions. A more detailed review of income taxes is included in a subsequent section of the md&A.

USE Of NON-gAAp fINANCIAL MEASURES

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

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

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

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

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

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

Return on capital employed (ROCE) refers to net earn-ings (or loss) for a given period, adjusted for the after-tax impact of interest expense, divided by the average of total assets less non-interest bearing current liabilities for the period. The company utilizes this measure to compare its performance to other competitors in its industry.

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

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2008 VS. 2007

fINANCIAL SUMMARY(in millions of dollars, unless otherwise noted)

2007 2008

sales 2,750 2,376

Freight and sales deductions 316 292

Export taxes 18 11

cost of sales 2,218 1,943

sg&A 133 109

EbITdA 65 21

depreciation and amortization 173 123

Other items (227) (25)

Operating earnings (loss) 119 (77)

Interest, foreign exchange and other 118 45

Loss (gain) on translation of foreign debt (149) 6

Pre-tax earnings (loss) 150 (128)

Income tax expense 1 11

minority interests (1) –

Net earnings (loss) from continuing operations 150 (139)

Loss from discontinued operations (199) (11)

Net loss (49) (150)

Total assets (at year end) 2,655 1,622

Total long-term debt (at year end)(1) 1,340 405

(1) Includes current portion

CONSOLIDATED SALES(in millions of dollars)

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2004

3,1713,016

2006

2,750

2007

3,109

2005

2,376

2008

CONSOLIDATED SALES BY SEGMENT(in millions of dollars)

0

1,000

2,000

3,000

4,000

2004

3,1713,016

2006

2,750

2007

3,109

2005

2,376

2008

Forest Products

Paper

Pulp

Chemicals



EBITDA BY SEGMENT(in millions of dollars)

2004

142

42

2006

65

2007

13

2005

21

2008

Forest Products

Paper

Pulp Corporate

Chemicals

FINANCIAL PERFORMANCE

EBITDA $ millions (left scale)

0

100

200

$300

0

5

10

15%

2004 2006 20072005 2008

142

42

65

1321

EBITDA % sales (right scale)

sales decreased by $374 million as compared to the prior year. The decline was the result of lower sales volumes in all segments. Pricing in all segments was negatively impacted by currency as the canadian dollar averaged Us $0.991, a 10% increase from Us $0.900 in the prior year. The Forest Products segment sales declined by $215 million as a result of lower prices and shipments. The Pulp segment sales decreased by $48 million as a result of lower shipments, partially offset by higher prices. The Paper segment sales declined by $74 million as a result of lower selling prices

and shipments. The chemical’s segment sales declined by $43 million as a result of lower third-party product sales.

In terms of geographical distribution, the U.s. remained the company’s principal market with 33% of consolidated sales in fiscal 2008, as compared to 36% in the prior year. canadian sales represented 17% of sales, as compared to 19% in the prior year. sales outside of the U.s. and canada represented the remaining 50% in fiscal 2008, as compared to 45% a year ago.

SALES(in millions of dollars)

2007 2008 Total variance Price varianceVolume &

mix variance

Forest Products 832 617 (215) (39) (176)

Pulp 1,458 1,410 (48) 76 (124)

Paper 509 435 (74) (11) (63)

chemicals 173 130 (43) 2 (45)

corporate 2 3 1 – 1

2,974 2,595 (379) 28 (407)

Less: internal sales (224) (219) 5

sales 2,750 2,376 (374)

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EbITdA declined by $44 million over the prior year. The Forest Products segment EbITdA declined by $4 million as lower prices more than offset the impact of lower costs. The segment benefited from a $20 million favourable adjustment to the carrying values of log and lumber inventories as increasing lumber selling prices led to higher projected net realizable values. The Pulp segment EbITdA declined by $31 million as higher manufacturing

costs, primarily fibre and energy related, exceeded the positive impact of higher selling prices. The Paper segment EbITdA declined by $14 million as a result of lower prices. The chemicals segment EbITdA declined by $1 million due to the lower profitability of the resin binder business. corporate general and administrative expenses declined by $6 million driven primarily by cost reduction initiatives.

The company generated an operating loss of $77 million compared to operating earnings of $119 million in fiscal 2007. The Forest Products segment generated an oper-ating loss of $90 million in fiscal 2008, compared to operating earnings of $129 million in fiscal 2007. during the prior year, the company recorded net proceeds of $238 million pertaining to the recovery of lumber duties on deposit with the United states department of commerce that had accumulated since may 2002. The amount received by the company corresponded to approximately 82% of the total amount deposited. Fiscal 2008 Forest Products depreciation expense declined by $17 million. In February 2008, the company applied fresh start accounting and the carrying values of the Forest Products segment fixed assets were reduced by $169 million. The Pulp segment generated operating earnings of $59 million

during the most recently completed fiscal year, compared to operating earnings of $46 million a year ago. As a partial offset to the previously noted decrease in EbITdA, the segment depreciation expense declined by $12 million. As a result of fresh start accounting, the carrying values of the Pulp fixed assets were reduced by $217 million. As well, depreciation expense decreased by $4 million due to the review of the estimated useful life of several Pulp segment fixed assets that indicated their useful life was longer than originally anticipated. In the prior year, the Pulp segment absorbed a charge of $29 million relating to severance and related items as a result of the permanent closure of the smooth Rock Falls pulp mill. The Paper segment generated an operating loss of $25 million compared to an operating loss of $27 million in the prior year. As an offset to the previously noted decline in EbITdA, the segment

EBITdA(in millions of dollars)

2007 2008 Total variance Price variance

Cost & volume variance

Forest Products (68) (72) (4) (39) 35

Pulp 149 118 (31) 76 (107)

Paper 5 (9) (14) (11) (3)

chemicals 10 9 (1) 2 (3)

corporate (31) (25) 6 – 6

65 21 (44) 28 (72)

OpERATINg EARNINgS (LOSS) (in millions of dollars)

2007 2008 Total varianceEBITDA variance

Depreciation & amortization

varianceOther items

variance

Forest Products 129 (90) (219) (4) 17 (232)

Pulp 46 59 13 (31) 12 32

Paper (27) (25) 2 (14) 18 (2)

chemicals 6 6 – (1) 1 –

corporate (35) (27) 8 6 2 –

119 (77) (196) (44) 50 (202)



depreciation expense declined by $18 million. As a result of fresh start accounting, the carrying values of the Paper fixed assets were reduced by $394 million. The chemicals segment operating earnings were unchanged. The decline in EbITdA was offset by lower depreciation expense. As a result of fresh start accounting, the carrying values of the chemicals segment fixed assets were reduced by $20 million.

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

INTEREST, fOREIgN EXCHANgE ANd OTHER(in millions of dollars)

2007 2008

Interest on indebtedness 125 55

Interest income – lumber duties (30) –

Interest income (7) (5)

Foreign exchange items 19 (11)

Other items 11 6

118 45

Interest on long-term debt declined by $70 million as a result of the company’s financial recapitalization. In the prior year, the company had Us $1.2 billion of senior unsecured notes in circulation. In december 2007, the company announced the details of its proposed recapit-alization transaction. during the months of January and February 2008, no interest was paid on the senior unsecured notes. On February 29, the notes were converted into new shares of Tembec and a new Us $300 million term loan was put in place. In the prior year, the company received a total of Us $242 million as a refund of lumber duties. The refund was divided into two components in the financial statements. An amount of $238 million was credited to operating earnings and a further $30 million was shown as interest income.

TRANSLATION Of fOREIgN dEBT

during the five-month period ended February 29, 2008, the company recorded a gain of $12 million on its Us $ denominated debt as the relative value of the canadian dollar increased from Us $1.005 to Us $1.016.

during the same five-month period, the euro appreciated from c $1.419 to c $1.494 and the company recorded a loss of $3 million on the translation of its euro-denominated debt. during the seven-month period ended september 27, 2008, the company recorded a loss of $14 million on its new Us $300-million loan as the relative value of the canadian dollar decreased from Us $1.016 to Us $0.968. In addition, the company recorded a loss of $1 million on the translation of its euro-denominated debt as the relative value of the euro increased from c $1.494 to c $1.509. In the prior year, the company recorded a gain of $147 million on the translation of its Us $ denominated debt as the rela-tive value of the canadian dollar increased from Us $0.895 to Us $1.005.

INCOME TAXES

during the year ended september 2008, the company recorded an income tax expense of $11 million on a pre-tax loss from continuing operations of $128 million. The income tax expense reflected a $52 million unfavourable variance versus an anticipated income tax recovery of $41 million based on the company’s effective tax rate of 31.9%. The non-recognition of period losses increased the income tax expense by $52 million. based on past financial perform-ance, future income tax assets of the company’s canadian operations have been limited to the amount that is more likely than not to be realized.

during fiscal 2007, the company recorded an income tax expense of $1 million on pre-tax earnings from continuing operations of $150 million. The income tax expense reflected a $49 million favourable variance versus an anticipated income tax expense of $50 million based on the company’s effective tax rate of 33.3%. The non-taxable portion of the gain on translation of Us $ denominated debt reduced the income tax expense by $21 million. The recognition of prior period losses decreased the income tax expense by $20 million. based on past financial performance, future income tax assets of the company’s canadian operations have been limited to the amount that is more likely than not to be recovered. Finally, the rate differential between jurisdictions decreased the income tax expense by $10 million.

dISCONTINUEd OpERATIONS

The financial results of the st. Francisville paper mill have been reclassified as discontinued operations. during the year ended september 2008, the idled facility generated a loss of $11 million. In the prior year, the facility had gener-ated a loss of $199 million, including $173 million relating to asset impairment.

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NET LOSS

The company generated a net loss of $102 million or $1.19 per share for the five-month period ended February 29, 2008, and a net loss of $48 million or $0.48 per share for the seven-month period ended september 27, 2008, compared to a net loss of $49 million or $0.58 per share in the prior year. As noted previously, the company’s financial results were impacted by certain specific items. The following table summarizes the impact of these items on the reported financial results. The company believes

it is useful supplemental information as it provides an indication of results excluding the specific items. This supplemental information is not intended as an alterna-tive measure for net earnings as determined by canadian gAAP. The table below contains one recurring item, namely the gain or loss on translation of foreign debt. because the company has a substantial amount of Us $ denominated debt, relatively minor changes in the value of the canadian dollar versus the U.s. dollar can lead to large unrealized periodic gains or losses. As well, this item receives capital gains/loss tax treatment and is not tax-affected at regular business income rates.

Year ended September 2007

Five months ended February 29, 2008

Seven months ended September 27, 2008

$ millions $ per share $ millions $ per share $ millions $ per share

Net loss as reported – in accordance with gAAP (49) (0.58) (102) (1.19) (48) (0.48)

specific items (after-tax):

Loss (gain) on translation of foreign debt (124) (1.45) (8) (0.09) 12 0.12

gain on derivative financial instruments – – – – (1) (0.01)

Other items:

smooth Rock Falls pulp mill 20 0.23 – – – –

gain on sale of davidson sawmills (1) (0.01) – – – –

Recovery of lumber export duties and interests (185) (2.16) – – – –

gain on sale of land (10) (0.12) (13) (0.16) – –

Reversal of previously accrued closure costs (2) (0.02) (3) (0.03) – –

writedown of gaspesia investments – – 2 0.02 – –

gain on reduced equity participation in Av cell – – (4) (0.04) – –

gain on sale of Av cell and Av Nackawic shares – – – – (1) (0.01)

gain relating to Temlam joint venture – – – – (5) (0.05)

discontinued operations – st. Francisville 199 2.32 4 0.05 7 0.07

Net loss excluding specific items – not in accordance with gAAP (152) (1.79) (124) (1.44) (36) (0.36)



fOURTH QUARTER ANALYSIS

The company reported a net loss of $4 million or $0.04 per share in the fourth quarter ended september 27, 2008, compared to net earnings of $22 million or $0.25 per share in the same quarter of fiscal 2007. The weighted average number of common shares outstanding was 100 million, up from 85.6 million in the prior year.

sales decreased by $46 million as compared to the same quarter a year ago. The decline was the result of lower sales volumes in all segments, partially offset by higher prices in the Pulp and Paper segments. currency did not affect pricing as the canadian dollar averaged Us $0.959, a small increase from Us $0.957 in the year-ago quarter. The Forest Products segment sales declined by $36 million as a result of lower shipments. The Pulp segment sales declined by $8 million as a result of lower shipments, partially offset by improved pricing. Paper segment sales increased by $10 million due to higher prices, partially offset by lower shipments.

EbITdA increased by $6 million over the prior-year quarter. The Forest Products segment EbITdA improved by $4 million because of lower costs. The segment bene-fited from a $10 million favourable adjustment to the

carrying values of log and lumber inventories as increasing lumber selling prices led to higher projected net realizable values. The Pulp segment EbITdA declined by $15 million. higher manufacturing costs exceeded the positive impact of higher selling prices. The Paper segment EbITdA increased by $17 million due to higher selling prices.

The company generated operating earnings of $13 million compared to an operating loss of $18 million in the same quarter a year ago. In addition to the previously noted improvement in EbITdA, the depreciation expense declined by $25 million. In February 2008, the company applied fresh start accounting and the carrying values of fixed assets were reduced by $804 million.

Interest on long-term debt declined by $20 million as a result of the company’s financial recapital-ization. In the prior year quarter, the company had Us $1.2 billion of senior unsecured notes in circulation. On February 29, 2008, the notes were converted into new shares of Tembec and a new Us $300-million term loan was put in place. The september 2007 quarter expense of $12 million relating to foreign exchange items was caused primarily by the restatement of trade receivables in U.s. currency as the canadian dollar closing rate versus the U.s. dollar had increased by more than 7% at the end of the september 2007 quarter versus the closing rate at the end of June 2007.

QUARTERLY fINANCIAL INfORMATION(in millions of dollars, except per share amounts)

2007 2008

Dec. 06 Mar. 07 June 07 Sept. 07 Dec. 07

Two months ended

Feb. 29, 2008

One month ended

Mar. 29, 2008 June 08 Sept. 08

sales 649 714 712 675 545 405 188 609 629

EbITdA 14 24 4 23 (16) (1) – 9 29

depreciation & amortization 45 43 41 44 42 30 8 24 19

Other items (217) (4) (3) (3) (19) (1) – (2) (3)

Operating earnings (loss) 186 (15) (34) (18) (39) (30) (8) (13) 13

Net earnings (loss) from continuing operations 144 (35) 19 22 (57) (41) (15) (25) (1)

Net earnings (loss) 138 (45) (164) 22 (60) (42) (17) (27) (4)

Net earnings (loss) per share:

From continuing operations 1.69 (0.42) 0.23 0.25 (0.67) (0.47) (0.15) (0.25) (0.01)

basic and fully diluted 1.62 (0.54) (1.91) 0.25 (0.70) (0.49) (0.17) (0.27) (0.04)

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during the september 2008 quarter, the company recorded a loss of $7 million on the translation of its Us $ denominated debt as the relative value of the canadian dollar decreased from Us $0.990 to Us $0.968. The company recorded a gain of $4 million on the trans-lation of its euro-denominated debt as the relative value of the euro versus the canadian dollar decreased from c $1.596 to c $1.509. In the comparable period a year ago, the canadian dollar had increased from Us $0.939 to Us $1.005 and the company had recorded a gain of $85 million on its Us $ denominated debt. The company had also recorded a gain of $1 million on the translation of its euro-denominated debt as the relative value of the euro versus the canadian dollar decreased from c $1.442 to c $1.419.

during the september 2008 quarter, the company recorded an income tax expense of $3 million on pre-tax earnings from continuing operations of $2 million. The income tax expense reflected a $3 million unfavourable variance versus an anticipated nil expense based on the company’s effective tax rate of 31.9%. The non-recogni-tion of period losses increased the income tax expense by $4 million. based on past financial performance, future income tax assets of the company’s canadian operations have been limited to the amount that is more likely than not to be realized. during the september 2007 quarter, the company recorded an income tax expense of $3 million on pre-tax earnings from continuing operations of $25 million. The income tax expense reflected a $6 million favour-able variance versus an anticipated income tax expense of $9 million based on the company’s effective tax rate of 33.3%. The non-taxable portion of the gain on transla-tion of Us $ denominated debt reduced the income tax expense by $11 million. The rate differential between juris-dictions decreased the income tax expense by a further $3 million. The non-recognition of period losses increased the income tax by $11 million.

The financial results of the st. Francisville paper mill have been reclassified as discontinued operations. during the quarter ended september 2008, the idled facility gener-ated a loss of $3 million. In the prior year quarter, revenues equalled expenses and the operation broke even.

The fourth quarter 2008 interim md&A issued on November 19, 2008, provides a more extensive analysis of items having impacted the company’s fourth quarter financial results.

SUMMARY Of QUARTERLY RESULTS

On a sequential quarterly basis, sales have benefited from improvements in Us $ reference prices for pulp. Lumber

prices were generally flat but remained at relatively low levels. Newsprint prices declined by Us $103 per tonne in fiscal 2007 but increased by Us $185 per tonne in fiscal 2008. The strengthening of the canadian dollar versus the U.s. currency has continued to negatively impact results, increasing from an average rate of Us $0.877 in the first quarter of fiscal 2007 to Us $1.018 in the first quarter of fiscal 2008, a 16% increase. The relative value of the canadian dollar has declined by approximately 6% to the end of the september 2008 quarter, but remained at relatively high levels. As a result, the company continued to generate relatively low levels of EbITdA, with margins ranging from a low of negative 3% to a high of 5% in the most recent quarter.

The company’s financial performance and that of its Forest Products segment for the last eight quarters were negatively impacted by export taxes on lumber shipped to the U.s. Total amount incurred over the last two years was $29 million, an amount equal to approximately 34% of the total company EbITdA of $86 million.

The company generated EbITdA of $86 million in the last eight quarters. The amount was insufficient to cover depreciation and amortization expense totalling $296 million. As a partial offset to the marginal levels of EbITdA previously noted, the company has recorded other items having a net favourable impact of $252 million over the last eight quarters. The following summarizes other items recorded:

(in millions of dollars) 2007 2008

gain on sale of land and assets – various quarters in fiscal 2007 and fiscal 2008 (18) (16)

Recovery of lumber duties – december 2006 (238) –

Loss on permanent closure of smooth Rock Falls pulp mill – december 2006 29 –

Other items – (9)

(227) (25)

due to the stronger canadian dollar, the company recorded a gain of $143 million on the translation of its foreign-denominated debt over the last two years. however, the impact of the quarterly translation gains and losses added considerable volatility to the results, with the impact ranging from a gain of $111 million in the June 2007 quarter to a loss of $61 million in the december 2006 quarter.



