UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED September 30, 2006

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER: 1-1872

BOWATER INCORPORATED

(Exact Name of Registrant as Specified in its Charter)

Delaware		62-0721803
(State of Incorporation)		(I.R.S. Employer Identification No.)

55 East Camperdown Way, P.O. Box 1028, Greenville, SC 29602

(Address of principal executive offices)(Zip Code)

(864) 271-7733

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for at least the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large Accelerated Filer þ      Accelerated Filer o      Non accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of November 1, 2006.

Class		Outstanding at November 1, 2006
Common Stock, $1.00 Par Value		55,932,236 Shares

 

 

BOWATER INCORPORATED
I N D E X

				Page Number
PART I FINANCIAL INFORMATION
Item 1.		Financial Statements:
		Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2006 and 2005			3
		Consolidated Balance Sheets at September 30, 2006 and December 31, 2005			4
		Consolidated Statements of Capital Accounts for the Nine Months Ended September 30, 2006 and 2005			5
		Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2006 and 2005			6
		Notes to Consolidated Financial Statements			7 – 23
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			24 – 43
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			44
Item 4.		Controls and Procedures			44
PART II OTHER INFORMATION
Item 1.		Legal Proceedings			45
Item 6.		Exhibits			46
SIGNATURES					47
Exhibit 4.1
Exhibit 10.1
Exhibit 10.2
Exhibit 10.3
Exhibit 10.4
Exhibit 10.5
Exhibit 10.6
Exhibit 12.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

BOWATER INCORPORATED

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2006				2005				2006				2005
Net sales		$	875.9			$	872.9			$	2,668.5			$	2,607.4
Costs and expenses:
Cost of sales, excluding depreciation, amortization and cost of timber harvested			650.7				630.5				2,028.6				1,880.6
Depreciation, amortization and cost of timber harvested			80.8				82.5				243.1				245.9
Distribution costs			83.4				83.8				249.8				256.1
Selling and administrative expenses			47.9				41.0				127.2				121.0
Impairment and other related charges			246.4				—				246.4				11.9
Net gain on disposition of assets			(54.0	)			(9.9	)			(154.5	)			(30.7	)
Operating (loss) income			(179.3	)			45.0				(72.1	)			122.6
Interest expense			(50.8	)			(50.0	)			(149.5	)			(149.5	)
Other income, net			4.9				1.9				9.7				7.0
Loss before income taxes, minority interests, and cumulative effect of accounting change			(225.2	)			(3.1	)			(211.9	)			(19.9	)
Income tax benefit (provision)			9.9				(14.5	)			(29.5	)			(1.1	)
Minority interests, net of tax			(0.8	)			1.6				(1.5	)			2.3
Loss before cumulative effect of accounting change			(216.1	)			(16.0	)			(242.9	)			(18.7	)
Cumulative effect of accounting change, net of tax			—				—				(2.6	)			—
Net loss		$	(216.1	)		$	(16.0	)		$	(245.5	)		$	(18.7	)
Loss per share:
Basic loss per common share:
Loss before cumulative effect of accounting change		$	(3.76	)		$	(0.28	)		$	(4.23	)		$	(0.33	)
Cumulative effect of accounting change, net of tax			—				—				(0.05	)			—
Net loss per share		$	(3.76	)		$	(0.28	)		$	(4.28	)		$	(0.33	)
Diluted loss per common share:
Loss before cumulative effect of accounting change		$	(3.76	)		$	(0.28	)		$	(4.23	)		$	(0.33	)
Cumulative effect of accounting change, net of tax			—				—				(0.05	)			—
Net loss per share		$	(3.76	)		$	(0.28	)		$	(4.28	)		$	(0.33	)
Average number of shares outstanding (in millions):
Basic and diluted			57.4				57.4				57.4				57.4
Dividends declared per common share		$	0.20			$	0.20			$	0.60			$	0.60

See accompanying notes to consolidated financial statements.