SEgMENT REVIEw–2008 VS. 2007

fOREST pROdUCTS(in millions of dollars)

2007 2008

Total sales 832 617

consolidated sales 687 472

Lumber duties/export taxes 18 11

EbITdA (68 ) (72)

EbITdA margin on total sales (8.2)% (11.7)%


Other items (253) (21)

Operating earnings (loss) 129 (90)

Identifiable assets (excluding cash) 709 298

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

The Forest Resource management group is responsible for managing all of the company’s canadian forestry operations. This includes the harvesting of timber, either directly or by contractual agreements, and all silviculture and regeneration work required to ensure a sustainable supply for the manufacturing units. The group is also responsible for third-party timber purchases, which are needed to supplement total requirements. The group’s main objective is the optimization of the flow of timber into various manufacturing units. As the company’s forest activity in canada is conducted primarily on crown Lands, the Forest Resource management group works closely with provincial governments to ensure harvesting plans and operations comply with established regulations and stumpage charged by the provinces is reasonable and

reflects the fair value of the timber harvested. during fiscal 2008 the company’s operations harvested and deliv-ered 5.1 million cubic metres of timber versus 6.0 million cubic metres in 2007. Additional supply of approximately 0.9 million cubic metres was secured mainly through purchases and exchanges with third parties, down from 1.1 million cubic metres in the prior year.

The Forest Products group includes operations located in Quebec, Ontario, Alberta and british columbia. The group focuses on three main product areas: sPF lumber, specialty wood and engineered wood. The sPF lumber operations can produce approximately 1.7 billion board feet of lumber. The specialty wood operations can annu-ally produce 60 million board feet of lumber and 20 million square feet of hardwood flooring. The engineered wood operations produce laminated veneer lumber (LvL), finger joint lumber, wood I-beams, and rim joists.

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

Spf LUMBER mbf

stud lumber – Taschereau/La sarre, Qc(1) 200,000

stud lumber – senneterre, Qc 150,000

stud lumber – cochrane, ON 170,000

stud lumber – kapuskasing, ON 105,000

Random lumber – Nouvelle/saint-Alphonse, Qc(2) 75,000

Random lumber – béarn, Qc 110,000

Random lumber – chapleau, ON 135,000

Random lumber – Timmins, ON 100,000

Random lumber – hearst, ON 160,000

Random lumber – canal Flats, bc(3) 180,000

Random lumber – Elko, bc(3) 270,000

Finger joint lumber – cranbrook, bc 25,000

1,680,000

SpECIALTY wOOd mbf

Pine and hardwood lumber – mattawa, ON 30,000

hardwood lumber – huntsville, ON 30,000

60,000

thousand square ft.

Flooring – huntsville, ON 12,000

Flooring – Toronto, ON 8,000

20,000

ENgINEEREd wOOd thousand cubic ft.

Laminated veneer lumber – ville-marie, Qc(4) 475

Laminated veneer lumber – Amos, Qc(4) 2,300

2,775

mbf

Engineered finger joint lumber – La sarre, Qc 60,000

Engineered finger joint lumber – kirkland Lake, ON 30,000

90,000

thousand linear ft.

wood I-beams – bolton, ON(4) 40,000

wood I-beams – calgary, Ab(4) 18,000

wood I-beams – blainville, Qc(4) 5,000

63,000

(1) sites are operated as a combined entity.(2) volumes reflect 50% of the actual capacity as the units are part of the Temrex joint venture.(3) The Elko and canal Flats sawmills rely on the cranbrook planer mill to dry and dress 80,000 mbf of lumber.(4) volumes reflect 50% of the actual plant capacity as the units are part of the Temlam joint venture. On september 15, 2008, Temlam and a

subsidiary of Temlam made voluntary assignments in bankruptcy. As a result, Tembec will no longer apply the proportionate consolidation method to account for this investment.



The segment is dominated by sPF lumber, which repre-sented 73% of building material sales in fiscal 2008, compared to 74% in the prior year. The average selling price of sPF lumber was $34 per mbf (thousand board feet) lower than in the prior year. The lower prices were the result of lower Us $ reference prices for lumber and a canadian dollar that averaged 10% higher versus the U.s. currency. Engineered wood prices and revenues were also negatively impacted by the stronger canadian dollar. Overall, specialty wood represented 16% of building material sales in fiscal 2008, up from 13% in fiscal 2007. Engineered wood sales in the year were at 11%, down from 13% in the prior year.

The Forest Products group produced and shipped approxi-mately 1.6 million tonnes of wood chips in fiscal 2008, 89%

of which were directed to the company’s pulp and paper operations. In 2007, the group produced 1.6 million tonnes and shipped 83% of this volume to the pulp and paper mills. The internal transfer price of wood chips is based on current and expected market transaction prices.

Total sales for this segment reached $617 million, a decrease of $215 million over the prior year. Lower selling prices and volumes of sPF lumber accounted for $124 million of the decrease. wood chip sales declined by $54 million as a result of lower sPF production. Overall, the Forest Products segment generated 20% of company consolidated sales, down from 25% in the prior year. The group’s main market is North America, which represented 100% of consolidated sales in fiscal 2008, as compared to 97% in the prior year.

Sales ($ millions) Shipments (000 units) Selling prices ($/unit)

2007 2008 2007 2008 2007 2008

sPF lumber (mbf) 427 303 1,273.6 1,004.3 336 302

specialty wood

Pine and hardwood (mbf) 19 15 28.4 25.3 669 593

hardwood flooring (000 square ft) 57 54 12.8 11.7 4,453 4,615

76 69

Engineered wood

LvL (cubic ft) 25 19 1,173.1 1,088.0 21 17

Engineered finger joint lumber (mbf) 10 2 19.9 5.0 502 400

wood I-beams and rim joists (000 linear ft) 39 23 27.7 17.8 1.41 1.29

74 44

Total building materials 577 416

wood chips, logs and by-products 255 201

Total sales 832 617

Internal wood chip and other sales (145) (145)


The volume of sPF lumber sold in fiscal 2008 declined by 269.3 million board feet or 21%. shipments were equal to 60% of capacity, down from 76% in fiscal 2007. In response to continued low demand for lumber and the resulting lower prices, the company reduced production

by curtailing operations at several facilities for either indefinite or temporary periods. The relatively difficult market conditions also affected the specialty wood and engineered wood businesses.

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MarketsThe benchmark random length western sPF (#2 and better) lumber net price averaged Us $231 per mbf in 2008, a decrease from Us $252 per mbf in 2007. In the East, the random length Eastern sPF average lumber price (delivered great Lakes) decreased from Us $333 per mbf to Us $313 per mbf in 2008. The company considers these to be relatively low levels, approximately Us $60 to Us $80 below normal trend line prices for random lumber. The reference price for stud lumber decreased as well with the Eastern average lumber price (delivered great Lakes) down from Us $322 per mbf to Us $291 per mbf, a level approximately Us $80 to Us $100 per mbf below trend line prices. The collapse in prices was driven by a very weak U.s. housing market. U.s. housing starts declined from 1.44 million units in fiscal 2007 to 1.02 million units in fiscal 2008, a 29% decrease. while the company recognized several years ago that U.s. housing starts could not main-tain the 2 million unit per year run rate of the 2005/2006 period, and that a degree of market correction would likely occur at some point, the severity and extent of the correction had not been anticipated. The negative effects of the sub-prime mortgage difficulties, the latter having fuelled the strong demand in 2005/2006, have been much greater than originally anticipated.

In addition to difficult market conditions and a stronger canadian dollar, the company’s financial performance

continued to be impacted by tariffs on lumber shipped to the U.s. between may 2002 and september 2006, the company’s softwood lumber exports to the U.s. were subject to countervailing and anti-dumping duties. On October 30, 2006, the company recovered net proceeds of $268 million pertaining to softwood lumber duties. The total amount received corresponded to approxi-mately 82% of the duties remitted and interest thereon since may 2002. The recovery was part of a new softwood lumber agreement between canada and the U.s. which became effective on that date. The duties were replaced by a combination of export taxes and volume restraints or quotas that vary depending on the option selected by the individual canadian provinces. The company’s Eastern canadian sawmills, located in Quebec and Ontario, are currently subject to export quota limitations and a 5% export tax on lumber shipped to the U.s. during fiscal 2008, these mills incurred a total of $3 million in export taxes, down from $6 million in the prior year. The company’s british columbia sawmills are subject to a 15% export tax but shipments are not quota limited. Under certain circumstances the tax may be increased to 22.5%. during fiscal 2008, these mills incurred a total of $8 million in export taxes, based on a 15% rate for the entire period. This compares to $12 million of export taxes paid in fiscal 2007. The lower shipments to the U.s. and the lower selling prices generated the reduction in export taxes.

Tembec average

KD stud del. Great Lakes

KD #2 and better del. Great Lakes

0

100

200

300

400

284 295 314283

296 285

301

277

2007 2008

QUARTERLY PRICES – EASTERN SPF DELIVERED(US $ per mbf)

1 3 4 1 22 3 4

Tembec average

0

100

200

300

400

272 268282

263 258 259

288

244

2007 2008

QUARTERLY PRICES – WESTERN SPF MILL NET(US $ per mbf)

1 3 4 1 22 3 4

Western SPF KD #2 and better



Operating ResultsThe following summarizes EbITdA variances by major business:

(in millions of dollars) Variance – favourable (unfavourable)

Price Export taxes Costs Total

sPF lumber (34) 7 28 1

specialty wood 1 – 2 3

Engineered wood (6) – (3) (9)

Other segment items – – 1 1

(39) 7 28 (4)

Fiscal 2008 EbITdA was negative $72 million compared to negative EbITdA of $68 million in the prior year. Lower selling prices for sPF lumber and engineered wood reduced EbITdA by a combined $40 million. The previously noted decline in lumber export taxes provided a $7 million offset. Lower sPF lumber manufacturing costs provided

the largest offset, declining by $28 million. The lower costs include a $20 million favourable adjustment to the carrying values of log and lumber inventories as increasing selling prices led to higher projected net realizable values. The EbITdA margin was negative 11.7% compared to negative 8.2% in the prior year.

The following summarizes operating results variances by major element:

(in millions of dollars)2007 2008

Variance – favourable

(unfavourable)

EbITdA (68) (72) (4)

depreciation and amortization 56 39 17

Other items (253) (21) (232)

Operating earnings (loss) 129 (90) (219)

The Forest Products segment generated an operating loss of $90 million in fiscal 2008, compared to operating earnings of $129 million in fiscal 2007. Fiscal 2008 depreci-ation expense declined by $17 million. In February 2008, the company applied fresh start accounting and the carrying values of the Forest Products segment fixed assets were reduced by $169 million. during the prior

year, the company recorded net proceeds of $238 million pertaining to the recovery of lumber duties on deposit with the U.s. department of commerce that had accumu-lated since may 2002. The amount received by the company corresponded to approximately 82% of the total amount deposited.

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pULp(in millions of dollars)

2007 2008

Total sales 1,458 1,410

consolidated sales 1,384 1,343

EbITdA 149 118

EbITdA margin on total sales 10.2 % 8.4 %


Other items 29 (3)

Operating earnings (loss) 46 59

Identifiable assets (excluding cash) 1,209 979

The Pulp group consists of ten market pulp manufacturing facilities operating at nine sites. The facilities are divided into two main types. seven paper pulp mills produce soft-wood kraft, hardwood kraft and high-yield pulps. Three specialty pulp mills produce specialty cellulose, fluff and dissolving pulps. Eight of the pulp mills are wholly-owned and the company has a 50% joint venture position in the marathon, Ontario softwood kraft pulp mill. All of the company’s financial and statistical data include its 50% proportionate share of the mill. The company has respon-sibility for marketing the entire output of the mill. Up until september 2007, the company had a 50% joint venture position in the Atholville, New brunswick, dissolving pulp mill (Av cell). The company’s partner in the Av cell joint venture was the Aditya birla group, which effectively purchased the entire output of the mill at market prices.

On september, 30, 2007, the Aditya birla group purchased additional equity of Av cell. As the company did not purchase additional equity, the percentage of ownership of the Aditya birla group increased from 50% to 75% and the company’s ownership declined from 50% to 25%. As a result, the fiscal 2008 Pulp segment results do not include those of Av cell. The fiscal 2007 results include the company’s 50% share of the Av cell financial results. during fiscal 2008, the company subsequently sold 20% of its remaining 25% equity investment in Av cell to the Aditya birla group.

The paper pulp mills can produce approximately 1,740,000 tonnes per year after adjusting for propor-tionate joint ventures. The specialty pulp mills can produce approximately 380,000 tonnes per year.



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

pApER pULpS tonnes

softwood kraft – skookumchuck, bc 270,000

softwood kraft – Tarascon, France 260,000

softwood kraft – marathon, ON(1) 100,000

630,000

hardwood kraft – saint-gaudens, France 305,000

hardwood high-yield – Temiscaming, Qc 315,000

hardwood high-yield – matane, Qc 250,000

hardwood high-yield – chetwynd, bc 240,000

805,000

SpECIALTY pULpS

specialty cellulose – Temiscaming, Qc 165,000

specialty cellulose/fluff – Tartas, France 155,000

dissolving – Atholville, Nb(1) (2) 60,000

380,000

Total 2,120,000

(1) 50% of current annual capacity.(2) The company’s financial and statistical data include its 50% proportionate share of the mill’s results in fiscal 2007. The mill’s results are not

included in fiscal 2008 financial and statistical data.

Total sales for the Pulp group reached $1,410 million, a decrease of $48 million from the prior-year record sales of $1,458 million. The decrease in sales was caused by lower shipments for all grades of pulp partially offset by improved pricing for hardwood and specialty pulps. The 184,000 tonne decline in shipments was partly the result of the non-consolidation of the Av cell specialty pulp mill. Prior-year results included 58,900 tonnes of shipments and $53 million in sales from this facility. As well, very strong demand in the prior year had generated record shipments, which outpaced production by 24,000 tonnes. Entering fiscal 2008, pulp inventories were at relatively low levels and shipments from inventory were no longer possible. In fiscal 2008, production exceeded shipments

at 64,000 tonnes and inventories increased by the same amount. Approximately 50% of the increase occurred in the first quarter and was required due to insufficient levels of inventory to manage customer logistics. The other 50% of the increase occurred in the fourth quarter, when lower customer demand and weaker pulp market conditions reduced pulp shipments. while the segment benefited from higher Us $ reference prices for all grades of pulp, a portion of the improvement was offset by the value of the canadian dollar which averaged 10% higher versus the U.s. currency. The net price effect was an increase in sales of $76 million or $42 per tonne. After eliminating internal sales, the Pulp group generated 57% of consolidated sales, up from 50% in the prior year.

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2007 2008 2007 2008 2007 2008

Paper pulps

softwood kraft 458 419 595.3 544.7 769 769

hardwood kraft 200 184 298.2 257.7 671 714

hardwood high-yield 429 449 720.9 699.3 595 642

specialty pulps 346 317 364.5 293.2 949 1,081

Total pulp sales 1,433 1,369 1,978.9 1,794.9

Other sales 25 41

Total sales 1,458 1,410

Internal sales (74) (67) (90.4) (75.2)

consolidated sales 1,384 1,343 1,888.5 1,719.7

MarketsThe Pulp segment is more “global” than the other business groups within Tembec. In 2008, 83% of consolidated pulp sales were generated outside of canada and the U.s. as compared to 82% in the prior year. The company markets its pulp on a worldwide basis, primarily through its own sales force. The Pulp group maintains sales or representa-tive offices in Toronto, canada, signy/Nyon, switzerland, san sebastian, spain, and beijing, china. The company’s sales force also periodically markets pulp and paperboard produced by third parties. In fiscal 2007, agency pulp sales totalled 1,000 tonnes. There were no agency pulp sales in fiscal 2008.

year over year, average pulp selling prices increased by $42 per tonne. In fiscal 2007, the benchmark Nbsk pulp price (delivered U.s.) began the year at Us $770 per tonne and experienced a continuous series of price increases, eventually closing out the year at Us $850 per tonne. The average selling price for the year was Us $803 per tonne. In fiscal 2008, the series of successive reference price increases continued until August 2008, peaking at Us $885 per tonne. The market weakened in september 2008 and prices declined, closing out the year at Us $870 per tonne. The average selling price for the year was Us $875 per tonne, an increase of Us $72 per tonne over fiscal 2007. After giving effect to the stronger canadian dollar and the company’s customer/product mix, this translated into the same price for softwood kraft paper pulp, an increase of

$43 per tonne for hardwood kraft paper pulp and $47 per tonne for high-yield paper pulp. specialty pulp markets also improved in fiscal 2008 as average selling prices increased by $132 per tonne.

Tembec average – all grades

0

100

200

300

400

500

600

700

800

900

630653

678646

714 774 784750

2007 2008

QUARTERLY PRICES(US $ per tonne)

1 3 4 1 22 3 4

NBSK published price




(in millions of dollars) Variance – favourable (unfavourable)

PriceMix and volume Mill costs

Foreign exchange impact on

costs Other Total

Paper pulps 43 (11) (63) (7) – (38)

specialty pulps 33 2 (22) (4) (2 )(1) 7

76 (9) (85) (11) (2) (31)

(1) EbITdA declined by $2 million as a result of the exclusion of the Av cell financial results in fiscal 2008.

Fiscal 2008 EbITdA was $118 million compared to $149 million in the prior year. The previously noted improvement in selling prices was more than offset by lower shipments and higher costs. Total production in fiscal 2008 decreased by 96,200 tonnes as compared to the prior year. The prior-year production included 57,800 tonnes of production from the Av cell specialty pulp mill. There was no production included in fiscal 2008. during the most recent year, the company undertook 53,600 tonnes of total downtime, including 23,400 tonnes of market-related production curtailments as the company experienced weaker demand in the last quarter of fiscal 2008. In fiscal 2007, 53,200 tonnes of mainten-ance downtime was taken, including 14,000 tonnes of lost production associated with an explosion in one of the two flash dryers at the Temiscaming high-yield pulp mill. There were no market-related curtailments in fiscal 2007. The company defines “market downtime” as temporary production curtailments designed to reduce or control excess finished goods inventory levels. Total consolidated pulp inventories at september 27, 2008, represented approximately 30 days of production. This was higher than in 2007 when the year ended with 14 days of production in inventory. The company considers 25 to 30 days to be a normal level.

mill level costs increased by $85 million due primarily to higher energy (+$21 million), fibre (+$21 million), chemical (+$16 million) and freight (+$15 million). The reported costs of the company’s three French pulp mills was also

negatively impacted by foreign exchange as the value of the euro averaged 2% higher versus the canadian dollar.

Total 2008 shipments of 1,794,900 tonnes include 55,500 tonnes of high-yield pulp and 19,700 tonnes of softwood kraft pulp consumed by the company’s paperboard operations as compared to 61,800 tonnes and 28,200 tonnes respectively in the prior year. Overall, internal pulp consumption declined by 14,800 tonnes, primarily because of the impact of production curtailments at the paperboard operations.

The six North American pulp mills purchased approxi-mately 1.8 million bone-dry tonnes of wood chips in fiscal 2008, down from 2.1 million in the prior year. The prior-year figure includes 155,000 bone-dry tonnes relating to the Av cell specialty pulp mill. volumes for this mill are not included in fiscal 2008 data. Of this amount, approximately 48% was supplied by the Forest Products group, compared to 41% in the prior year. The remaining requirements were purchased from third parties under contracts and agreements of various durations. The three pulp mills located in southern France purchased 1.5 million bone-dry tonnes of wood in fiscal 2008, unchanged from the prior year. The fibre is mainly sourced from many private landowners.

Overall, higher manufacturing costs more than offset the improvement in pricing and the EbITdA margin declined from 10.2% to 8.4%.




(unfavourable)

EbITdA 149 118 (31)


Other items 29 (3) 32

Operating earnings 46 59 13

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The Pulp segment generated operating earnings of $59 million during the most recently completed fiscal year, compared to operating earnings of $46 million a year ago. As a partial offset to the previously noted decrease in EbITdA, the segment depreciation expense declined by $12 million. In February 2008, the company applied fresh start accounting and the carrying values of the Pulp segment fixed assets were reduced by $217 million. As

well, depreciation expense decreased by $4 million due to the review of the estimated useful life of several Pulp segment fixed assets that indicated their useful life was longer than originally anticipated. In the prior year, the Pulp segment absorbed a charge of $29 million relating to severance and related items as a result of the permanent closure of the smooth Rock Falls pulp mill.

pApER(in millions of dollars)

2007 2008


EbITdA 5 (9 )

EbITdA margin 1.0 % (2.1)%


Other items (3 ) (1 )

Operating loss (27 ) (25 )


The Paper segment includes four paper manufacturing facilities with a total of nine paper machines. The mills located in kapuskasing, Ontario and Pine Falls, manitoba, produce newsprint. The facility located in Temiscaming, Quebec produces multi-ply coated paperboard. The paperboard mill is partially integrated with a high-yield pulp mill and also consumes pulp manufactured by the company at other sites. The st. Francisville, Louisiana mill produces coated and specialty papers. The total capacity of the Paper group is 1,005,000 tonnes. beginning in fiscal 2008, the Paper segment includes the finan-cial results of a hydro-electric dam located in smooth Rock Falls, Ontario.

In July 2007, the company indefinitely idled the paper facility in st. Francisville, Louisiana. despite efforts to restructure the operation, the mill’s financial performance remained relatively poor. The company has not identified a feasible restructuring plan to resume operations at the facility. As well, the company has retained the services of an outside party to actively seek the sale of the site. As this operation is the only coated paper facility owned by the company, its financial results have been reclassi-fied as discontinued operations. The segment analysis that follows includes only continuing operations and excludes all st. Francisville operating results.

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

NEwSpRINT tonnes(1)

kapuskasing, ON 330,000

Pine Falls, mb 185,000

515,000

COATEd pApER

st. Francisville, LA – coated No. 3 & 4(2) 280,000

SpECIALTY pApER

specialty kraft paper – st. Francisville, LA(2) 30,000

coated paperboard – Temiscaming, Qc 180,000

210,000

Total 1,005,000

(1) Although the above table shows all capacities in metric tonnes, coated paper and certain specialty paper are sold primarily in short tonnes.(2) The facility was indefinitely idled in July 2007. The financial results have been reclassified as discontinued operations.



The $74 million decline in sales resulted primarily from lower shipments. Newsprint shipments declined by 69,200 tonnes primarily due to the indefinite idling of one of the three paper machines at the kapuskasing newsprint mill. Increases in Us $ reference prices were negated by a stronger canadian dollar, which averaged 10% higher versus the U.s. currency. Fiscal 2008 operations were

negatively impacted by weaker market demand. The company incurred 5,100 tonnes of maintenance down-time and 100,000 tonnes of market-related downtime. In the prior year, maintenance downtime totalled 6,100 and there were only 6,900 tonnes of market-related downtime. Overall, the Paper segment generated 18% of consolidated sales in fiscal 2008, down from 19% in the prior year.


2007 2008 2007 2008 2007 2008

Newsprint 315 262 474.4 405.2 664 647

coated paperboard 194 170 174.2 153.0 1,114 1,111

Electricity sales – 3

consolidated sales 509 435 648.6 558.2

MarketsThe focus of the Paper business is in North America, which accounted for 93% of consolidated sales in 2008, unchanged from the prior year. The U.s. alone accounted for 77% of consolidated sales. In fiscal 2007, the benchmark price for newsprint (48.8 gram–East coast) began the year at Us $663 per tonne and then experienced successive monthly decreases, ending the year at Us $560 per tonne. The average selling price for the year was Us $606 per tonne. In fiscal 2008, the trend was reversed and prices increased sequentially, eventually reaching Us $745 per tonne in september 2008. The average selling price for the

year was Us $646 per tonne, a Us $40 per tonne increase over the prior year. After giving effect to the stronger canadian dollar, the company’s average selling price for newsprint decreased by $17 per tonne.

The benchmark for coated bleached boxboard (15 point) averaged Us $919 per short ton in fiscal 2008, a Us $71 per short ton increase over the prior year. here again, the improved Us $ reference prices were offset by the stronger canadian dollar and average prices for coated bleached board decreased by $3 per tonne.

Tembec average – newsprint

0

100

200

300

400

500

600

700

800

641

587560

602565

671

715

609

2007 2008

QUARTERLY PRICES(US $ per tonne)

1 3 4 1 22 3 4

Newsprint published price

Tembec average – coated board rolls

0

100

200

300

400

500

700

600

900

800

1,000

824859 869853

891926

937

907

2007 2008

QUARTERLY PRICES(US $ per short ton)

1 3 4 1 22 3 4

15 PT SBS – transaction price

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Variance – favourable (unfavourable)

(in millions of dollars) PriceMix and volume Mill costs Other Total

Newsprint (8) – (3) 5 (6)

coated paperboard (3) – (5) – (8)

(11) – (8) 5 (14)

Fiscal 2008 EbITdA was negative $9 million compared to $5 million in the prior year. Lower average selling prices for newsprint and coated paperboard reduced EbITdA by $11 million. manufacturing costs increased by $8 million, primarily due to higher freight (+$4 million), energy (+$3 million) and labour (+$5 million). A decrease in fibre costs (-$4 million) provided a partial offset. Other costs, primarily group sg&A expenses, were lower as a result of cost reduction initiatives. In the prior fiscal year, the company incurred 6,900 tonnes of market-related downtime and 6,100 tonnes of maintenance downtime. In fiscal 2008, maintenance downtime was 5,100 tonnes, while market-related downtime reached 100,000 tonnes. weaker demand for newsprint and coated board led to the increased market downtime.

The Paper group’s two newsprint mills utilize virgin fibre, primarily in the form of wood chips. during fiscal 2008, the operations purchased 407,000 bone-dry tonnes of virgin fibre, of which approximately 85% was internally sourced. In the prior year, they had purchased 411,000 bone dry tonnes of virgin fibre, with 80% being sourced inter-nally. The operations in kapuskasing and Pine Falls can produce newsprint that contains recycled fibre. In 2008, these two facilities consumed 6,400 tonnes of waste-paper, down from 77,200 tonnes in 2007. due to the significant increase in demand and price for wastepaper, the company ceased its utilization in fiscal 2008.

Overall, fiscal 2008 was another difficult year. The combined negative impact of lower newsprint prices and higher costs reduced the EbITdA margin to negative 2.1%, down from 1.0% in the prior year.




(unfavourable)

EbITdA 5 (9) (14)


Other items (3) (1) (2)

Operating earnings (loss) (27) (25) 2

The Paper segment generated an operating loss of $25 million compared to an operating loss of $27 million in the prior year. As an offset to the previously noted decline in EbITdA, the segment depreciation expense declined

by $18 million. In February 2008, the company applied fresh start accounting and the carrying values of the Paper segment fixed assets were reduced by $394 million.



CHEMICALS(in millions of dollars)

2007 2008

Total sales 173 130


EbITdA 10 9

EbITdA margin on total sales 5.8 % 6.9 %


Operating earnings 6 6


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

The resin business produces powder and liquid phenolic resins at three operating sites in Quebec: Temiscaming, Longueuil and Trois-Pistoles. The company also oper-ates a fourth manufacturing operation located in Toledo, Ohio which manufactures powder and liquid amino-based resins, and distributes other products such as melamine. The Longueuil operation also produces formaldehyde, both for internal resin production and external sales. In addition to its manufactured products, the resin business also markets third-party resin binders to complement its customer offering. sales of third-party products totalled $7 million in fiscal 2008, compared to $47 million

in the prior year. during fiscal 2008, a relatively large contract with a third-party supplier expired and was not renewed. The segment also purchases and resells pulp mill by-product chemicals from third parties. These sales are included in “Other chemicals”.

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


2007 2008 2007 2008 2007 2008

Resin and related products (tonnes) 123 78 97.0 83.1 1,268 937

Lignin (tonnes) 38 41 192.9 181.9 197 225

Alcohol (000 litres) 10 8 11.7 10.1 855 792

Other chemicals 2 3

Total sales 173 130

Internal sales (3) (4)


Marketschemical products are sold primarily in North America with sales representing 79% of consolidated sales in 2008, compared to 86% in 2007. Resin products, which accounted for 60% of total chemical sales, are designed for the Osb industry and other specialty applications. Lignin is sold as a binder, dispersant and surfactant for indus-trial markets such as animal feed, concrete admixture and carbon black. Ethanol is sold into the canadian vinegar, hygiene and cosmetics markets. The chemical Products group sales represented 5% of consolidated sales in 2008, down from 6% in the prior year.

Operating ResultsThe difficult U.s. housing environment noted in the Forest Products segment review also negatively impacted demand and price for Osb panels. The primary customers for the company’s resin products are Osb manufacturers. The decline in selling prices led to an EbITdA reduction of $3 million in the resin business. Improved pricing for lignin products partially offset the resin shortfall, increasing EbITdA by $2 million. Operating earnings were unchanged at $6 million, with lower depreciation and amortization expense offsetting the $1 million reduction in EbITdA.

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fINANCIAL pOSITION ANd LIQUIdITY

fREE CASH fLOw(in millions of dollars)

2007 2008

cash flow from operations before working capital changes 146 (50)

Net fixed asset additions (75) (63)

Free cash flow (negative) 71 (113)

Fiscal 2007 amounts in the above table have not been restated to reflect the reclassification of the st. Francisville paper mill as discontinued operations.

cash flow from operations before working capital changes in fiscal 2008 was negative $50 million, a $196 million decline from fiscal 2007. The prior year had benefited from a $268-million refund of lumber deposits and related interest. Partially offsetting this item, the company reduced its fiscal 2008 interest expense by $70 million as a result of the recapitalization that occurred on February 29, 2008. For the year ended september 2008, non-cash working

capital items used $33 million as compared to $26 million generated in the prior-year period. The company is subject to seasonal increases of timber and log inven-tories during the winter months and subsequent declines during the summer months. After allowing for net fixed asset additions of $63 million, free cash flow for fiscal 2008 was negative $113 million versus a positive amount of $71 million a year ago.

CApITAL SpENdINg(in millions of dollars)

2007 2008

Forest Products 20 8

Pulp 46 49

Paper 8 5

chemicals 1 2

corporate – (1)

Net fixed asset additions 75 63

As a % of total sales 2.5 % 2.4 %

As a % of fixed asset depreciation 43 % 53 %

Fiscal 2007 amounts in the above table have not been restated to reflect the reclassification of the st. Francisville paper mill as discontinued operations.

In response to relatively low EbITdA and significant oper-ating losses brought on by challenging market conditions, the stronger canadian dollar and export taxes on lumber shipped to the U.s., the company has continued to limit capital expenditures. during fiscal 2008, net fixed asset additions totalled $63 million compared to $75 million in the prior year. The company estimates that minimum annual capital expenditures of $60 to $70 million are required to adequately maintain its facilities. The amount spent was equal to 53% of fixed asset depreciation and 2.4% of total sales.

significant capital expenditures in fiscal 2008 included an amount of $17 million to complete the construction of a new $48-million biomass/bark boiler at the Tartas specialty pulp mill. The new boiler was put into service in the fourth quarter of fiscal 2008 and will reduce purchased fossil fuel costs at this facility in fiscal 2009. An investment

of $6 million was made to begin the installation of a condensing turbine and a 12-megawatt electrical gener-ator at the Tarascon paper pulp mill. A further amount of $11 million will be spent in fiscal 2009 to complete the installation. It is anticipated that the turbine will be put in service in the third quarter of fiscal 2009, reducing energy costs at the pulp mill.

significant capital expenditures in fiscal 2007 included $2 million to complete the conversion of the previously idled kirkland Lake, Ontario sawmill to a finger-joint lumber manufacturer. The facility, converted at a cost of $12 million, began operations in October 2006 but was subsequently idled in may 2007 due to the downturn in the U.s. housing market. An investment of $5 million was made to complete the installation of a condensing turbine and a 20-megawatt electrical generator at the saint-gaudens pulp mill. The $17-million project was put



into service in march 2007. An amount of $4 million was spent to complete the construction of an alkaline liquor evaporation system at the Tartas pulp mill. The system, constructed at a total cost of $18 million, was started up in december 2006, significantly reducing the environ-mental impact of the mill’s waste effluent stream. Also at the Tartas pulp mill, an amount of $21 million was spent to continue with the construction of a new $48-million biomass/bark boiler.

ACQUISITIONS, INVESTMENTS ANd dIVESTITURES

during fiscal 2008, the Aditya birla group purchased 20% of the company’s remaining 25% equity interest in the issued and outstanding shares of both Av cell and Av Nackawic for total consideration of $9 million. A $7 million loan previously made to Av cell was also reimbursed. As well, the company disposed of several parcels of land for total consideration of $17 million. The land was of relatively high value and was better suited to commercial development than to long-term forestry and timber harvesting. during fiscal 2007, the company also disposed of several parcels of relatively high-value land for $13 million. The company also generated proceeds of $2 million in the sale of the previously idled davidson, Quebec pine and hardwood sawmills.

fINANCINg ACTIVITIES

Net debt to total capitalization stood at 30% at september 2008, a decrease of 33% from 63% at

september 2007. The significant de-leveraging of the company’s balance sheet is the result of the financial recapitalization that occurred on February 29, 2008. The conversion of Us $1.2 billion of unsecured senior notes into equity of Tembec generated this improvement.

NET DEBT TO TOTAL CAPITALIZATION(in percentage)

20

30

40

50

60

70

2004

48%

65%

2006

63%

2007

59%

2005

30%

2008

Actual

Objective < 40%

As part of its long-term strategy, the company has resolved to maintain its percentage of net debt to total capitalization to 40% or less. The objective of the plan is to keep a strong balance sheet and maintain the ability of the company to access capital markets at favourable rates. The company remains committed to this program.

LONg-TERM dEBT(in millions of dollars)

2007 2008

Tembec Inc. – 6% unsecured notes – pre-recapitalization 20 –

Tembec Inc. – 6% unsecured notes – post-recapitalization – 16

Tembec Industries – Us $350 million 8.625% unsecured senior notes – June 2009 348 –

Tembec Industries – Us $500 million 8.5% unsecured senior notes – February 2011 498 –

Tembec Industries – Us $350 million 7.75% unsecured senior notes – march 2012 348 –

Tembec Industries – Us $300 million bearing interest at LIbOR (+700 basis points) or prime (+600 basis points) rate – 310

Tembec sAs debt 20 20

Tembec Envirofinance sAs debt 32 35

Tembec Energie sAs debt 10 9

Proportionate share of marathon debt (50%) 7 5

Proportionate share of Temlam debt (50%) 39 –

Other debt 21 10

1,343 405

current portion included in above 26 18

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As previously noted, the financial recapitalization that occurred on February 29, 2008, had a significant impact on the company’s long-term debt. Three separate series of unsecured senior notes totalling Us $1.2 billion were converted into 95% of the common equity of Tembec. As part of the financial recapitalization, the company entered into a loan agreement with various lenders for a non-revolving term loan of Us $300 million due February 28, 2012. The facility is secured by a charge on the assets of the company’s material North American operations, including a first priority charge on all assets except receivables and inventories, where it has a second priority charge.

As part of the financial recapitalization, $20 million of 6% unsecured notes were cancelled and replaced with new $14 million 6% unsecured notes having a maturity of september 30, 2012. The class b, series 2 and class b, series 4 preferred shares totalling $26 million were cancelled and replaced with new $4 million 6% unsecured notes having a maturity of september 30, 2012. Principal payments of $2 million were made on the new 6% unsecured notes subsequent to the financial recapitalization.

during the year, the company’s French operations increased, via Tembec Envirofinance sAs, its non-interest bearings loans by $3 million to assist with the financing of certain capital expenditures being undertaken at the pulp mills.

The marathon joint venture does not currently meet certain financial covenants on its operating line and its term loan with a syndicate of banks. discussions with lenders are ongoing and the company believes it will reach a satis-factory agreement to maintain and extend the credit agreement. There is no recourse to the shareholders on either of these loan facilities. The $5-million loan balance is included in current portion of long-term debt.

At the end of september 2008, Tembec had net cash of $112 million plus unused operating lines of $207 million. At the date of the previously audited financial statements, the company had net cash of $14 million and unused operating lines of $203 million. The company defines “operating lines” to include loans of various durations which are secured by charges on accounts receivable and/or inventories. Operating lines are used primarily to fund short-term requirements associated with both seasonal and cyclical inventory increases which can occur in the company’s business segments. The company would not normally draw on the operating lines to fund capital expenditures or normal average working capital require-ments. The operating lines are established across multiple entities and jurisdictions to ensure they meet the needs of the various operating units.

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

OpERATINg LINES–UNUSEd(in millions of dollars)

2007 2008

canadian operations 135 157

U.s./French operations 56 46

Proportionate share of joint ventures 12 4

203 207

At the beginning of fiscal 2007, the company had in place a committed revolving working capital facility of $150 million maturing in march 2009, secured by receiv-ables and inventory. The company also had in place a committed non-revolving working capital facility of $136 million maturing in June 2008, secured by receivables and inventory. In January 2007, the company amended the $150-million facility by increasing it to $250 million and extending its committed period to december 2009. The amended revolving working capital facility effectively replaced the revolving $150-million and the non-revolving $136-million facilities. As of the end of september 2007, the amount available on the $250-million facility (borrowing base) was $229 million, of which $135 million was unused. As part of the financial recapitalization that occurred on February 29, 2008, the company negotiated a new $205-million revolving working capital facility maturing in december 2011. The new facility has a first priority charge over the receivables and inventory and a second priority charge over the remainder of the assets of the company’s significant North American operations. As of the end of september 2008, the amount available on the $205 million facility (borrowing base) was $197 million, of which $157 million was unused.

The French operations are supported by several mill specific “receivable factoring” agreements. As such, the borrowing base fluctuates periodically, depending on shipments and cash receipts. As at september 27, 2008, the amount available was $86 million, of which $46 million was unused.