BOWATER INCORPORATED

		September 30,				December 31,
		2006				2005
ASSETS
Current Assets:
Cash and cash equivalents		$	120.8			$	30.1
Accounts receivable, net			461.5				410.1
Inventories			356.0				365.8
Timberlands held for sale			7.9				123.1
Other current assets			29.9				61.2
Total current assets			976.1				990.3
Timber and timberlands			75.8				85.4
Fixed assets, net			2,915.7				3,049.1
Goodwill			592.9				794.1
Other assets			249.5				233.5
Total assets		$	4,810.0			$	5,152.4
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current installments of long-term debt		$	15.1			$	22.2
Short-term bank debt			—				55.0
Accounts payable and accrued liabilities			515.2				487.3
Dividends payable			11.2				11.2
Total current liabilities			541.5				575.7
Long-term debt, net of current installments			2,366.3				2,400.0
Pension, other postretirement benefits and other long-term liabilities			547.3				572.9
Deferred income taxes			371.2				329.4
Minority interests in subsidiaries			62.5				58.9
Commitments and contingencies
Shareholders’ equity:
Common Stock, $1 par value. Authorized 100,000,000 shares; issued 67,528,308 and 67,529,294 shares at September 30, 2006 and December 31, 2005, respectively			67.5				67.5
Exchangeable Shares, no par value. Unlimited shares authorized; 1,434,130 and 1,434,445 shares outstanding September 30, 2006 and December 31, 2005			68.1				68.1
Additional paid-in capital			1,626.8				1,621.6
Retained (deficit) earnings			(180.1	)			100.1
Accumulated other comprehensive loss			(175.3	)			(156.0	)
Treasury stock at cost, 11,601,601 and 11,605,074 shares at September 30, 2006 and December 31, 2005, respectively			(485.8	)			(485.8	)
Total shareholders’ equity			921.2				1,215.5
Total liabilities and shareholders’ equity		$	4,810.0			$	5,152.4

See accompanying notes to consolidated financial statements.

BOWATER INCORPORATED

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006

																		Accumulated
										Additional				Retained				Other								Total
		Common				Exchangeable				Paid In				(Deficit)				Comprehensive				Treasury				Shareholders’
		Stock				Shares				Capital				Earnings				Loss				Stock				Equity
Balance at December 31, 2005		$	67.5			$	68.1			$	1,621.6			$	100.1			$	(156.0	)		$	(485.8	)		$	1,215.5
Dividends on Common Stock ($0.60 per share)			—				—				—				(34.7	)			—				—				(34.7	)
Retraction of exchangeable shares (315 shares issued and exchangeable shares retracted)			—				—				0.1				—				—				—				0.1
Stock-based compensation costs for equity awards			—				—				5.1								—				—				5.1
Treasury stock used for dividend reinvestment plans and to pay employee and director benefits (3,473 shares)			—				—				—				—				—				—				—
Comprehensive loss:
Net loss			—				—				—				(245.5	)			—				—				(245.5	)
Minimum pension liability			—				—				—				—				(5.1	)			—				(5.1	)
Foreign currency translation			—				—				—				—				4.0				—				4.0
Change in unrealized gain on hedged transactions, net of tax of $11.1			—				—				—				—				(18.2	)			—				(18.2	)
Total comprehensive loss																											(264.8	)
Balance at September 30, 2006		$	67.5			$	68.1			$	1,626.8			$	(180.1	)		$	(175.3	)		$	(485.8	)		$	921.2

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005

																		Accumulated
										Additional								Other								Total
		Common				Exchangeable				Paid In				Retained				Comprehensive				Treasury				Shareholders’
		Stock				Shares				Capital				Earnings				Loss				Stock				Equity
Balance at December 31, 2004		$	67.4			$	69.7			$	1,618.2			$	266.5			$	(28.6	)		$	(485.9	)		$	1,507.3
Dividends on Common Stock ($0.60 per share)			—				—				—				(34.3	)			—				—				(34.3	)
Retraction of exchangeable shares (31,913 shares issued and exchangeable shares retracted)			—				(1.6	)			1.6				—				—				—				—
Stock options exercised (69,000 shares)			0.1				—				1.8				—				—				—				1.9
Tax benefit on exercise of stock options			—				—				0.3				—				—				—				0.3
Amortization of unearned compensation			—				—				0.1				—				—				—				0.1
Restricted stock units cancellation (10,203 shares)			—				—				(0.4	)			—				—				—				(0.4	)
Treasury stock used for dividend reinvestment plans and to pay employee and director benefits (2,615 shares)																							0.1				0.1
Comprehensive loss:
Net loss			—				—								(18.7	)			—				—				(18.7	)
Minimum pension liability, net of tax of $0.5			—				—								—				(0.9	)			—				(0.9	)
Foreign currency translation			—				—				—				—				2.3				—				2.3
Change in unrealized gain on hedged transactions, net of tax of $29.0			—				—				—				—				(47.4	)			—				(47.4	)
Total comprehensive loss																											(64.7	)
Balance at September 30, 2005		$	67.5			$	68.1			$	1,621.6			$	213.5			$	(74.6	)		$	(485.8	)		$	1,410.3