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



COMMON SHARES(in millions)

2007 2008

shares outstanding – opening 85.6 85.6

Financial recapitalization

– conversion of existing equity – (85.6)

– Issued to existing equity – 5.0

Financial recapitalization

– Issued to unsecured senior noteholders – 95.0

shares outstanding – ending 85.6 100.0

On december 19, 2007, the company announced a proposed financial recapitalization transaction. On February 22, 2008, the transaction was approved by the company’s shareholders and the holders of its unsecured senior notes (the noteholders). On February 29, 2008, the financial recapitalization was implemented. The following are key elements of the plan:

conversion of Us $1.2 billion of unsecured senior notes • into equity of the company;

The noteholders received 88% of the equity of the • company in full settlement of their notes;

An additional 7% of the equity was allocated to note-• holders who backstopped a new Us $300-million four-year term loan;

Existing shareholders received 5% of the equity of the • company and 11,111,111 warrants to acquire common shares of the company.

The warrants are convertible into an equal amount of common shares and expire on February 29, 2012. They shall be deemed to be exercised and shall be automatically converted into common shares of the company when the 20-day volume-weighted average trading price of a single common share reaches or exceeds $12 or immediately prior to any transaction that would constitute a change of control.

In addition to the previously noted warrants, an addi-tional 201,456 shares may be issued pursuant to options granted under the prior Long-Term Incentive Plan (LTIP). The exercise price of the options ranges from $16.61 per share to $306.85 per share with expiry dates from 2009 to 2016. As at september 27, 2008, 135,465 options were exercisable. At the end of the prior year, 3.7 million shares were issuable pursuant to options. The exercise price of the options ranged from $0.97 per share to $17.92 per share and a total of 1.7 million were exercisable. The significant decline in the number of options outstanding and the significant increase in strike price are the result of adjustments required by the financial recapitalization that occurred in February 2008.

CONTRACTUAL OBLIgATIONS(in millions of dollars)

TotalWithin 1 year 2–3 years 4–5 years

After 5 years

Long-term debt 405 18 36 331 20

Interest on long-term debt 121 35 70 16 –

Operating leases 26 6 10 5 5

Purchase obligations 110 55 38 8 9

Pension obligations:

Normal cost 113 10 21 22 60

contractual 77 23 31 12 11

852 147 206 394 105

The table above shows the company’s contractual obli-gations as at september 27, 2008. The company has long-term debt with contractual maturities and applicable interest. The operating lease obligations relate primarily to property and equipment rentals entered into in the normal course of business. Purchase obligations relate to ongoing normal commercial commitments to purchase timber, wood chips, energy, chemicals and other operating

inputs. They also include outstanding obligations relating to capital expenditures. Pension obligations have two components. The normal cost obligations are limited to a ten-year period and are based on estimated future employee service for existing registered defined benefits plans. contractual obligations include estimated solvency and going concern amortization payments.

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2007 VS. 2006

fINANCIAL SUMMARY(in millions of dollars, unless otherwise noted)

2006(1) 2007

sales 3,016 2,750

EbITdA 42 65


Other items 182 (227)

Operating earnings (loss) (325) 119

Net earnings (loss) from continuing operations (295) 150

Net loss (292) (49)

Net loss per share – basic (3.41) (0.58)

diluted loss per share (3.41) (0.58)

Total assets (at end of year) 3,034 2,655

Total long-term debt (at end of year)(2) 1,454 1,340

(1) Restated to reclassify st. Francisville financial results as discontinued operations.(2) Includes current portion.

sales decreased by $266 million as compared to fiscal 2006. The decline was the result of lower sales volumes in all of the company’s reportable business segments combined with lower forest products selling prices. Improved prices in the Pulp segment provided a substan-tial offset. currency negatively affected revenue as the value of the canadian dollar versus the U.s. currency increased by 3%. The Forest Products segment sales declined by $256 million as a result of lower Us $ refer-ence prices and lower shipments. The Pulp segment sales increased by $7 million on the strength of significantly improved Us $ reference prices, offset by lower ship-ments caused primarily by the permanent closure of a pulp mill. The Paper segment sales experienced lower prices and shipments.

EbITdA improved by $23 million over the prior year. The Forest Products segment EbITdA declined by $105 million

because of lower prices. The Pulp segment EbITdA improved by $124 million as prices improved substan-tially. The Paper segment EbITdA declined by $16 million primarily because of lower selling prices.

The company generated operating earnings of $119 million compared to an operating loss of $325 million in fiscal 2006. In addition to the previously noted $23 million improvement in EbITdA, the balance of the improve-ment relates primarily to other items. In the prior year, the company had absorbed charges totalling $183 million in relation to the idling of the smooth Rock Falls, Ontario pulp mill. during fiscal 2007, the company recorded a credit of $238 million pertaining to the recovery of lumber export duties on deposit with the U.s. department of commerce. This was partially offset by a $29 million charge for pension and severance costs associated with the perma-nent closure of the smooth Rock Falls pulp mill.



OpERATINg EARNINgS (LOSS)(in millions of dollars)

2006 2007 Total varianceEBITDA variance

Depreciation & amortization

varianceOther items

variance

Forest Products (16) 129 145 (105) (2) 252

Pulp (245) 46 291 124 13 154

Paper (15) (27) (12) (16) 1 3

chemicals 4 6 2 2 – –

corporate (53) (35) 18 18 – –

(325) 119 444 23 12 409

Interest on long-term debt was relatively unchanged. The reduction in short-term interest expense related to the decrease in utilization of short-term operating lines since the receipt of the lumber duty refund. In October 2006, the company received a total of Us $242 million as a refund of lumber duties. The refund was divided into two components in the financial statements. An amount of $238 million was credited to operating earnings and a further $30 million was shown as interest income.

during the year ended september 2007, the company recorded a gain of $147 million on the translation of its Us $ denominated debt as the relative value of the canadian dollar increased from Us $0.895 to Us $1.005. The company recorded a further gain of $2 million on the translation of its euro-denominated debt. In the prior year, the canadian dollar had increased from Us $0.854 to Us $0.895, and the company had recorded a gain of $64 million on its Us $ denominated debt.

during fiscal 2007, the company recorded an income tax expense of $1 million on pre-tax earnings from continuing operations of $150 million. The income tax expense reflected a $49 million favourable variance versus an anticipated income tax expense of $50 million based on the company’s effective tax rate of 33.3%. The non-taxable portion of the gain on translation of the Us $ denominated debt reduced the income tax expense by $21 million. The recognition of prior period losses decreased the income tax expense by $20 million. based on past financial perform-ance, future income tax assets of the company’s canadian operations have been limited to the amount that is more likely than not to be recovered. Finally, the rate differential between jurisdictions decreased the income tax expense

by $10 million. during fiscal 2006, the company recorded an income tax recovery of $72 million on a pre-tax loss from continuing operations of $367 million. The income tax recovery reflected a $51 million unfavourable variance versus an anticipated income tax recovery of $123 million based on the company’s effective tax rate of 33.3%. The non-recognition of period losses decreased the income tax recovery by $67 million. This was partly offset by the non-taxable portion of the gain on translation of Us $ denominated debt and the rate differential between jurisdictions which increased the income tax recovery by $9 million and $8 million respectively.

In fiscal 2006, the company sold its Osb mill located in saint-georges-de-champlain, Quebec for total considera-tion of $98 million. The sale generated an after-tax gain of $47 million. As well, the Osb mill generated an after-tax gain of $4 million during the five-month period it was owned by the company in fiscal 2006. There was no impact on the financial statements of fiscal 2007.

The financial results of the st. Francisville paper mill oper-ations have been reclassified as discontinued operations. during the year ended september 2006, the facility generated a net loss of $48 million, including a charge of $7 million relating to severance and related costs for the restructuring of the operations. In fiscal 2007, the facility generated a net loss of $199 million, including an unusual charge of $173 million relating to asset impairment.

For the year ended september 2007, the company gener-ated a net loss of $49 million or $0.58 per share versus a net loss of $292 million or $3.41 per share in fiscal 2006.

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RISKS ANd UNCERTAINTIES

pROdUCT pRICES

The company’s financial performance is dependent on the selling prices of its products. The markets for most lumber, pulp and paper products are cyclical and are influenced by a variety of factors. These factors include periods of excess product supply due to industry capacity addi-tions, 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 possible net losses.

based on 2009 planned sales volumes, the following table illustrates the approximate annual impact of changes to average canadian dollar selling prices on after-tax earnings.

SELLINg pRICE SENSITIVITY

Impact on after-tax earnings

($ millions)

Average selling

prices ($) 4th quarter –

2008

Pulp – $25/tonne 30 829

Paper – $25/tonne 10 875

sPF lumber – $10/mbf 7 330

The company’s strategy is to mitigate price volatility by maintaining operations in three core sectors, namely wood products, pulp and paper; maintaining low cost, high-quality flexible production facilities; establishing and developing long-term relationships with its customers; and developing specialty niche products where possible. In addition, the company may periodically purchase lumber, pulp and newsprint price hedges to mitigate the impact of price volatility. At september 27, 2008, the company held lumber futures equal to approximately 3% of its annual sPF lumber capacity. The fair value of the contracts was $1 million. At september 29, 2007, the company did not hold any product price hedges.

fOREIgN EXCHANgE

The company’s revenues for most of its products are affected by fluctuations in the relative exchange rates of the canadian dollar, the U.s. currency and the euro. The prices for many products, including those sold in canada and Europe are generally driven by Us $ refer-ence prices of similar products. The company generates

approximately $2.0 billion of Us $ denominated sales annually from its canadian and European operations. As a result, any decrease in the value of the U.s. dollar relative to the canadian dollar and the euro reduces the amount of revenues realized on sales in local currency. In addi-tion, since business units purchase the majority of their production inputs in local currency, fluctuations in foreign exchange can significantly affect the unit’s relative cost position when compared to competing manufacturing sites in other currency jurisdictions. This could result in the unit’s inability to maintain its operations during periods of low prices and/or demand.

based on 2009 planned sales volumes and prices, the following table illustrates the impact of a 1% change in the value of the U.s. dollar versus the canadian dollar and the euro. For illustrative purposes, an increase of 1% in the value of the U.s. dollar is assumed. A decrease would have the opposite effects of those shown below.

fOREIgN EXCHANgE SENSITIVITY(in millions of dollars)

sales increase 20

cost of sales increase 3

EbITdA increase 17

Interest expense increase –

cash flow increase 17

Loss on Us $ debt translation 3

Pre-tax earnings increase 14

Tax expense increase 5

Net earnings increase 9

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

To further reduce the impact of fluctuations in the value of the U.s. dollar, the company has adopted a policy of hedging up to 50% of its anticipated receipts in U.s. dollars for up to 36 months in duration. At september 27, 2008, and september 29, 2007, the company did not hold any foreign exchange contracts.

OpERATIONAL RISKS

The manufacturing activities conducted by the company’s operations are subject to a number of risks including avail-ability and price of fibre, competitive prices for purchased



energy, a productive and reliable workforce, compliance with environmental regulations, maintenance and replace-ment/upgrade of process equipment to manufacture competitive quality products. The manufacturing facili-ties must also be operated at high rates of utilization and efficiency to maintain a competitive cost structure.

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

Energy is an important component of mill costs, espe-cially for high-yield pulp mills and newsprint mills. In 2008, purchased energy costs totalled approximately $228 million, 59% of which was electricity. Electrical purchases are made primarily from large public utilities, at rates set by regulating bodies. In certain jurisdictions, electricity is deregulated which can lead to greater price volatility. To mitigate the effect of price fluctuations on its financial performance, the company employs several tactics, including the securing of longer term-supply agree-ments, the purchase of derivative financial instruments and operational curtailments in periods of high prices (load shedding). At september 2008 and september 2007, the company did not hold any derivative financial instruments relating to purchased electricity. Fossil fuels, primarily natural gas, are purchased at market rates. The company periodically purchases derivative financial instruments to hedge its exposure. At september 27, 2008, and september 29, 2007, the company did not hold any natural gas hedges.

Nearly all the company’s manufacturing units have a unionized workforce. Over the past 30 years, the company has successfully negotiated new collective agreements

in nearly all instances, with very few work stoppages. At many of the company’s facilities, as well as those of the North American industry as a whole, we have seen reductions in employment levels resulting from techno-logical and process improvements resulting in a workforce with more years of service. This increases the relative costs of pensions and benefits. At september 2008, the company had approximately 5,300 hourly paid employees covered by collective bargaining agreements. At september 27, 2008, there were three agreements covering 135 employees that had expired and were under active negotiations. during fiscal 2009, a total of 15 agree-ments covering 1,800 employees will expire. The remaining contracts expire at various dates up to April 2012. The company anticipates it will reach satisfactory agreements on contracts currently under active negotiations and those expiring in the future.

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

The production of pulp and paper products is capital intensive. The company estimates it must spend approxi-mately $60 – $70 million per year on capital expenditures to avoid degradation of its current operations.

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

TRAdE RESTRICTIONS/LUMBER EXpORT TAXES

The company’s manufacturing operations are located primarily in canada. however, sales into the canadian market represented only 17% of consolidated sales in 2008. As such, the company’s financial results are highly dependent on its ability to sell its products into the “export” markets. Tariffs and trade barriers that reduce or prohibit the movement of our products across international borders

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constitute an ongoing risk. The recent agreement between canada and the United states over softwood lumber is a case in point. In may 2002, the U.s. department of commerce initially assessed the company with aggregate countervailing and antidumping duties at an average rate of 29%. On October 12, 2006, canada and the United states entered into an agreement to govern the shipment of canadian softwood lumber into the United states. As part of the agreement, the company received a Us $242 million payment on October 30, 2006, pertaining to the recovery of lumber duties on deposit with the U.s. department of commerce that had accumulated since may 2002. The outcome was less than satisfactory. Through a combina-tion of quotas and export taxes, the agreement will ensure that canadian producers of softwood lumber will remain at a disadvantage versus U.s. producers when it comes to accessing the U.s. market.

fINANCIAL RISKS/dEBT SERVICE

Of the total long-term debt of $387 million, 80% relates to a Us $300-million term loan expiring February 2012. The term loan does not require periodic payments for principal amortization. since the entire principal amount will become due on the maturity date, it is possible the company will not have the required funds/liquidity to repay the principal due. The company may require access to the public or private debt markets to issue new debt instruments to replace or partially replace the term loan. There is no assurance that the company will be able to refinance this loan on commercially acceptable terms. The company’s objective is to maintain a relatively modest debt level and improve its financial results prior to the maturity of the term loan.

EVALUATION Of dISCLOSURE CONTROLS ANd pROCEdURES

disclosure controls and procedures have been established by the company to ensure that information disclosed by the company in this md&A and the related financial state-ments was properly recorded, processed, summarized and reported within the time periods specified by applicable securities regulatory authorities. disclosure controls and procedures are designed to ensure that the information required to be disclosed by the company in the reports that are filed or submitted is accumulated and communicated

to the management, including the company’s Executive vice President, Finance and chief Financial Officer, to allow timely decisions regarding required disclosure.

The company’s President and chief Executive Officer and the company’s Executive vice President, Finance and chief Financial Officer have evaluated the disclosure controls and procedures and have determined that such disclosure controls and procedures are effective.

CHANgES IN INTERNAL CONTROLS

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

OVERSIgHT ROLE Of AUdIT COMMITTEE ANd BOARd Of dIRECTORS

The Audit committee reviews the company’s annual md&A and related financial statements with management and the external auditors, and recommends their approval to the board. management and the internal auditors of the company also present periodically to the committee a report of their assessment of the company’s internal

controls and procedures for financial reporting. The external auditors periodically prepare for management a report on internal control weaknesses identified during the course of the auditor’s annual audit, which is reviewed by the Audit committee.

AddITIONAL INfORMATION

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

52TembecAR 08 - EN CONS. FIN.

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

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

The company’s external auditors are responsible for auditing the consolidated financial statements and giving an opinion thereon. The external auditors also prepare for management a report on internal control weaknesses identified during the course of the annual audit. In addition, the company employs internal auditors to evaluate the effectiveness of its systems, policies and procedures.

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

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

Management’s Responsibility

MICHEL J. dUMASExecutive vice President, Finance and chief Financial Officer


November 14, 2008

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we have audited the consolidated balance sheets of Tembec Inc. as at september 27, 2008, and February 29, 2008, and of the Predecessor as at september 29, 2007, and the consolidated statements of operations, comprehensive loss, retained earnings (deficit) and cash flows for the seven-month period ended september 27, 2008, and of the Predecessor for the five-month period ended February 29, 2008, and the twelve-month period ended september 29, 2007. These financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

we conducted our audits in accordance with canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.

In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the company as at september 27, 2008, February 29, 2008, and of the Predecessor as at september 29, 2007, and the results of its operations and its cash flows for the periods then ended in accordance with canadian generally accepted accounting principles.

Auditors’ Report to the Shareholders

chARTEREd AccOUNTANTs

montreal, canada November 14, 2008


consolidated Financial statements

CONSOLIdATEd BALANCE SHEETS(in millions of dollars)

The Company

The Company

The Predecessor

Sept. 27,2008

Feb. 29,2008

Sept. 29,2007

Assets

current assets:

cash and cash equivalents $ 113 $ 116 $ 14

derivative financial instruments (note 20) 1 – –

Accounts receivable (notes 8 and 20) 371 341 347

Inventories (notes 4 and 8) 414 459 436

Prepaid expenses 19 20 15

current assets of discontinued operations (note 3) 2 5 18

920 941 830

Investments 9 29 28

Fixed assets (note 6) 670 711 1,584

Other assets (note 7) 22 20 146

Future income taxes (note 18) 1 – 67

$ 1,622 $ 1,701 $ 2,655

Liabilities and shareholders’ Equity

current liabilities:

bank indebtedness $ 1 $ 7 $ –

Operating bank loans (note 8) 49 62 89

Accounts payable and accrued charges 375 351 363

Interest payable 3 – 17

current portion of long-term debt (note 9) 18 21 26

current liabilities related to discontinued operations (note 3) 3 2 6

449 443 501

Long-term debt (note 9) 387 414 1,314

Other long-term liabilities and credits (note 10) 223 235 125

Future income taxes (note 18) 2 1 93

minority interests (note 11) 1 – 5

Redeemable preferred shares (notes 12 and 13) – – 26

Non-current liabilities related to discontinued operations (note 3) 38 38 25

shareholders’ equity:

share capital (note 13) 570 570 831

contributed surplus (note 13) – – 9

Accumulated other comprehensive loss – – (3)

deficit (48) – (271)

522 570 566

$ 1,622 $ 1,701 $ 2,655

guarantees, commitments and contingencies (note 14)see accompanying notes to consolidated financial statements.

On behalf of the board:


JAMES V. CONTINENzAchairman of the board

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55

CONSOLIdATEd STATEMENTS Of OpERATIONSseven-month period ended september 27, 2008, five-month period ended February 29, 2008, and year ended september 29, 2007(in millions of dollars, unless otherwise noted)

The Company

The Predecessor

The Predecessor

Seven monthsto Sept. 27,

2008

Five monthsto Feb. 29,

2008

Twelve monthsto Sept. 29,

2007

sales $ 1,426 $ 950 $ 2,750

Freight and sales deductions 181 111 316

Lumber duties and export taxes (note 14) 7 4 18

cost of sales 1,139 804 2,218

selling, general and administrative 61 48 133

depreciation and amortization (note 15) 51 72 173

Recovery of lumber duties (note 16) – – (238)

Restructuring and asset impairment charges (credits) (note 16) (3) – 27

gain on land sales and other (note 16) (2) (20) (16)

Operating earnings (loss) from continuing operations (8) (69) 119

Interest, foreign exchange and other (note 17) 13 32 118

Exchange loss (gain) on long-term debt 15 (9) (149)

Earnings (loss) before income taxes from continuing operations (36) (92) 150

Income tax expense (note 18) 5 6 1

share in earnings of a related company – – (1)

Net earnings (loss) from continuing operations (41) (98) 150

Loss from discontinued operations (note 3) (7) (4) (199)

Net loss $ (48) $ (102) $ (49)

basic and diluted earnings (loss) per share from continuing operations (note 13) $ (0.41) $ (1.14) $ 1.75

basic and diluted loss per share from discontinued operations (note 3) $ (0.07) $ (0.05) $ (2.33)

basic and diluted loss per share (note 13) $ (0.48) $ (1.19) $ (0.58)

see accompanying notes to consolidated financial statements.



CONSOLIdATEd STATEMENTS Of COMpREHENSIVE LOSSseven-month period ended september 27, 2008, five-month period ended February 29, 2008, and year ended september 29, 2007(in millions of dollars)

The Company

The Predecessor

The Predecessor


2008


2008


2007

Net loss $ (48) $ (102) $ (49)

Other comprehensive income (loss) – – –

comprehensive loss $ (48) $ (102) $ (49)

CONSOLIdATEd STATEMENTS Of RETAINEd EARNINgS (dEfICIT)seven-month period ended september 27, 2008, five-month period ended February 29, 2008, and year ended september 29, 2007(in millions of dollars)

The Company

The Predecessor

The Predecessor


2008


2008


2007

Retained earnings (deficit), beginning of year $ – $ (271) $ (249)

Adjustment resulting from a change in accounting policies (note 2) – – 27

Restated retained earnings (deficit), beginning of year – (271) (222)

Net loss (48) (102) (49)

(48) (373) (271)

Adjustment for fresh start accounting (note 1) – 373 –

Retained earnings (deficit), end of year $ (48) $ – $ (271)


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57

CONSOLIdATEd STATEMENTS Of CASH fLOwSseven-month period ended september 27, 2008, five-month period ended February 29, 2008, and year ended september 29, 2007(in millions of dollars)

The Company

The Predecessor

The Predecessor


2008


2008


2007

cash flows from operating activities:

Net loss $ (48) $ (102) $ (49)

Adjustments for:

Loss from discontinued operations 7 4 199

depreciation and amortization (note 15) 51 72 173

Unrealized foreign exchange and others (note 17) (2) (2) (1)

Exchange loss (gain) on long-term debt 15 (9) (149)

Future income taxes (note 18) 1 6 (26)

Utilization of investment tax credits (1) (7) 27

Restructuring and asset impairment charges (credits) (note 16) (3) – 21

gain on land sale and other (note 16) (2) (20) (16)

differences between cash contributions and pension expense (11) (8) (13)

Other 4 5 (3)

11 (61) 163changes in non-cash working capital:

Accounts receivable (35) 22 30

Inventories 35 (54) 33

Prepaid expenses – (4) 3

Accounts payable and accrued charges 29 (26) (40)

29 (62) 26

40 (123) 189cash flows from investing activities:

Reduced participation in joint ventures 6 (5) –

Additions to fixed assets (42) (23) (73)

Proceeds from disposal of fixed assets 2 – 2

decrease in investments 22 2 3

Proceeds on land sales and other – 17 15

Other 2 1 (3)

(10) (8) (56)cash flows from financing activities:

change in operating bank loans (13) (27) (146)

Increase in long-term debt 5 300 45

Repayments of long-term debt (9) (5) (14)

change in other long-term liabilities (2) (3) 2

Recapitalization fees and other – (36) (5)

(19) 229 (118)

cash generated by continuing operations 11 98 15

cash used by discontinued operations (note 3) (7) (4) (26)

4 94 (11)

Foreign exchange loss (gain) on cash and cash equivalents held in foreign currencies (1) 1 (1)

Net increase (decrease) in cash and cash equivalents 3 95 (12)

cash and cash equivalents, net of bank indebtedness, beginning of period 109 14 26

cash and cash equivalents, net of bank indebtedness, end of period $ 112 $ 109 $ 14

Interest paid in the seven months ended september 2008 totalled $21 million (five months ended February 2008 – $48 million; 2007 – $127 million) and income taxes paid (recovered) amounted to $(1) million (five months ended February 2008 – $(1) million; 2007 – $1 million).




CONSOLIdATEd BUSINESS SEgMENT INfORMATION(in millions of dollars)

The Company


Forest Products Pulp Paper Chemicals

Corporate and other Consoli dated

sales:

External $ 276 $ 810 $ 270 $ 70 $ – $ 1,426

Internal 86 36 – 3 1 126

362 846 270 73 1 1,552Earnings (loss) before the

following (29) 68 9 5 (15) 38

depreciation and amortization (note 15) 16 31 2 2 – 51

Other items (note 16) (3) – – – (2) (5)

Operating earnings (loss) from continuing operations (42) 37 7 3 (13) (8)

Net fixed asset additions:

gross fixed asset additions 7 31 3 1 – 42

Proceeds from disposal (1) (1) – – – (2)

6 30 3 1 – 40Identifiable assets – excluding

cash and cash equivalents 298 979 170 50 12 1,509

cash and cash equivalents 113

Total assets $ 1,622

The Predecessor



Corporate and other Consoli dated

sales:

External $ 196 $ 533 $ 165 $ 56 $ – $ 950

Internal 59 31 – 1 2 93

255 564 165 57 2 1,043Earnings (loss) before the

following (43) 50 (18) 4 (10) (17)

depreciation and amortization (note 15) 23 31 15 1 2 72

Other items (note 16) (18) (3) (1) – 2 (20)

Operating earnings (loss) from continuing operations (48) 22 (32) 3 (14) (69)


gross fixed asset additions 2 19 2 1 (1) 23

Proceeds from disposal – – – – – –

2 19 2 1 (1) 23Identifiable assets – excluding

cash and cash equivalents 371 953 141 42 78 1,585



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59

CONSOLIdATEd BUSINESS SEgMENT INfORMATION(in millions of dollars)

The Predecessor

Twelve months ended September 29, 2007


Corporate and other Consolidated

sales:

External $ 687 $ 1,384 $ 509 $ 170 $ – $ 2,750

Internal 145 74 – 3 2 224

832 1,458 509 173 2 2,974

Earnings (loss) before the following (68) 149 5 10 (31) 65

depreciation and amortization (note 15) 56 74 35 4 4 173

Other items (note 16) (253) 29 (3) – – (227)

Operating earnings (loss) from continuing operations 129 46 (27) 6 (35) 119


gross fixed asset additions 21 46 4 1 1 73

Proceeds from disposal (1) – – – (1) (2)

20 46 4 1 – 71

goodwill 2 – – 1 – 3

Identifiable assets – excluding cash and cash equivalents 709 1,209 582 71 70 2,641





CONSOLIdATEd gEOgRApHIC SEgMENT INfORMATIONseven-month period ended september 27, 2008, five-month period ended February 29, 2008, and year ended september 29, 2007(in millions of dollars)

The Company


Forest Products Pulp Paper Chemicals Consolidated

sales (by final destination):

canada $ 142 $ 23 $ 40 $ 31 $ 236

United states 133 113 209 23 478

Pacific Rim and India – 282 6 2 290

United kingdom, Europe and other 1 392 15 14 422

$ 276 $ 810 $ 270 $ 70 $ 1,426

The Predecessor




canada $ 108 $ 15 $ 27 $ 28 $ 178

United states 87 78 128 17 310

Pacific Rim and India – 171 – 1 172


$ 196 $ 533 $ 165 $ 56 $ 950

The Predecessor

Twelve months ended September 29, 2007



canada $ 319 $ 30 $ 83 $ 102 $ 534

United states 346 216 389 44 995

Pacific Rim and India 2 469 1 1 473


$ 687 $ 1,384 $ 509 $ 170 $ 2,750

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Fixed assets and goodwill:

canada $ 494 $ 544 $ 1,385

United states 2 2 6

United kingdom, Europe and other 174 165 196

$ 670 $ 711 $ 1,587

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62TembecAR 08 - EN NOTES

Notes to consolidated Financial statements

The following table summarizes the impact of adjustments required to implement the Plan and to reflect the adoption of fresh start accounting:

Adjustments

Feb. 29, 2008 Balance

prior to plan implementation

Plan of arrangement

Equity and other financing transactions

Fresh start accounting

Feb. 29, 2008 Balance

after plan

Assets

current assets:

cash and cash equivalents $ 15 $ – $ 101 $ – $ 116

Accounts receivable 341 – – – 341

Inventories 488 – – (29) 459

Prepaid expenses 20 – – – 20

current assets from discontinued operations 5 – – – 5

869 – 101 (29) 941

Investments 30 – – (1) 29

Fixed assets 1,515 – – (804) 711

Other assets 194 – (12)(2) (138) 20

(24)(3)

Future income taxes 45 – – (45) –

$ 2,653 $ – $ 65 $ (1,017) $ 1,701

Liabilities and shareholders’ Equity

current liabilities:

bank indebtedness $ 7 $ – $ – $ – $ 7

Operating bank loans 227 – (165)(3) – 62

Accounts payable and accrued charges 354 – (4)(3) 1(5e) 351

Interest payable 25 – (25)(3) – –

current portion of long-term debt 21 – – – 21

current liabilities related to discontinued operations 2 – – – 2

636 – (194) 1 443

Long-term debt 1,302 (1,181)(1) 295(3) – 414

(2)(4)

Unamortized financing items (2) 2(1) (24)(3) 24(5c) –

Other long-term liabilities 125 – – 110(5d) 235

Future income taxes 77 – – (76) 1

Redeemable preferred shares 26 – (26)(4) – –

Non-current liabilities related to discontinued operations 25 – – 13(5d) 38

shareholders’ equity:

share capital 831 – 558(2) (819) 570

contributed surplus 9 1,179(1) (570)(2) (618) –

28(4) (28)

Accumulated other comprehensive loss (3) – – 3(6b) –

deficit (373) – – 373(6b) –

464 1,179 16 (1,089) 570

$ 2,653 $ – $ 65 $ (1,017) $ 1,701

(3)

(5e)

(5a)

(5b)

(5a)

(5c)

(5e)

(5e)

(6a)

(6b)

(6b)

NOTE 1. BASIS Of pRESENTATION (continued)

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pLAN Of ARRANgEMENT AdJUSTMENTSIn conjunction with the Plan of Arrangement approved by the Ontario superior court of Justice, certain amounts classified as “Accounts payable and accrued liabilities” and “Long-term debt” were subject to recapitalization. Liabilities subject to recapitalization recorded as at February 29, 2008, amounted to $1,179 million.

Under the Plan of Arrangement, the capital reorganization provided for the following:

1 The cancellation of the Indentures and the irrevocable extinguishment and elimination of all of the Noteholders’ entitlements with respect to the Existing Notes and the Indentures. such Noteholders’ were entitled to their pro rata share, based on the face amount of Existing Notes held, of 45% of the recapitalized equity of the company. In addition, Noteholders had an opportunity to participate as lenders in the New Loan and be entitled to an additional 43% of the recapitalized equity of the company (see below).

EQUITY ANd OTHER fINANCIAL TRANSACTION AdJUSTMENTS2 As part of the Plan of Arrangement, Noteholders received 95% or 95 million New common shares of the recapitalized

equity of the company having a fair value of $542 million of the total of $570 million. Issuance costs amounted to $12 million.

3 As part of the Plan of Arrangement, Qualifying Noteholders had the opportunity to participate in the New Loan in a maximum principal amount of Us $300 million. gross proceeds of $295 million were used to pay $4 million of fees and $25 million of unpaid Noteholders interest to the end of december. An amount of $165 million was set aside to repay the cIT facility. The balance is earmarked for capital expenditures and general corporate purposes. Fees amounted to $24 million.

4 The company refinanced the 6% Investissement Québec notes having a total carrying value of $20 million with a new $14 million 6% note having a maturity of september 30, 2012. The class b series 2 and class b series 4 shares totalling $26 million were cancelled and replaced with a new $4 million 6% note having a maturity of september 30, 2012.

fRESH START ACCOUNTINg AdJUSTMENTSAs a result of the substantial realignment of equity and non-equity interests, the identifiable assets and liabilities of the company have been revalued to reflect the expected fair values of such assets and liabilities, as required under the cIcA handbook section 1625, Comprehensive Revaluation of Assets and Liabilities (“cIcA 1625”). The process of undertaking such a comprehensive revaluation is commonly referred to as “fresh start accounting”.

The company was required to perform a comprehensive balance sheet revaluation under the provisions of cIcA 1625. Under fresh start accounting, the company performed an assessment of the fair value of identifiable assets and liabilities, whether or not previously recorded. The adjustments were to revalue assets and liabilities that met the recognition criteria under canadian generally Accepted Accounting Principles (“gAAP”) on a new cost basis. Under cIcA 1625, goodwill is not recorded even if the net fair value of identifiable assets and liabilities is less than the fair value of the company equity upon the Implementation date.

For purposes of this audited consolidated balance sheet, the fair values ascribed to the assets and liabilities are fair values as at February 29, 2008, and are based on the guidance provided in cIcA handbook section 1581, Business Combinations. These fair values are subject to change to the extent of further valuation reports and analysis.

5 The fair value adjustments are as follows:

(a) The carrying value of “inventories” are adjusted to reflect estimated fair value;

(b) “Investments” are adjusted to fair value;

(c) “Other assets” and “deferred credits” including deferred financing costs, goodwill, timber and cutting rights are adjusted to nil;

(d) “Pension assets and employee future benefit obligations” included in “other long-term liabilities” are adjusted to reflect the accrued benefit obligation based on management’s best-estimate assumptions on a going-forward basis; plan assets are adjusted to fair value; and



(e) “Future income taxes” have been adjusted to reflect the tax effects of differences between the fair value of identifiable assets and liabilities and their estimated tax bases and the benefits of any unused tax losses and other deductions to the extent that these amounts are more likely than not to be realized. The resulting future income tax amounts have been measured based on the rates substantively enacted that are expected to apply when the temporary differences reverse or the unused tax losses and other reductions are realized. This future income tax liability does not represent an actual cash tax liability due by the company. In addition, the company has reflected a valuation allowance against certain of its estimated future income tax assets. Any reversal of this valuation allowance in future periods will result in a credit to shareholders’ equity.

6 shareholders’ equity adjustments relate to:

(a) the net fair value adjustment to assets and liabilities; and

(b) the reclassification of the “deficit” and other “shareholders’ equity” balances that arose prior to the fresh start to share capital.

NOTE 2. SIgNIfICANT ACCOUNTINg pOLICIES

The financial statements of the company and the Predecessor are prepared in accordance with canadian gAAP. The accounting policies of the company are consistent with those of the Predecessor, with the exception of the fair value adjustments applied under fresh start accounting and certain accounting policies as outlined above.

The consolidated financial statements of the Predecessor were prepared in accordance with canadian gAAP on a going-concern basis, which assumed that the Predecessor would be able to realize its assets and discharge its liabilities in the normal course of business in the foreseeable future, with no adjustments made in the carrying amounts of the assets, liabilities, revenues and expenses.

BASIS Of VALUATIONwith the application of fresh start accounting on February 29, 2008, by the company, all assets and liabilities were reported at fair values as further described in note 1. goodwill is not recorded under gAAP applicable to fresh start accounting. In addition, a review of the estimated remaining useful life of certain fixed assets was also undertaken. The review indicated that the estimated useful life of several pulp segment fixed assets was longer than originally anticipated and periodic future depreciation expense should be reduced. The implementation of these changes in estimates reduced Pulp segment depreciation expense by $4 million in the september 2008 quarter.

CHANgE IN ACCOUNTINg pOLICIESThe company adopted the new standards of the cIcA handbook section 3031, Inventories. This section, which is effective for year ends beginning January 1, 2008, requires that inventories be measured at the lower of cost and net realizable value. The initial implementation of this new policy did not have an impact on the results of the company. however, during the fiscal year, the Forest Products segment benefited from an $18 million favourable adjustment to the carrying value of its log inventories as further described in note 4.

The company adopted the new standards of the cIcA handbook section 3862, Financial Instruments – Disclosures, section 3863, Financial Instruments – Presentation, and section 1535, Capital Disclosures. These new sections are effective for interim and annual financial statements beginning on or after October 1, 2007. section 3862 requires an increased emphasis on disclosing the nature and the extent of risk arising from financial instruments and how the company manages those risks. section 3863 establishes standards for presentation of financial instruments and non-financial derivatives. sections 3862 and 3863 replaced section 3861, Financial Instruments – Disclosures and Presentation. section 1535 requires the company to disclose information to enable users of its financial statements to evaluate the company’s objectives, policies and processes for managing capital. Other than the additional disclosure in the notes to these financial statements, the adoption of these standards had no impact on the financial results of the company.

during fiscal 2007, the Predecessor changed retroactively its accounting policy relating to the evaluation of misstatements in its financial statements in accordance with section 1506, Accounting Changes of the CICA Handbook. The Predecessor applied a methodology consistent with that of the securities and Exchange commission (sEc) staff Accounting bulletin No. 108 (“sAb 108”), Considering the Effect of Prior Year Misstatements when Quantifying Misstatements in Current

NOTE 1. BASIS Of pRESENTATION (continued)

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65

Year Financial Statements. The Predecessor quantified the effect of prior-year misstatement on current-year financial statements, assessing their impact on both the financial position and results of operations of the company and evaluating the materiality of misstatements quantified on the above in light of quantitative and qualitative factors. There was no impact on the consolidated statements of operations and cash flows nor on the earnings (loss) per share for the year ended september 29, 2007; however, 2007 opening retained earnings increased by $27 million.

BASIS Of CONSOLIdATIONThe consolidated financial statements include the accounts of the company and the Predecessor, Tembec Inc. (the “corporation’’) and all its subsidiaries and joint ventures (collectively “Tembec’’ or the “company’’). Investments over which the corporation has effective control are fully consolidated. Investments over which the corporation exercises significant influence are accounted for by the equity method. The corporation’s interest in joint ventures is accounted for by the proportionate consolidation method.