See accompanying notes to consolidated financial statements

BOWATER INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS

		Nine Months Ended September 30,
		2006				2005
Cash flows from operating activities:
Net loss		$	(245.5	)		$	(18.7	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Cumulative effect of accounting change, net of tax			2.6				—
Stock-based compensation			1.8				0.1
Depreciation, amortization and cost of timber harvested			243.1				245.9
Impairment and other related charges			246.4				11.9
Deferred income tax provision (benefit)			21.6				(6.9	)
Minority interests, net of tax			1.5				(2.3	)
Pension contributions, net of pension benefit costs			(25.9	)			(22.7	)
Net gain on disposition of assets			(154.5	)			(30.7	)
Changes in working capital:
Accounts receivable			(51.4	)			(55.9	)
Inventories			6.8				(26.2	)
Income tax receivables and payables			11.2				4.6
Accounts payable and accrued liabilities			21.2				42.4
Other, net			(10.6	)			1.8
Net cash provided by operating activities			68.3				143.3
Cash flows from investing activities:
Cash invested in fixed assets, timber and timberlands			(138.0	)			(89.6	)
Dispositions of assets, including timber and timberlands			296.5				33.7
Net cash provided by (used for) investing activities			158.5				(55.9	)
Cash flows from financing activities:
Cash dividends, including minority interests			(34.7	)			(34.3	)
Short-term financing			370.9				413.9
Short-term financing repayments			(432.5	)			(461.0	)
Repurchase of long-term debt			(17.5	)			—
Payments of long-term debt			(22.3	)			(14.3	)
Stock options exercised			—				1.9
Net cash used for financing activities			(136.1	)			(93.8	)
Net increase (decrease) in cash and cash equivalents			90.7				(6.4	)
Cash and cash equivalents:
Beginning of year			30.1				29.7
End of period		$	120.8			$	23.3
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest, including capitalized interest of $2.8 and $0.6		$	129.6			$	124.4
Income taxes		$	6.8			$	1.0

See accompanying notes to consolidated financial statements.

BOWATER INCORPORATED

1. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements include the accounts of Bowater Incorporated and subsidiaries (“Bowater,” also referred to as “we” or “our”). The consolidated balance sheet as of September 30, 2006, and the related statements of operations, capital accounts and cash flows for the periods ended September 30, 2006 and 2005 are unaudited. In our opinion, all adjustments (consisting of normal recurring adjustments) necessary for fair presentation of the interim financial statements have been made. The results of the interim period ended September 30, 2006 are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the consolidated financial statements and related notes and critical accounting policies and estimates included in our most recent Annual Report on Form 10-K. Certain prior-year amounts in the financial statements and the notes have been reclassified to conform to the 2006 presentation. In the first quarter of 2006, we adjusted the amount of goodwill allocated to the timberlands held for sale. As a result, goodwill allocated to timberlands held for sale decreased by $12.7 million and goodwill increased by the same amount compared to the amounts previously reported in our 2005 consolidated financial statements and related notes. The reclassifications had no effect on total shareholders’ equity or net loss.

We adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20, Accounting Changes, and Statement No. 3, Reporting Accounting Changes in Interim Financial Statements (“SFAS 154”), as of January 1, 2006. SFAS 154 changes the requirements for the accounting for, and reporting of, a change in accounting principle. Previously, most voluntary changes in accounting principles were required to be recognized by way of a cumulative effect adjustment within net income during the period of the change. SFAS 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The adoption of SFAS 154 did not have any effect on our consolidated financial position, results of operations or cash flows.

We adopted SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4 (“SFAS 151”), as of January 1, 2006. SFAS 151 clarifies the types of costs that should be expensed rather than capitalized as inventory. This statement also clarifies the circumstances under which fixed overhead costs associated with operating facilities involved in inventory processing should be capitalized. The effect of adopting SFAS 151 was immaterial to our financial position and results of operations.

We adopted SFAS No. 123R, Share-based Payment (“SFAS 123R”), on January 1, 2006. See Note 2 for further information regarding the impact on our financial position and results of operations.