BUSINESS Of THE COMpANYThe 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. The Forest Products segment consists primarily of forest and sawmill operations, which produce lumber and building materials. The Pulp segment includes the manufacturing and marketing activities of a number of different types of pulps. The Paper segment consists primarily of production and sales of newsprint and bleached board. The chemicals segment consists primarily of the transformation and sale of resins and pulp by-products. Inter-segment transfers of wood chips, pulp and other services are recorded at transfer prices agreed to by the parties, which are intended to approximate fair market value. The accounting policies used in these business segments are the same as those described in the annual audited consolidated financial statements of the company.

USE Of ESTIMATESThe 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 plant and equipment, value of investments, impairment of long-lived assets and goodwill, employee future benefits, income taxes, asset retirement obligations and environmental accruals. Actual results could differ from those estimates.

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

CASH ANd CASH EQUIVALENTScash 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 cost, which approximates market value.

INVENTORIESFinished goods, log and wood chip inventories are valued at the lower of cost, determined on an average cost basis, and net realizable value. supplies and materials are valued at cost.

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

fIXEd ASSETS ANd gOVERNMENT ASSISTANCEFixed 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 Period

buildings, pulp, newsprint and paper mill production equipment 20–30 years

sawmill production equipment 10–15 years

Paperboard mill production equipment 25–30 years

certain forest access roads and timber holdings are depreciated in relation to the volume of wood cut, and certain machinery and equipment are depreciated using units of production method. 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 ASSETSLong-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.

OTHER ASSETS(i) development and pre-operating expenses are amortized on a straight-line basis over a period not exceeding

five years.

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

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

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

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

EMpLOYEE fUTURE BENEfITSEmployee future benefits include pension plans and other employee future benefit plans. Other employee future benefit plans include post-retirement life insurance programs, health care 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 plan covering inactive participants; andThe amortization of cumulative unrecognized net actuarial gains and losses in excess of 10% of the greater of the • accrued benefit obligation or fair value of plan assets at the beginning of year, over the average remaining service period of the active employee group covered by the defined benefit plans or the average remaining lifetime of those entitled to benefits for plan covering inactive participants.

The employee future benefit obligations are determined in accordance with the projected benefit method prorated on services.

NOTE 2. SIgNIfICANT ACCOUNTINg pOLICIES (continued)

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TRANSLATION Of fOREIgN CURRENCIESmonetary 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.

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

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

STOCK-BASEd COMpENSATION pLANSThe company uses the fair-value-based approach of accounting for stock options and performance share units (“PsUs”) granted to its employees, and directors share units (“dsUs”) granted to its directors. Any consideration paid by plan participants in the exercise of share options or purchase of stock is credited to capital stock. The contributed surplus component of stock-based compensation is transferred to capital stock upon the issuance of common shares. PsUs are amortized over their vesting periods and remeasured at each reporting period, until settlement, using the quoted market value. dsUs are accounted for in compensation expense at the time of issuance. Their value is remeasured at each reporting period, using the quoted market value.

dERIVATIVE fINANCIAL INSTRUMENTSThe 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 income.

EMISSION RIgHTS ANd TRAdINgThe company is participating in European Emissions Trading, in which it has been allocated allowances to emit a fixed tonnage of carbon dioxide in a fixed period of time.

Emissions allowances are initially recorded as intangible assets with a credit to deferred income. They are recognized when the company is able to exercise control and are measured at fair value at the date of initial recognition. The balances are netted for reporting purposes.

The liability to deliver allowances is recognized based on actual emissions and will be settled using allowances on hand measured at the carrying amount of those allowances, with any excess emissions being measured at the market value of the allowances at period-end. The resulting charge to cost of sales will be offset by the income from the original grant of the rights, together with income from the release or sale of surplus rights.

fUTURE CHANgES IN ACCOUNTINg pOLICIES

goodwill and intangible assets:In February 2008, the cIcA issued section 3064, Goodwill and Intangible Assets which replaced existing section 3062, Goodwill and Other Intangible Assets and section 3450, Research and Development. The new standard provides guidance on the recognition, measurement, presentation and disclosure of goodwill and intangible assets. This standard is effective for interim and annual financial statements relating to fiscal years beginning on or after October 1, 2008. The company does not expect that the adoption of this new standard will have any impact on its financial statement disclosures or results of operations.



general standards of financial statement presentation:The cIcA revised handbook section 1400, General Standards of Financial Statement Presentation. The revision to this section provides additional guidance related to management’s assessment of the company’s ability to continue as a going concern. This revision will become effective for the fiscal year beginning on October 1, 2008. The company does not anticipate any substantial change to its disclosure as a result of the adoption of the revised standards.

International financial Reporting Standards:In February 2008, the canadian Accounting standards board confirmed its decision requiring all publicly accountable entities to report under International Financial Reporting standards. This decision establishes standards for financial reporting with consistency in the global marketplace.

These standards are effective for interim and annual financial statements relating to fiscal years beginning on or after January 1, 2011. The company is currently evaluating the impact of these new standards.

NOTE 3. dISCONTINUEd OpERATIONS

2007In July 2007, the Predecessor indefinitely idled its coated paper facility in st. Francisville, Louisiana. despite efforts to restructure the operation, the mill’s financial performance remained relatively poor. As a result of the change in circumstances, the Predecessor recorded an asset impairment charge of $173 million in the June 2007 quarter. The Predecessor has not identified a feasible restructuring plan to resume operations at the facility. As well, the Predecessor has retained the services of an outside party to actively seek the sale of the site. As this operation is the only coated paper facility owned by the Predecessor, its financial results have been reclassified as discontinued operations. comparative figures have also been reclassified to exclude the coated paper results from the Predecessor’s continuing operations.

condensed balance sheet from discontinued operations related to the st. Francisville facility is as follows:

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Accounts receivable $ – $ 3 $ 12

Inventories 2 2 5

Prepaid expense – – 1

$ 2 $ 5 $ 18

Accounts payable and accrued charges $ 3 $ 2 $ 6

3 2 6

Accrued benefit liability – pension benefit plans 20 20 5

Accrued benefit liability – other benefit plans 14 14 17

Environmental obligations 4 4 3

$ 41 $ 40 $ 31

NOTE 2. SIgNIfICANT ACCOUNTINg pOLICIES (continued)

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condensed earnings from discontinued operations related to the st. Francisville facility are as follows:

The Company

The Predecessor

The Predecessor

Seven months to Sept. 27,

2008

Five months to Feb. 29,

2008

Twelve months to Sept. 29,

2007

sales $ – $ 2 $ 249

Operating loss $ (6) $ (4) $ (206)

Financial expenses $ 1 $ – $ (7)

Loss from discontinued operations $ (7) $ (4) $ (199)

Loss per common share from discontinued operations $ (0.07) $ (0.05) $ (2.33)

condensed cash flows from discontinued operations related to the st. Francisville facility are as follows:

The Company

The Predecessor

The Predecessor


2008


2008


2007

cash flows from operating activities $ (7) $ (4) $ (22)

cash flows from investing activities – – (4)

cash flows used by discontinued operations $ (7) $ (4) $ (26)

NOTE 4. INVENTORIES

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Finished goods $ 191 $ 203 $ 179

Logs and wood chips 119 154 150

supplies and materials 104 102 107

$ 414 $ 459 $ 436



The reserves for net realizable values relating to finished goods were as follows:

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Lumber $ 6 $ 12 $ 7

Pulp – 1 1

Paper 2 2 3

$ 8 $ 15 $ 11

On February 29, 2008, upon adoption of the new accounting standard of the cIcA handbook section 3031, the carrying value of log inventory of the Forest Products segment was reduced by $24 million. At september 27, 2008, the reserve amounted to $6 million. An $18 million favourable adjustment was recorded during the seven-month period ended september 27, 2008.

NOTE 5. INVESTMENTS IN JOINT VENTURES

The consolidated balance sheet includes the company’s proportionate share of assets and liabilities of 1387332 Ontario Limited (marathon Pulp joint venture), Temlam Inc. (February 29, 2008, only), and Temrex Forest Products Limited Partnership, each at 50%. The consolidated statements of the Predecessor include the amounts related to Av cell Inc., 1387332 Ontario Limited (marathon Pulp joint venture), Temlam Inc., and Temrex Forest Products Limited Partnership, each at 50%:

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Assets:

current assets $ 29 $ 48 $ 67

Fixed assets and other 20 62 154

$ 49 $ 110 $ 221

Liabilities and equity:

current liabilities $ 31 $ 39 $ 63

Long-term debt 8 48 54

Other long-term liabilities 6 8 5

Equity 4 15 99

$ 49 $ 110 $ 221

NOTE 4. INVENTORIES (continued)

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The consolidated statements of operations and cash flows include the company’s proportionate share of the revenues, expenses of 1387332 Ontario Limited (marathon Pulp joint venture), Temlam Inc. (to August 30, 2008), and Temrex Forest Products Limited Partnership, each at 50%. The consolidated statements of the Predecessor include the amounts related to Av cell Inc., 1387332 Ontario Limited (marathon Pulp joint venture), Temlam Inc., and Temrex Forest Products Limited Partnership, each at 50%:

The Company

The Predecessor

The Predecessor


2008


2008


2007

sales $ 92 $ 58 $ 230

Expenses 96 62 230

Loss before income taxes, interest, and minority interests $ (4) $ (4) $ –

Net loss $ (8) $ (6) $ (5)

cash provided by (used in):

Operating $ 2 $ (4) $ 9

Investing (1) – (3)

Financing – 1 (3)

$ 1 $ (3) $ 3

NOTE 6. fIXEd ASSETS

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

CostAccumulated depreciation

Net book value

Net book value Cost

Accumulated depreciation

Net book value

Land $ 20 $ – $ 20 $ 20 $ 20 $ – $ 20

Production buildings and equipment:

Pulp mills 485 21 464 455 1,856 1,143 713

Newsprint and paper mills 51 3 48 49 562 272 290

sawmills 104 14 90 135 552 312 240

Paperboard mill – – – – 294 147 147

Roads and timber holdings 5 – 5 – 149 70 79

Other buildings and equipment 29 8 21 20 101 55 46

Assets under construction 22 – 22 32 49 – 49

$ 716 $ 46 $ 670 $ 711 $ 3,583 $ 1,999 $ 1,584



NOTE 7. OTHER ASSETS

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

development, pre-operating costs and other $ – $ – $ 5

goodwill – – 3

Assets held for sale – – 2

Long-term loans to employees 2 2 2

Timber rights – – 24

deferred pension costs 1 – 78

Investment tax credit and income taxes receivable 19 18 32

$ 22 $ 20 $ 146

NOTE 8. OpERATINg BANK LOANS

On February 29, 2008, the company entered into a loan agreement with a syndicate of lenders for a revolving operating credit facility of $205 million maturing december 15, 2011, secured by all of the assets of the company’s material North American subsidiaries. This facility has a first priority charge over receivables and inventory having a carrying value of $607 million and a second priority charge over the remainder of the assets having a carrying value of $792 million. Interest is calculated based either on prime rate or banker’s acceptances rate. As at september 27, 2008, there were no drawings on this facility and $40 million was reserved for letters of credit.

The French operations are supported by several mill-specific “receivable factoring” agreements. As such, the borrowing base fluctuates periodically, depending on shipments and cash receipts. As at the end of september 2008, the amount available was $86 million, of which $46 million was unused.

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

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NOTE 9. LONg-TERM dEBT

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

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 $ 16 $ 18 $ –

6% Unsecured notes – – 20

Tembec Industries Inc.:

Term loan Us $300 million secured facility due February 28, 2012, bearing interest based on prime plus 6% or LIbOR plus 7% 310 295 –

8.625% unsecured senior notes (Us $350 million) – – 348



Tembec SAS:

Unsecured term loans (¤1 million in 2008; ¤2 million in 2007), bearing interest at rates up to 1.5%, repayable and maturing at various dates to december 2013 2 2 3

Term loan (¤8 million), repayable in two instalments of $10 million and $2 million on June 30, 2010, and June 30, 2011, respectively, bearing interest based on Euribor plus 2.4% 12 12 12

Other Tembec sAs obligations 6 6 5

Tembec Envirofinance SAS:

Unsecured term loans (¤23 million in 2008; ¤22 million in 2007), non-interest bearing, repayable and maturing at various dates from June 2014 to June 2018 35 33 32

Tembec Energie SAS:

5.47% capital lease obligation (¤6 million in 2008; ¤7 million in 2007), repayable in equal monthly instalments, maturing december 9, 2014 9 10 10

1387332 Ontario Limited (Marathon pulp joint venture) (50% proportionate consolidation):

Term loan bearing interest at prime rate plus 2.75%, matured on march 31, 2006 5 5 7

Temlam Inc. (50% proportionate consolidation):

Term loans bearing interest at 6.75% and between prime rate plus 3/4% and 1 1/2%, maturing on various dates to June 2015, repayable in monthly instalments of varying amounts (note 16) – 42 39

Other long-term obligations 10 12 21

405 435 1,343

Less current portion 18 21 26

Less unamortized financing costs – – 3

$ 387 $ 414 $ 1,314



On February 29, 2008, the company entered into a loan agreement with a syndicate of lenders for a non-revolving term loan of Us $300 million due February 28, 2012, secured by all of the assets of the company’s material North American subsidiaries. This facility has a first priority charge over all assets except receivables and inventories, where it has a second priority charge. Interest is calculated based either on prime rate or LIbOR rate. The loan agreement contains restrictive covenants, including restrictions on the incurrence of additional indebtedness, the payment of dividends, employee stock purchase plan payments, investments, the creation of liens, sale and leaseback transactions, certain amalgamations, mergers, consolidations and sales of assets and certain transactions with affiliates.

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

Instalments on consolidated long-term debt for the five years following september 27, 2008, are as follows:

2009 $ 18

2010 22

2011 14

2012 322

2013 9

NOTE 10. OTHER LONg-TERM LIABILITIES ANd CREdITS

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Accrued benefit liability – pension benefit plans $ 163 $ 175 $ 63

Accrued benefit liability – other benefit plans 45 44 38

balance payable on acquisitions 1 3 3

Reforestation – bc operations 6 8 6

Environmental and other asset retirement obligations 3 3 4

deferred government assistance – – 4

deferred gain on sale of assets – – 4

Other 5 2 3

$ 223 $ 235 $ 125

NOTE 9. LONg-TERM dEBT (continued)

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NOTE 11. MINORITY INTERESTS

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

bioenerg sAs $ 1 $ – $ –

Av cell Inc. – – 5

$ 1 $ – $ 5

NOTE 12. REdEEMABLE pREfERREd SHARES

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

16,627,500 series 2 class b preferred shares (note 1) $ – $ – $ 17

9,103,710 series 4 class b preferred shares (note 1) – – 9

$ – $ – $ 26

NOTE 13. SHARE CApITAL

a) Authorized capital

The authorized capital of the company consists of: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 amounts 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.

common shares and warrants issued

The Company

The Company

Sept. 27, 2008

Feb. 29, 2008

Issued and fully paid:

100,000,000 common shares $ 564 $ 564

11,095,839 warrants 6 6

$ 570 $ 570



The authorized capital of the Predecessor consisted of:Unlimited number of common voting shares, without par value;• Unlimited number of non-voting class b preferred shares issuable in series without par value, with other attributes to • be determined at time of issuance:

Unlimited number of series 2 class b shares redeemable at any time by the company and, commencing on -June 26, 2011, at the option of the holder, the redemption price being equal to the issue price plus declared and unpaid dividends. The series 2 class b shares were entitled to a preferential and non-cumulative dividend equal to the dividend yield percentage paid on the common shares;9,103,710 0.5% per month non-cumulative series 4 class b shares redeemable at any time by the company and after -september 30, 2009, at the option of the holder, the redemption price being equal to the issue price plus declared and unpaid dividends. The series 4 class b shares can be redeemed in cash or in a variable number of common shares at the option of the company;

250,000 class c shares, with a par value of $1 each, non-voting, participating and redeemable at the issue price plus • the increase in the book value per share since the issue date.

The Predecessor

Sept. 29, 2007

Issued and fully paid:

85,616,232 common shares $ 831

series 2 class b preferred shares (note 12) –

series 4 class b preferred shares (note 12) –

$ 831

b) Earnings (loss) per share

The following table sets forth the computation of the basic and diluted earnings (loss) per share:

The Company

The Predecessor

The Predecessor


2008


2008


2007

Net earnings (loss) from continuing operations $ (41) $ (98) $ 150

Net loss $ (48) $ (102) $ (49)

weighted average number of common shares outstanding 100,000,000 85,616,232 85,616,232

dilutive effects:

Employees’ stock options – – 197,011

weighted average number of diluted common shares outstanding 100,000,000 85,616,232 85,813,243

basic and diluted earnings (loss) per share from continuing operations $ (0.41) $ (1.14) $ 1.75

basic and diluted loss per share $ (0.48) $ (1.19) $ (0.58)

The diluted loss per share is the same as the basic loss per share as the dilutive factors result in a decrease in the loss per share. In the case of diluted earnings per share from continuing operations, the diluting factors are not significant enough to result in a decrease in the earnings per share.

NOTE 13. SHARE CApITAL (continued)

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c) stock-based compensation

Under the Long-Term Incentive Plan, the company may, from time to time, grant options to its employees. The plan provides 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 were granted during the period. The compensation expense recorded was not significant.

The following table summarizes the changes in options outstanding and the impact on weighted average per share exercise price during the year:

2008 2007

Shares

Weighted average

exercise price Shares

Weighted average

exercise price

balance, beginning of year 3,668,019 $ 6.28 4,829,239 $ 7.35

Options expired (198,000) 6.18 (1,161,220) 10.73

balance prior to recapitalization 3,470,019 6.28 3,668,019 6.28

cancellation of old options (3,470,019) 6.28 – –

Issuance of new options 202,649 107.56 – –

Options expired (1,193) 132.25 – –

balance, end of year 201,456 $ 107.41 3,668,019 $ 6.28

Exercisable, end of year 135,465 $ 129.76 1,739,289 $ 9.16

The following table summarizes the weighted average per share exercise price and the weighted remaining contractual life of the options outstanding as at september 27, 2008:

Outstanding options Exercisable options

Year grantedNumber of

options

Weighted remaining

contractual lifeAverage

exercise priceNumber of

options

Weighted average

exercise price

1999 12,653 0.15 $ 153.027 12,653 $ 153.027

2000 17,565 1.31 268.867 17,565 268.867

2001 4,089 2.29 195.466 4,089 195.466

2002 12,087 3.12 185.118 12,087 185.118

2003 8,741 4.20 176.313 8,741 176.313

2004 14,078 5.16 139.319 11,263 139.319

2005 80,851 6.43 86.451 48,510 86.451

2006 51,392 7.15 28.296 20,557 28.296

201,456 5.31 $ 107.410 135,465 $ 129.759



during the fiscal year 2006, the Predecessor established a performance share units (“PsUs”) 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 either cash or common shares of the company, which are purchased on the open market. As at september 27, 2008, 93,485 PsUs were outstanding.

Non-employee directors of the company are also given the option to receive part of their annual retainer, meeting fees and awards under the directors’ share Award Plan in the form of dsUs. A dsU is paid to a director upon termination of board service and is payable in the form of cash. As at september 27, 2008, 411,222 dsUs were outstanding and no significant amount was payable under this plan.

Under the Employee share Purchase Plan, employees may purchase common shares of the company up to 10% of their base salary or wage. The company contributes 25% of the amount invested by the employee if the shares are held for a minimum period of time. Purchases of common shares under this plan occur on the open market. In 2008 and 2007, the cost of share purchases for the benefit of the employees was insignificant.

NOTE 14. 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 2009.

LUMBER dUTIES ANd 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 anti-dumping duty orders on softwood lumber shipped to the U.s. from canada.

COMMITMENTS:The company has entered into operating leases for property, plant and equipment for expected cash outflows of $26 million, of which $6 million is due in fiscal 2009.

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

NOTE 13. SHARE CApITAL (continued)

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NOTE 15. dEpRECIATION ANd AMORTIzATION

The Company

The Predecessor

The Predecessor


2008


2008


2007

Fixed assets $ 51 $ 69 $ 165

deferred development, pre-operating costs and other – 3 7

Impairment charge – – 1

$ 51 $ 72 $ 173

during 2007, the company recognized an impairment charge of $1 million related to an Eastern Ontario sawmill. These assets are included in the Forest Products segment.

NOTE 16. OTHER ITEMS

2008

Restructuring and asset impairment charges:On september 15, 2008, Temlam Inc. and Jager building systems Inc., a subsidiary of Temlam Inc., made voluntary assignments in bankruptcy. As a result of these filings, the company concluded that, based on canadian gAAP, it had lost joint control over Temlam Inc. and ceased to apply the proportionate consolidation method to account for its 50% interest in Temlam Inc. As of the most recent reporting date of August 30, 2008, the company’s proportionate share of net liabilities exceeded the net assets by $10 million, resulting in a gain from the change in accounting for this investment. The company absorbed a charge of $6 million relating to trade amounts owing from Temlam Inc. and Jager building systems. The company also recognized a $1 million obligation to a creditor of Jager building systems. The net effect overall was a $3 million gain.

The following table provides information on the assets and liabilities removed from the company’s consolidated accounts:

Temlam Inc.

current assets $ 19

Long-term assets 30

current liabilities (16)

Long-term liabilities (43)

Net assets deficiency $ (10)

The company

current assets $ 6

Other obligations 1

Related company accounts $ 7

Net gain recognized upon deconsolidation $ (3)



The company recorded a current liability of $22 million with respect to a loan guarantee on a portion of the Temlam debt. subsequent to year-end, in October 2008, the company assumed the rank of secured lender to Temlam by effecting the payment of the $22 million. The company has recorded a current receivable of $22 million as a sales process of Temlam assets has been initiated and the full amount is anticipated to be recovered within one year.

during the February 2008 period, the Predecessor recorded a non-cash charge of $1 million relating to the writedown of fixed assets at its Temiscaming facility. As well, $2 million of mill closure provisions were reversed.

during the december 2007 quarter, the Predecessor recorded a non-cash charge of $2 million relating to the writedown of its investment in the failed gaspesia project. As well, $1 million of mill closure provisions were reversed.

gain on land sales and other:during the June 2008 quarter, the company recorded a net gain of $2 million on the sale of its 20% of the 25% equity interest it held in the issued and outstanding shares of both Av Nackawic and Av cell.

during the december 2007 quarter, the Predecessor completed the sale of a number of land properties and recorded a gain of $16 million. As well, the Predecessor reduced its participation in the equity of Av cell Inc. from 50% to 25% and recorded a gain of $4 million. The Predecessor also ceased applying the proportionate consolidation method to this investment and began applying the equity method.

2007

Restructuring and asset impairment charges:during the June 2007 quarter, the Predecessor recorded a loss of $1 million related to other assets valuation with respect to its interest in a pine lumber business in chile.

during the december 2006 quarter, the Predecessor announced the permanent closure of the smooth Rock Falls, Ontario, pulp mill. The facility had been idled since the end of July 2006. The Predecessor recorded a charge of $29 million relating to special termination pension benefits, severance and other related items.

Recovery of lumber duties:during the december 2006 quarter, the Predecessor recorded net proceeds of $238 million pertaining to the recovery of lumber duties on deposit with the UsdOc that had accumulated since may 2002. The amount received by the Predecessor corresponds to approximately 82% of the total amount deposited. In addition, the Predecessor received a further $30 million, which corresponds to approximately 82% of the interest accrued on the deposits since may 2002. This latter amount was recorded as interest income.

gain on land sales and other:The Predecessor completed the sale of a number of land and other properties and recorded a net gain of $1 million in the september 2007 quarter, $1 million in the June 2007 quarter, $4 million in the march 2007 quarter and $8 million in the december 2006 quarter.

during the september 2007 quarter, the Predecessor recorded a net gain of $2 million on the sale of the davidson, Quebec, sawmill, which had been closed in the June 2005 quarter.

during the June 2007 quarter, the Predecessor recorded a net gain of $1 million on the sale of the saint-Raymond paper mill, which had been closed during the June 2005 quarter. As a result of the sale, the balance of $2 million of mill closure provisions was also reversed.

during the december 2006 quarter, the Predecessor completed the sale of its small pine lumber operation located in brassac, France. The transaction had no significant effect on the Predecessor’s financial statements.

NOTE 16. OTHER ITEMS (continued)

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

Seven months to September 27, 2008

Forest Products


Investments $ – $ (2) $ (2)

Other (3) – (3)

$ (3) $ (2) $ (5)

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

Five months to February 29, 2008

Forest Products Pulp Paper


Investments $ – $ (4) $ – $ 2 $ (2)

gain on land sales (16) – – – (16)

Other (2) 1 (1) – (2)

$ (18) $ (3) $ (1) $ 2 $ (20)

Twelve months to September 29, 2007

Forest Products Pulp Paper Consolidated

Lumber duties $ (238) $ – $ – $ (238)

Pensions – 17 – 17

gain on land sales and other (15) – (1) (16)

severance, other labour-related and idling costs – 12 (2) 10

$ (253) $ 29 $ (3) $ (227)

The mill closure provisions are no longer significant and therefore not reported.



NOTE 17. INTEREST, fOREIgN EXCHANgE ANd OTHER

The Company

The Predecessor

The Predecessor


2008


2008


2007

Interest on long-term debt $ 20 $ 27 $ 117

Interest on short-term debt 4 4 8

Interest income – lumber duties – – (30)

Interest income (4) (1) (7)

20 30 88

Amortization of deferred financing costs – 2 5

derivative financial instruments loss (gain) (2) – (1)

Other foreign exchange items (9) 2 25

Loss (gain) on consolidation of foreign integrated subsidiaries – (4) (6)

bank charges and other financing expenses 4 2 7

(7) 2 30

$ 13 $ 32 $ 118

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NOTE 18. INCOME TAXES

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

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Future income tax assets:

Non-capital loss carryforwards and pool of deductible scientific research and development expenditures $ 328 $ 330 $ 386

Fixed assets 42 36 –

Employee future benefits 67 69 14

capital loss carryforwards – – 14

Financing charges 17 18 –

Other 25 19 17

valuation allowance (465) (456) (254)

14 16 177

Future income tax liabilities:

Fixed assets – – (77)

Exchange gain on long-term debt – – (105)

Timber rights – – (5)

Other (15) (17) (16)

(15) (17) (203)

Net future income tax liabilities $ (1) $ (1) $ (26)

As reported in the consolidated balance sheet:

Future income tax assets $ 1 $ – $ 67

Future income tax liabilities (2) (1) (93)

Net future income tax liabilities $ (1) $ (1) $ (26)



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 $ 6912009 to 2028

Non-capital loss carried forward for foreign subsidiaries 422024 to 2028

Pool of deductible scientific research and experimental development 439 Unlimited

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

The Company

The Predecessor

The Predecessor


2008


2008


2007

Earnings (loss) from continuing operations before income taxes and share in earnings of a related company $ (36) $ (92) $ 150

Income tax expense (recovery) based on combined federal and provincial income tax rates of 31.9% (2007 – 33.3%) $ (12) $ (29) $ 50

Increase (decrease) resulting from:

Future income taxes adjustment due to rate enactments – 4 1

change in valuation allowance 17 35 (20)

Rate differential between jurisdictions (3) 2 (10)

Permanent differences:

Non-taxable portion of exchange loss (gain) on long-term debt 2 (2) (21)

Non-deductible loss (gain) on consolidation of foreign integrated subsidiaries 1 (1) 1

Other permanent differences – (3) –

17 35 (49)

Income tax expense $ 5 $ 6 $ 1

Income taxes:

current $ 4 $ – $ 27

Future 1 6 (26)

Income tax expense $ 5 $ 6 $ 1

NOTE 18. INCOME TAXES (continued)

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NOTE 19. EMpLOYEE fUTURE BENEfITS

dEfINEd CONTRIBUTION pENSION pLANSThe 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 under these plans is equal to the company’s contribution. The 2008 pension expense was $6 million for the seven-month period ended september 27, 2008, and $5 million for the five-month period ended February 29, 2008 ($12 million in 2007).

dEfINEd BENEfIT pENSION pLANSThe company has several defined benefit pension plans. Non-unionized employees in canada joining the company after January 1, 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 EMpLOYEE fUTURE dEfINEd BENEfIT pLANSThe company offers post-retirement life insurance, health care and dental care plans to some of its retirees. The company offers post-employment health care and dental care plans to disabled employees. The company also assumes post-employment life insurance coverage of some of its disabled employees.

The post-retirement and post-employment benefit expenses and the obligations related to the defined 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 July 1, 2006, or April 1, 2007.

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

dESCRIpTION Of fUNd ASSETSThe assets of the pension plans are held by an independent trustee and accounted for separately in the company’s pension funds. based on the fair value of assets held at June 30, 2008, the defined benefit pension plan assets were comprised of 1% (1% in 2007) in cash and short-term investments, 6% (5% in 2007) in real estate, 45% (42% in 2007) in bonds and 48% (52% in 2007) in canadian, U.s. and foreign equities.

fUNdINg pOLICYThe company’s funding policy for 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. The latest funding actuarial valuations were conducted for ten plans on december 31, 2007, five plans on december 31, 2006, and three plans on december 31, 2005. The two pension plans related to discontinued operations were last valued on January 1, 2008.



INVESTMENT pOLICYThe company follows a disciplined investment strategy, which provides diversification of investments by asset class, foreign currency, sector or 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 worldwide investment markets. Investment managers may deviate from these targets but 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. The accrued benefit obligation and the fair value of plan assets for accounting purposes were also measured as at February 29, 2008.

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

The Company

The Predecessor

The Predecessor

The Company

The Predecessor

The Predecessor


2008


2008


2007


2008


2008


2007

Accrued benefit obligation, at beginning of year $ 920 $ 882 $ 849 $ 58 $ 53 $ 59

current service cost 10 6 16 – – 1

Interest cost 29 20 48 2 1 3

Employee contributions 2 1 4 – – –

benefit paid (38) (25) (49) (1) (1) (3)

Plan amendments – 1 6 8 3 1

Actuarial loss (gain) (23) 33 6 (9) 1 (2)

Foreign exchange rate changes and other adjustments 7 2 (13) – – (2)

special termination benefits – – 17 – – –

Obligation being settled – – (1) – – –

decrease in obligation due to curtailment – – (1) – – (5)

Post-employment and other – – – 1 1 1

Accrued benefit obligation, at end of year $ 907 $ 920 $ 882 $ 59 $ 58 $ 53

Accrued benefit obligation, at end of year – discontinued operations $ 110 $ 107 $ 109 $ 7 $ 14 $ 14

NOTE 19. EMpLOYEE fUTURE BENEfITS (continued)

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


The Company

The Predecessor

The Predecessor

The Company

The Predecessor

The Predecessor


2008


2008


2007


2008


2008


2007

Fair value of defined benefit plan assets, at beginning of year $ 726 $ 751 $ 677 $ – $ – $ –

Actual return on plan assets 18 (16) 88 – – –

Employer contributions 23 15 44 1 1 3

Employee contributions 2 1 4 – – –

benefits paid (38) (25) (49) (1) (1) (3)

Foreign exchange rate changes 5 – (12) – – –

settlement payments – – (1) – – –

Fair value of defined benefit plan assets, at the end of year $ 736 $ 726 $ 751 $ – $ – $ –

Fair value of defined benefit plan assets, at the end of year – discontinued operations $ 87 $ 87 $ 93 $ – $ – $ –



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, 2008, February 29, 2008, and June 30, 2007, 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 over the expected average remaining life of the employee group covered by the plans.

Reconciliation of funded status for defined benefit plans:


The Company

The Company

The Predecessor

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Fair value of plan assets $ 736 $ 726 $ 751 $ – $ – $ –

Accrued benefit obligation (907) (920) (882) (59) (58) (53)

Plan deficit (171) (194) (131) (59) (58) (53)

Plan deficit – discontinued operations (23) (20) (16) (7) (14) (14)

Employer contribution after measurement date (June 30) 9 10 10 1 – 1

Unamortized past service cost – 13 12 8 5 1

Unamortized net actuarial loss (gain) (20) 191 119 (9) (3) (4)

Fresh start accounting adjustment – (215) – – (2) –

Accrued benefit asset (liability) $ (182) $ (195) $ 10 $ (59) $ (58) $ (55)

Accrued benefit liability – discontinued operations $ (20) $ (20) $ (5) $ (14) $ (14) $ (17)

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


The Company

The Company

The Predecessor

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

deferred costs $ 1 $ – $ 78 $ – $ – $ –

Accrued benefit liability (183) (195) (68) (59) (58) (55)

Accrued benefit asset (liability) (182) (195) 10 (59) (58) (55)

Accrued benefit liability – discontinued operations $ (20) $ (20) $ (5) $ (14) $ (14) $ (17)


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


The Company

The Company

The Predecessor

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Fair value of plan assets $ 682 $ 689 $ 637 $ – $ – $ –

Accrued benefit obligations (855) (883) (774) (59) (58) (53)

Plan deficit (173) (194) (137) (59) (58) (53)

Plan deficit – discontinued operations $ (23) $ (20) $ (16) $ (7) $ (14) $ (14)

COMpONENTS Of NET pERIOdIC COST fOR dEfINEd BENEfIT pLANScomponents of net periodic benefit cost for defined benefit pension plans:

The Company

The Predecessor

The Predecessor


2008


2008


2007

current service cost $ 10 $ 6 $ 16

Interest cost 29 20 48

Actual return on plan assets (18) 16 (88)

Actuarial loss (gain) (23) 33 6

Plan amendments and other – 1 24

Net expense (income) before adjustments to recognize the long-term nature of the plans (2) 76 6

difference between expected and actual return on plan assets (13) (38) 38

difference between net actuarial loss (gain) and actuarial loss (gain) 23 (31) 1

difference between amortization of past service costs for the year and actual plan amendments for the year – (1) (6)

Net periodic benefit cost $ 8 $ 6 $ 39

Net periodic benefit cost – discontinued operations $ – $ – $ 3



components of net periodic benefit cost for other defined benefit plans:

The Company

The Predecessor

The Predecessor


2008


2008


2007

current service cost $ – $ – $ 1

Interest cost 2 1 3

Post-employment 1 1 1

Actual past service costs 8 3 –

Actuarial loss (gain) (9) 1 (1)

curtailment gain – – (7)

Net loss (income) before adjustments to recognize the long-term nature of the plans 2 6 (3)

difference between amortization of past service costs for the year and actual plan amendment for the year (8) (3) –

difference between net actuarial loss (gain) and actuarial loss (gain) 9 (1) 2

Periodic benefit cost (revenue) $ 3 $ 2 $ (1)

Periodic benefit cost (revenue) – discontinued operations $ – $ – $ (5)

Assumptions:weighted average significant assumptions for defined benefit pension plans:

The Company

The Predecessor

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Accrued benefit obligation at end of year:

discount rate 5.56 % 5.35 % 5.55 %

Rate of compensation increase 3.03 % 3.03 % 2.99 %

Net periodic benefit cost for the year:

discount rate 5.35 % 5.55 % 5.53 %


Expected long-term return on assets 7.29 % 7.27 % 7.24 %


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weighted average significant assumptions for other defined benefit plans:

The Company

The Predecessor

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Accrued benefit obligation at end of year:

discount rate 5.56 % 5.39 % 5.66 %


benefit cost for the year:

discount rate 5.39 % 5.66 % 5.72 %


Assumed health care cost trend rate at end of year:

Initial health care cost trend 8.89 % 9.06 % 9.07 %

Annual rate of decline in trend rate 0.53 % 1.00 % 1.00 %

Ultimate health care cost trend rate 5.00 % 5.00 % 5.00 %

Effect of change in health care cost trend rate (1% increase)

Total of service cost and interest cost $ – $ – $ –

Accrued benefit obligation $ 4 $ 4 $ 4

Effect of change in health care cost trend rate (1% decrease)

Total of service cost and interest cost $ – $ – $ –

Accrued benefit obligation $ (4) $ (4) $ (3)

NOTE 20. fINANCIAL INSTRUMENTS

RECOgNITION ANd MEASUREMENTThe company has classified its cash and cash equivalents as held-for-trading. Accounts receivable are classified as loans and receivables. The company’s investments consist mainly of equity investments, which are excluded from the cIcA standard, and of loans receivable which are classified as loans and receivables. bank indebtedness, operating bank loans, accounts payable and accrued charges, long-term debt, including interest payable, and redeemable preferred shares of the Predecessor are classified as other liabilities, all of which are measured at amortized cost. All derivatives and embedded derivatives are measured at fair value and the company has maintained its policy not to use hedge accounting.

fAIR VALUEThe carrying amount of cash and cash equivalents, derivative financial instruments, accounts receivable, operating bank loans and accounts payable and accrued charges approximates their fair values because of the near-term maturity of those instruments. The fair value of long-term debt that is actively traded is based on the closing trading value at the respective period-end dates. The fair value of the long-term debt that is not actively traded, balance payable on acquisition of companies and redeemable preferred shares of the Predecessor has been determined based on management’s best estimate of fair value to renegotiate these financial instruments with similar terms at the respective year-end dates.



The carrying value and the fair value of long-term debt, balance payable on acquisition of companies and redeemable preferred shares are as follows:

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

carrying value $ 406 $ 438 $ 1,372

Fair value $ 406 $ 438 $ 645

fINANCIAL RISK MANAgEMENT

OverviewThe company has exposure to the following risks from its use of financial instruments:

credit risk• Liquidity risk• market risk•

Foreign currency rate risk -Interest rate risk -commodity price and operational risk -

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 MANAgEMENTcredit 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 obtains credit insurance coverage. bad debt write-offs have been insignificant in the past. The allowance for doubtful accounts for the company as at september 27, 2008, was $4 million. The comparable amounts for the company as at February 29, 2008, and for the Predecessor as at september 29, 2007, remained unchanged at $3 million.