2. Stock-based Compensation

We maintain incentive stock plans that provide for grants of stock options, equity participation rights (“EPRs”) and restricted stock units to our directors, officers and key employees. We also maintain a Mid-Term Incentive Plan (“MTIP”) that is tied to the performance of our common stock. These plans are described more fully below.

Adoption of New Accounting Guidance and Transition

Prior to January 2006, we accounted for these plans under the recognition and measurement provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, (“APB 25”) as permitted by SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”). Under APB 25:

•

Compensation expense was generally not recognized for stock options if the exercise price equaled or exceeded the market value of the underlying common stock on the date of grant. As of December 31, 2005, all existing and outstanding stock options were fully vested.

BOWATER INCORPORATED

	•		The restricted stock units granted were measured at fair value, which was determined as the average of the high and low trading price of the stock on the date of the grant, and amortized over the vesting period. As of December 31, 2005, all restricted stock unit grants awarded prior to that date were fully amortized.
	•		A liability for the EPRs was recorded based on its intrinsic value. At December 31, 2005, the EPRs base price was higher than Bowater’s stock price on that date; therefore, no liability was recorded.
	•		A liability for the MTIP was recorded when the performance criteria were met. At December 31, 2005, we did not meet the performance criteria of the MTIP cycles outstanding; therefore, no liability was recorded.

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123R using the modified-prospective transition method. Under that method, compensation cost recognized in 2006 includes (a) compensation cost for all share-based payments granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123 and (b) compensation cost for all share-based payments granted on or subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. We recognize compensation costs on a straight-line basis over the requisite service period for the award in accordance with the provisions of SFAS 123R.

Prior to the adoption of SFAS 123R, we presented the tax benefit of deductions arising from the exercise of stock options as operating cash flows in the Consolidated Statements of Cash Flows. SFAS 123R requires that we classify the cash flows resulting from the tax benefit that arises when the tax deductions exceed the compensation cost recognized for equity awards (excess tax benefits) as financing cash flows. There were no excess tax benefits arising from equity awards for the three and nine months ended September 30, 2006.

The adoption of SFAS 123R resulted in a cumulative effect of accounting change of $2.6 million, net of tax, (or $0.05 per share) that we recorded in the first quarter of 2006. This cumulative charge represents the fair value of the EPR obligation at January 1, 2006, net of tax. The assumptions used to calculate the fair value at January 1, 2006 are included in the Equity Participation Rights section of this note.

Pro Forma Information under SFAS 123 for Periods Prior to 2006

Results for periods prior to adoption of SFAS 123R have not been restated. The table below illustrates the pro forma effect on net loss and loss per share if we had applied the fair value recognition provisions of SFAS 123 to Bowater’s stock-based compensation plans in prior periods.

		Three Months Ended				Nine Months Ended
		September 30,				September 30,
(Unaudited, in millions, except per - share amounts)		2005				2005
Net loss as reported:		$	(16.0	)		$	(18.7	)
Add: Stock-based compensation expense included in net loss, net of tax			—				—
Deduct : Stock-based compensation expense determined under fair value method, net of tax			(1.4	)			(4.3	)
Pro forma net loss		$	(17.4	)		$	(23.0	)
Loss per share:
Basic, as reported		$	(0.28	)		$	(0.33	)
Basic, pro forma			(0.30	)			(0.40	)
Diluted, as reported		$	(0.28	)		$	(0.33	)
Diluted, pro forma			(0.30	)			(0.40	)

BOWATER INCORPORATED
Notes to Consolidated Financial Statements – Unaudited

For purpose of the above disclosure, the fair value of each option granted in the three and nine months ended September 30, 2005 was estimated on the date of grant using the Black-Scholes-Merton (BSM) option-pricing model with the weighted average assumptions below.

Assumptions:
Expected dividend yield			2.2	%
Expected volatility			29.0	%
Risk-free interest rate			4.0	%
Expected life (in years)			7.2
Weighted average fair value of each option		$	11.16

We estimated the expected dividend yield, expected volatility and expected life of each stock option based upon historical experience. The risk-free rate of interest was based on a zero-coupon U.S. Treasury instrument with a remaining term approximating the expected life of the stock option. Forfeitures were recognized as they occurred.

Expense Information under SFAS 123R

The following table details the stock-compensation expense recorded in the Consolidated Statements of Operations by award:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Unaudited, in millions)		2006				2005				2006				2005
Stock Options		$	0.2			$	—			$	0.4			$	—
Restricted Stock Units			2.9				—				4.8				0.1
EPRs			(0.5	)			—				(3.4	)			—
MTIP			—				—				—				—
Stock-based compensation expense		$	2.6			$	—			$	1.8			$	0.1

The following table details the tax (benefit) provision by award:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Unaudited, in millions)		2006				2005				2006				2005
Stock Options		$	—			$	—			$	(0.1	)		$	—
Restricted Stock Units			(0.7	)			—				(1.1	)			(0.1	)
EPRs			0.1				—				0.8				—
MTIP			—				—				—				—
Tax benefit		$	(0.6	)		$	—			$	(0.4	)		$	(0.1	)

As required by SFAS 123R, we now estimate forfeitures of employee stock awards and recognize compensation cost only for those awards expected to vest. Forfeiture rates are determined based on historical experience. Estimated forfeitures are adjusted to actual forfeiture experience as needed. Compensation expense for performance-based awards is recognized when it is probable that the performance criteria will be met.

Stock Plans

We currently have awards outstanding under four stock-based compensation plans: the 1997 Stock Option Plan, the 2000 Stock Option Plan, the 2002 Stock Option Plan, and the 2006 Stock Option and Restricted Stock Plan. All of these plans were approved by our shareholders. These plans authorized the grant of up to 8.4 million shares of our common stock in the form of incentive stock options, non-qualified stock options, restricted stock

BOWATER INCORPORATED

units and equity participation rights. At September 30, 2006, approximately 2.4 million shares were available for grant under these Plans.

Stock Options

Stock options granted generally become exercisable over a period of two to three years. Unless terminated earlier in accordance with their terms, all options expire 10 years from the date of grant. Our Board of Directors approved the issuance of 350,630 stock options in May 2006, which either cliff vest after 32 months (100,630 shares) or vest ratably over 36 months (250,000 shares).

A summary of option activity under our stock plans as of September 30, 2006, and the changes during the nine months ended September 30, 2006, is presented below:

										Weighted
						Weighted				Average				Aggregate
		Number Of				Average				Remaining				Intrinsic
		Shares				Exercise				Contractual				Value
(Unaudited)		(000’s)				Price				Life (years)				($000)
Outstanding at December 31, 2005			5,067			$	44
Granted during the period			351				27
Exercised during the period			—				—
Canceled during the period			(409	)			40
Outstanding at September 30, 2006			5,009			$	43				5.2			$	—
Exercisable at September 30, 2006			4,672			$	45				4.9			$	—

In accordance with SFAS 123R, we estimated the fair value of each stock option on the date of grant using a BSM option-pricing formula, applying the following weighted-average assumptions, and amortize that value to expense over the option’s requisite service period using the straight-line attribution approach:

Assumptions:
Expected dividend yield			2.95	%
Expected volatility			32.1	%
Risk-free interest rate			5.1	%
Expected life (in years)			6.1

The expected dividend yield is based on the projected annual dividend payment per share divided by the stock price on the measurement date. The expected life represents the period over which the share-based awards are expected to be outstanding; therefore, the expected life has been determined using historical experience. The risk-free rate of interest is based on a zero-coupon U.S. Treasury instrument with a remaining term approximating the expected life of the stock option. The expected volatility is based on an equal weighting of the historical volatility of our common stock (measured over a term approximating the expected life) and implied volatility from traded options on our common stock having a life of more than one year.

During the three and nine months ended September 30, 2006, all vested options had a strike price greater than the closing price of our common stock (i.e., were “out-of-the-money”). As a result, there were no stock option exercises during the first nine months of 2006. The total intrinsic value of stock options exercised was $0.9 million during the three and nine months ended September 30, 2005.

As of September 30, 2006, there was $2.4 million of unrecognized compensation cost related to stock option awards granted under our stock plans. The unrecognized cost is expected to be recognized over a weighted-average period of 2.5 years.

Restricted Stock Units

BOWATER INCORPORATED
Notes to Consolidated Financial Statements – Unaudited

On May 10, 2006, we issued four separate grants of restricted stock units totaling 775,529 shares, of which 43,530 shares were performance-based awards. The performance-based awards cliff vest after 32 months. The remaining shares, which were service-based awards, cliff vest after 32 months (178,342 shares), 20 months (503,657 shares) or 12 months (50,000 shares). On August 7, 2006 and September 27, 2006, we issued grants of restricted stock units totaling 20,000 shares and 10,000 shares, respectively. These awards were all service-based awards that cliff vest after 36 months. No restricted stock units were granted in 2005.