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

The Company

The Company

The Predecessor

Sept. 27, 2008

Feb. 29, 2008

Sept. 29, 2007

Loans and receivables $ 380 $ 361 $ 367

cash and cash equivalents $ 113 $ 116 $ 14

NOTE 20. fINANCIAL INSTRUMENTS (continued)

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The maximum exposure to credit risk for trade accounts receivable at september 27, 2008, by geographical region was as follows:

canada $ 40

United states 85

Pacific Rim and India 30

United kingdom, Europe and other 132

287

Allowance for doubtful accounts (4)

Trade receivables net 283

Temlam sale (note 16) 22

Other receivables including input tax credits 66

Accounts receivable $ 371

The aging of trade accounts receivable at september 27, 2008 was as follows:

Gross Allowance

Not past due $ 243 $ –

Past due 0 – 30 days 34 –



more than 90 days 4 4

$ 287 $ 4

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

The Company

Sept. 27, 2008

Feb. 29, 2008

Opening balance $ 3 $ 3

Impairment loss recognized 1 –

Ending balance $ 4 $ 3

LIQUIdITY RISK MANAgEMENTLiquidity 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 capital expenditures, interest and principal repayments and seasonal working capital requirements, which would require approximately $200 million of liquidity.

EXpOSURE TO LIQUIdITY RISKA 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 totaled $319 million at september 27, 2008. 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:

Carrying amount

Contractual cash flows

6 months or less

6 – 12 months 1 – 2 years 2 – 5 years

More than 5 years

secured bank loans $ 343 $ 462 $ 23 $ 18 $ 47 $ 369 $ 5

Unsecured loans 62 64 5 7 11 26 15

Operating bank loans 49 49 49 – – – –

Trade and others 381 381 381 – – – –

bank overdraft 1 1 1 – – – –

$ 836 $ 957 $ 459 $ 25 $ 58 $ 395 $ 20

fOREIgN CURRENCY RATE RISK MANAgEMENTThe company is exposed to currency risk on sales, purchases and long-term debt that are denominated in a currency other than the respective functional currencies of foreign and domestic operations, primarily the canadian $ and euro. The currencies in which these transactions are primarily denominated are canadian $, Us $ and euro.

The company’s revenues for most of its products are affected by fluctuations in the relative exchange rates of the canadian $, the Us $ 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 $2.2 billion of Us $ denominated sales annually from its canadian and European operations. As a result, any decrease in the value of Us $ relative to the canadian $ and the euro reduces the amount of revenues realized on sales in local currency. In addition, since business units purchase the majority of their production inputs in local currency, fluctuations in foreign exchange can significantly affect the unit’s relative cost position when compared to competing manufacturing sites in other currency jurisdictions. This could result in the unit’s inability to maintain its operations during period of low prices and/or demand.

Sensitivity analysisbased on 2009 planned sales volumes and prices, the following table illustrates the impact of a 1% change in the value of the Us $ versus the canadian $ and the euro. For illustrative purposes, an increase of 1% in the value of the Us $ is assumed. A decrease would have the opposite effects of those shown below:

sales increase $ 20

cost of sales increase 3

gross margin 17

Loss on Us $ debt translation 3

Pre-tax earnings increase 14

Tax expense increase 5

Net earnings increase $ 9

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

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 $, the company has adopted a policy of hedging up to 50% of its anticipated Us $ receipts for up to 36 months in duration. The company does not currently hold any significant foreign exchange contracts.

NOTE 20. fINANCIAL INSTRUMENTS (continued)

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INTEREST RATE RISK MANAgEMENTInterest 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.

Sensitivity analysisAt september 27, 2008, if interest rates had been 100 basis points higher (lower), related to the Us $300 million term loan, interest would have increased (decreased) by Us $3 million annually.

COMMOdITY pRICE ANd OpERATIONAL RISK MANAgEMENTThe 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 hedges to mitigate the impact of price volatility. At september 27, 2008, the company held lumber futures equal to approximately 3% of its annual sPF lumber capacity. The fair value of the contracts was $1 million. The Predecessor did not hold any significant product price hedges at september 29, 2007.

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 hedges. The company does not currently hold any significant hedges.

NOTE 21. 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 total debt (long-term debt plus bank indebtedness/operating lines) less cash and cash equivalents. Total capitalization includes net debt plus future income taxes, other long-term liabilities, shareholders’ equity, deferred credits and other.

The company’s strategy, which is unchanged from september 29, 2007, 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 debt to total capitalization ratio for the company as at september 27, 2008, and February 29, 2008, and for the Predecessor as at september 29, 2007 was 30%, 31% and 63% respectively.

The significant decrease in the net debt to total capitalization ratio resulted primarily from the recapitalization transaction that occurred on February 29, 2008.

NOTE 22. COMpARATIVE fIgURES

certain 2007 comparative figures have been reclassified to conform with the financial statement presentation adopted for 2008.


TEN-YEAR fINANCIAL REVIEw

1999 2000The Predecessor

2001 2002 2003 2004 2005 2006The Predecessor

2007Combined

2008

(1)

SALES & EARNINgS (in millions of dollars)

sales $ 1,884 $ 2,598 $ 2,991 $ 2,917 $ 2,890 $ 3,171 $ 3,109 $ 3,016 $ 2,750 $ 2,376

Freight and sales deductions 211 277 333 364 425 482 452 397 334 303

cost of sales 1,211 1,652 2,048 2,126 2,240 2,380 2,484 2,434 2,218 1,943

selling, general and administrative 99 114 136 153 151 167 160 143 133 109

EbITdA 363 555 474 274 74 142 13 42 65 21

depreciation and amortization 119 146 199 195 194 201 213 185 173 123

Unusual items 15 (2 ) 24 18 47 210 182 (227 ) (25 )

Interest on debt 97 94 129 162 149 137 130 134 125 55

Exchange loss (gain) on long-term debt (35 ) 20 69 (4 ) (264 ) (94 ) (125 ) (64 ) (149 ) 6

Foreign exchange and other financial charges (credits) 43 (9 ) 28 25 (48 ) (249 ) (135 ) (28 ) (7 ) (10)

124 306 49 (128 ) 25 100 (280 ) (367 ) 150 (128 )

Income taxes (recovery) 47 108 15 (48 ) (27 ) 23 (92 ) (72 ) 1 11

share in loss (earnings) of related companies and minority interests 1 (2 ) (1 )

Net earnings (loss) from continuing operations 76 198 34 (80 ) 54 77 (188 ) (295 ) 150 (139)

Net earnings (loss) from discontinued operations (35 ) (37 ) (31 ) (112 ) 3 (199 ) (11)

Interest on equity component of convertible debentures 1

Net earnings (loss) applicable to common shares $ 75 $ 198 $ 34 $ (115) $ 17 $ 46 $ (300) $ (292) $ (49) $ (150)

ASSETS & CApITALIzATION (in millions of dollars)

working capital (excluding cash and short-term debt) $ 336 $ 382 $ 546 $ 499 $ 441 $ 417 $ 512 $ 482 $ 430 $ 426

Investments 19 26 28 60 55 22 19 32 28 9

Fixed assets (net) 1,749 2,065 2,590 2,493 2,425 2,418 2,114 1,834 1,584 670

Other assets 118 140 163 275 284 236 258 232 213 23

Net assets $ 2,222 $ 2,613 $ 3,327 $ 3,327 $ 3,205 $ 3,093 $ 2,903 $ 2,580 $ 2,255 $ 1,128

Net debt $ 898 $ 995 $ 1,623 $ 1,799 $ 1,644 $ 1,485 $ 1,681 $ 1,663 $ 1,415 $ 342

deferred items and other long-term liabilities 10 61 143 130 147 175 140 150 150 261

Future income taxes 174 252 239 188 215 196 146 121 93 2

minority interests 84 31 8 9 7 5 5 5 5 1

Redeemable preferred shares 37 26 26 26 26 26 26 26 26

shareholders’ equity 1,019 1,248 1,288 1,175 1,166 1,206 905 615 566 522

Total capitalization $ 2,222 $ 2,613 $ 3,327 $ 3,327 $ 3,205 $ 3,093 $ 2,903 $ 2,580 $ 2,255 $ 1,128

Net fixed assets additions $ 91 $ 265 $ 231 $ 99 $ 132 $ 143 $ 144 $ 82 $ 71 $ 63

fINANCIAL STATISTICS

common shares outstanding at year-end 73,881,392 81,666,459 86,147,268 86,415,732 85,817,932 85,860,932 85,616,232 85,616,232 85,616,232 100,000,000

book value per share ($) 12.61 15.04 14.72 13.37 13.59 14.05 10.57 7.18 6.61 5.22

Earnings (loss) per share from continuing operations ($) 1.05 2.46 0.41 (0.93 ) 0.64 0.89 (2.20 ) (3.45 ) 1.75 (1.55 )

Earnings (loss) per share ($) 1.05 2.46 0.41 (1.34 ) 0.20 0.53 (3.50 ) (3.41 ) (0.58 ) (1.67 )

diluted earnings (loss) per share ($) 0.91 2.29 0.40 (1.34 ) 0.20 0.53 (3.50 ) (3.41 ) (0.58 ) (1.67 )

EbITdA margin 19.3 % 21.4 % 15.8 % 9.4 % 2.6 % 4.5 % 0.4 % 1.4 % 2.4 % 0.9 %

(1) The 2008 annual financial results (combined) include those of the Predecessor for the five-month period ended February 29, 2008, and of the company for the seven-month period ended september 27, 2008. The comparative figures have been restated to reflect the effect of the adoption of certain canadian Institute of chartered Accountants recommendations. From 2002, the comparative figures have been reclassified to exclude the oriented strand board and the coated paper results from the continuing operations.

97Tembec

AR 08 - EN NOTES


97

TEN-YEAR fINANCIAL REVIEw

1999 2000The Predecessor

2001 2002 2003 2004 2005 2006The Predecessor

2007Combined

2008

(1)

SALES & EARNINgS (in millions of dollars)

sales $ 1,884 $ 2,598 $ 2,991 $ 2,917 $ 2,890 $ 3,171 $ 3,109 $ 3,016 $ 2,750 $ 2,376

Freight and sales deductions 211 277 333 364 425 482 452 397 334 303

cost of sales 1,211 1,652 2,048 2,126 2,240 2,380 2,484 2,434 2,218 1,943

selling, general and administrative 99 114 136 153 151 167 160 143 133 109

EbITdA 363 555 474 274 74 142 13 42 65 21

depreciation and amortization 119 146 199 195 194 201 213 185 173 123

Unusual items 15 (2 ) 24 18 47 210 182 (227 ) (25 )

Interest on debt 97 94 129 162 149 137 130 134 125 55

Exchange loss (gain) on long-term debt (35 ) 20 69 (4 ) (264 ) (94 ) (125 ) (64 ) (149 ) 6

Foreign exchange and other financial charges (credits) 43 (9 ) 28 25 (48 ) (249 ) (135 ) (28 ) (7 ) (10)

124 306 49 (128 ) 25 100 (280 ) (367 ) 150 (128 )

Income taxes (recovery) 47 108 15 (48 ) (27 ) 23 (92 ) (72 ) 1 11

share in loss (earnings) of related companies and minority interests 1 (2 ) (1 )

Net earnings (loss) from continuing operations 76 198 34 (80 ) 54 77 (188 ) (295 ) 150 (139)

Net earnings (loss) from discontinued operations (35 ) (37 ) (31 ) (112 ) 3 (199 ) (11)

Interest on equity component of convertible debentures 1

Net earnings (loss) applicable to common shares $ 75 $ 198 $ 34 $ (115) $ 17 $ 46 $ (300) $ (292) $ (49) $ (150)

ASSETS & CApITALIzATION (in millions of dollars)

working capital (excluding cash and short-term debt) $ 336 $ 382 $ 546 $ 499 $ 441 $ 417 $ 512 $ 482 $ 430 $ 426

Investments 19 26 28 60 55 22 19 32 28 9

Fixed assets (net) 1,749 2,065 2,590 2,493 2,425 2,418 2,114 1,834 1,584 670

Other assets 118 140 163 275 284 236 258 232 213 23

Net assets $ 2,222 $ 2,613 $ 3,327 $ 3,327 $ 3,205 $ 3,093 $ 2,903 $ 2,580 $ 2,255 $ 1,128

Net debt $ 898 $ 995 $ 1,623 $ 1,799 $ 1,644 $ 1,485 $ 1,681 $ 1,663 $ 1,415 $ 342

deferred items and other long-term liabilities 10 61 143 130 147 175 140 150 150 261

Future income taxes 174 252 239 188 215 196 146 121 93 2

minority interests 84 31 8 9 7 5 5 5 5 1

Redeemable preferred shares 37 26 26 26 26 26 26 26 26

shareholders’ equity 1,019 1,248 1,288 1,175 1,166 1,206 905 615 566 522

Total capitalization $ 2,222 $ 2,613 $ 3,327 $ 3,327 $ 3,205 $ 3,093 $ 2,903 $ 2,580 $ 2,255 $ 1,128

Net fixed assets additions $ 91 $ 265 $ 231 $ 99 $ 132 $ 143 $ 144 $ 82 $ 71 $ 63

fINANCIAL STATISTICS

common shares outstanding at year-end 73,881,392 81,666,459 86,147,268 86,415,732 85,817,932 85,860,932 85,616,232 85,616,232 85,616,232 100,000,000

book value per share ($) 12.61 15.04 14.72 13.37 13.59 14.05 10.57 7.18 6.61 5.22

Earnings (loss) per share from continuing operations ($) 1.05 2.46 0.41 (0.93 ) 0.64 0.89 (2.20 ) (3.45 ) 1.75 (1.55 )

Earnings (loss) per share ($) 1.05 2.46 0.41 (1.34 ) 0.20 0.53 (3.50 ) (3.41 ) (0.58 ) (1.67 )

diluted earnings (loss) per share ($) 0.91 2.29 0.40 (1.34 ) 0.20 0.53 (3.50 ) (3.41 ) (0.58 ) (1.67 )

EbITdA margin 19.3 % 21.4 % 15.8 % 9.4 % 2.6 % 4.5 % 0.4 % 1.4 % 2.4 % 0.9 %

(1) The 2008 annual financial results (combined) include those of the Predecessor for the five-month period ended February 29, 2008, and of the company for the seven-month period ended september 27, 2008. The comparative figures have been restated to reflect the effect of the adoption of certain canadian Institute of chartered Accountants recommendations. From 2002, the comparative figures have been reclassified to exclude the oriented strand board and the coated paper results from the continuing operations.


dIRECTORS

OffICERS

James V. Continenza(1) chairman of the board, Tembec Inc.

James M. Lopez(3) President and chief Executive Officer, Tembec Inc.

Norman M. Betts(2) Associate Professor, Faculty of Administration, University of New brunswick

James E. Brumm(1) company director

James N. Chapman(1) company director

Luc Rossignol(3) President, Local 233, communications, Energy and Paperworkers Union

Francis M. Scricco(1) company director

David J. Steuart(2)(3) company director

Lorie Waisberg(2) company director

(1) member of the corporate governance and human Resources committee

(2) member of the Audit committee

(3) member of the Environment, health and safety committee

James V. Continenza chairman of the board

James M. Lopez President and chief Executive Officer

Chris Black Executive vice President, President, Paper group

Michel J. Dumas Executive vice President, Finance and chief Financial Officer

Antonio Fratianni vice President, general counsel and secretary

Stephen J. Norris Treasurer

Yvon Pelletier Executive vice President, President, Pulp group

Dennis Rounsville Executive vice President, President, Forest Products group

Richard Tremblay corporate controller

John Valley Executive vice President, business development and corporate Affairs

99Tembec

AR 08 - EN NOTES


99

SHAREHOLdER INfORMATION

STOCK EXCHANgE LISTINgThe common shares and the warrants of Tembec Inc. are listed on the Toronto stock Exchange under the symbols Tmb and Tmb.wT, respectively.

NUMBER Of SHARESAs at september 27, 2008, there were 100,000,000 Tembec common shares outstanding.

TRANSfER AgENT ANd REgISTRAROur transfer agent, computershare Trust company of canada, can assist you with a variety of shareholder related services, including changes of address and lost share certificates.

computershare Trust company of canadacustomer service1500 University streetsuite 700montreal, Quebeccanada h3A 3s8Tel.: 1-800-564-6253

ANNUAL gENERAL MEETINgThe Annual general meeting of shareholders of Tembec Inc. will be held on Thursday, January 29, 2009, at 11:00 a.m., Eastern time, at:

hilton montreal bonaventureOutremont Room900 de La gauchetière blvd. westmontreal, Quebeccanada h5A 1E4Tel.: 514-878-2985

An archived version of the webcast of the Annual general meeting of shareholders will be available on Tembec’s website after the meeting.

AddITIONAL INfORMATION MAY BE OBTAINEd fROM:Tembec Inc.communications and Public Affairs department10 gatineau RoadP.O. box 5000Temiscaming, Quebeccanada J0z 3R0Tel.: 819-627-4387Fax: 819-627-1178

Tembec files all mandatory information with canadian securities regulatory authorities and this information is available from Tembec upon request.

HEAd OffICETembec Inc.800 René-Lévesque blvd. westsuite 1050montreal, Quebeccanada h3b 1x9Tel.: 514-871-0137Fax: 514-397-0896www.tembec.com

CORpORATE OffICETembec Inc.10 gatineau RoadP.O. box 5000Temiscaming, Quebeccanada J0z 3R0Tel.: 819-627-4387Fax: 819-627-1178www.tembec.com

Additional copies of the following documents and other information can also be obtained at the above address or on Tembec’s and sEdAR’s websites.

• Annual Report• Quarterly Reports• management Information circular• Annual Information Form

Pour obtenir un exemplaire de la version française du rapport annuel, veuillez vous adresser au service des communications et des affaires publiques.


design: TAxI

Printing: Transcontinental Litho Acme

cover: Printed on 10pt. Fsc-certified kallima® coated cover

c1s Plus, manufactured by Tembec’s Temiscaming, Quebec

paperboard mill.

Interior: Printed on 70 lb. text Fsc-certified mohawk® beckett

Expression Radiance, manufactured using pulp from Tembec’s

skookumchuck, british columbia mill.

TEmbEc INc.

©2008 All rights reserved

Printed in canada

101Tembec

AR 08 - EN NOTES

C4TembecAR 08 - EN COVERS

C1Tembec

AR 08 - EN COVERS

Truths.

TEMBEC2008 ANNUAL REPORT

W W W . T E M B E C . C O M

SW-COC-000952

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