A summary of the status of our restricted stock units as of September 30, 2006, and changes during the nine months ended September 30, 2006, is presented below:

		Number Of Shares				Weighted Average Fair
(Unaudited)		(000’s)				Value at Grant Date
Outstanding at December 31, 2005			—			$	—
Granted during the period			806				26
Vested during the period			(37	)			26
Forfeited during the period			(26	)			26
Outstanding at September 30, 2006			743			$	26

As of September 30, 2006, there was $16.1 million of unrecognized compensation cost related to restricted stock units granted under our stock plans. The unrecognized cost is expected to be recognized over a weighted-average period of 1.5 years.

We have a policy of issuing treasury shares to satisfy share option exercises and the vesting of restricted stock units. The right to dividends declared are accrued during the vesting period and paid in cash to the employee upon the vesting of the restricted stock units, in accordance with our stock plans.

Equity Participation Rights

EPRs confer the right to receive cash based on the appreciation of Bowater’s common stock price, but no right to acquire stock ownership. The rights have a vesting period of two years and, unless terminated earlier in accordance with their terms, expire 10 years after the grant date. The base price is the fair market value of our common stock on the day of grant. The rights may be redeemed only for cash, and the amount paid to the employee at the time of exercise is the difference between the base price and the average high/low of our common stock on the day of settlement. There have been no grants of EPRs since January 2003.

The EPR awards are classified as liability awards under SFAS 123R since the EPRs are cash settled. In accordance with SFAS 123R, liability awards are remeasured at fair value at each reporting period and the income or expense included in the consolidated statement of operations.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements – Unaudited

Information with respect to rights granted under the EPR Plan as of September 30, 2006 is as follows:

										Weighted
						Weighted				Average
		Number of				Average				Remaining				Aggregate
		Rights				Exercise				Contractual				Intrinsic
(Unaudited)		(000’s)				Price				Term				Value
Outstanding at December 31, 2005			2,173			$	48
Granted during the period			—				—
Settled during the period			—				—
Canceled during the period			(133	)			47
Outstanding at September 30, 2006			2,040			$	48				3.7			$	—
Exercisable at September 30, 2006			2,040			$	48				3.7			$	—

As of September 30, 2006, the fair value of our EPRs liability is $0.4 million. The fair value of each of our EPRs was estimated using a BSM option pricing model that uses the assumptions noted in the table below. The expected life of each EPR is based on a weighted-average of the observed historical exercise patterns and the midpoint of the remaining term of the EPR. Expected volatility is based on an equal weighting of the historical volatility of our common stock (measured over a term approximating the expected life) and implied volatility from traded options on our common stock having a life of more than six months or one year, as appropriate. The risk-free rate of interest is based on a zero-coupon U.S. Treasury instrument with a remaining term approximating the expected life of the EPR. The expected dividend yield is based on the projected annual dividend payment per share divided by the stock price on the measurement date. These assumptions are evaluated and revised, as necessary, at each reporting date.

The fair value of each EPR was estimated using the BSM option-pricing model with the following assumptions:

		September 30,				January 1,
(Unaudited)		2006				2006
Assumptions:
Dividend yield			3.9	%			2.6	%
Expected volatility			30.8 - 32.7	%			30.0 - 33.0	%
Weighted average expected volatility			31.7	%			30.1	%
Risk-free interest rate			4.6 - 4.9	%			4.1 - 4.4	%
Expected EPR life in years			0.3 – 3.3				0.1 - 3.6
Weighted average fair value of EPRs		$	0.21			$	1.70
Fair value range of each EPR grant		$	0.00 – 0.81			$	0.01-4.60

Mid-Term Incentive Plan

In 2003, we implemented a MTIP with rolling three-year plan cycles. MTIP cycles currently outstanding include the 2004-2006 and the 2005-2007 years. Each MTIP cycle runs from January 1 to December 31. The MTIP is designed to link rewards of key executives to the performance of our common stock and to encourage the generation of cash flow from operations. Awards may be paid in any form, including, without limitation, cash, stock, restricted stock, phantom stock, stock options, and stock appreciation rights at the discretion of the Committee.

Participants can earn up to 90% of base salary with the allocation between performance and discretionary awards. For all MTIP cycles outstanding the allocation is 50% based on performance and 50% discretionary. Payouts under the MTIP will be made only to the extent that Bowater generates cash from operations in excess of normal dividends paid during the plan cycle sufficient to fund the awards. The performance award formula computes a payout percentage based on the total shareholder return (“TSR”) of Bowater’s common stock (taking into account changes in price and dividends paid) compared to a peer group. If Bowater’s TSR equals the peer group’s average TSR, participants may receive a payout of 16.67% of base salary. This amount increases

BOWATER INCORPORATED
Notes to Consolidated Financial Statements – Unaudited

linearly to a maximum payout of 45% of base salary, if Bowater’s TSR equals or exceeds 90% of the highest TSR in the peer group. Payouts under the discretionary component of the plan (up to 50% of the maximum award) may be awarded at the end of the plan cycle.

The MTIP plans are classified as liability plans under SFAS 123R since we have typically paid the award in cash. In accordance with SFAS 123R, liability plans are remeasured at fair value at each reporting period and the related income or expense is included in the consolidated statement of operations. The fair value of each award is estimated each reporting period using a Monte Carlo Simulation approach in a risk-neutral framework and includes ranges of assumptions for stock price volatility, risk-free interest rates, and expected dividends. Expected volatility is based on an equal weighting of the historical volatility of our common stock and implied volatility from traded options on our common stock and ranged from 27% to 32%. The risk-free rate of interest is based on a zero-coupon U.S. Treasury instrument with a remaining term approximating the expected term of the MTIP and was approximately 5%. The expected dividend yield of 2% to 3% is based on the projected annual dividend payment per share divided by the stock price on the grant date. The fair value at January 1, 2006 and September 30, 2006 was nominal.

3. Impairment and Other Related Charges

Goodwill Impairment

During the third quarter, Bowater realigned its organizational structure from a divisional-based structure to a functional-based structure. Our reportable segments are now based on our primary product lines. As a result of current economic conditions and the current operating environment at our Thunder Bay site, including the asset impairment charge we took related to paper machine No. 3, and our organizational realignment, we performed an interim goodwill impairment test on our existing reporting units. We test our goodwill for impairment using a two-step methodology. As discussed below, this two-step methodology contains estimates and judgments that are subjective and difficult to apply, and thus they are inherently uncertain. Our management has reviewed these estimates with the Audit Committee of our Board of Directors.

The initial step of the goodwill impairment test involves a comparison of the fair value of each of our reporting units, as defined under Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets,” with its carrying amount. If a reporting unit’s carrying amount exceeds its fair value, then goodwill of the reporting unit is considered to be impaired, and a second step must be performed to measure the amount of the impairment. Fair value is determined with the assistance of an independent third party. In making our determination of fair value, we rely primarily on the discounted cash flow method. This method uses projections of cash flows from each of the reporting units. Several of the key assumptions include periods of operation, projections of product pricing, production levels, product costs, market supply and demand, foreign exchange rates, inflation, weighted average cost of capital and capital spending. We derive these assumptions used in our valuation models from several sources. Many of these assumptions are derived from our internal budgets which would include existing sales data based on current product lines and assumed production levels, manufacturing costs and product pricing. Our products are commodity products, therefore, pricing is inherently volatile and often follows a cyclical pattern; the average price over a commodity cycle forms the basis of our product pricing assumption. We derive our pricing estimates from information generated internally, from industry research firms and other published reports and forecasts. Since performing our prior year impairment test, exchange rates have continued to climb to historically high levels. Given the current exchange rate environment, we believe a potential buyer would now consider a shorter-term view of exchange rates. Therefore, in this analysis, foreign exchange rates are based on a 2007 forecast followed by a gradual reversion to a 5-year historical average.

In addition to the assumptions discussed above, we determined the fair value of our Thunder Bay reporting unit utilizing a probability-weighted approach which assumes that a potential buyer of the facility would consider alternative courses of action in estimating the discounted cash flows. Courses of action that were probability-weighted in our fair value estimation include operating the Thunder Bay facility as it is currently operated, restarting paper machine No. 3, which has been permanently shut by us, but could be fully operational to a potential buyer of the facility, and converting one of the other newsprint machines to production of coated paper grades.

As a result of the continued strengthening of the Canadian dollar and a reduction in our estimated probability that a third-party would restart paper machine No. 3 or convert another machine, our interim goodwill impairment test related to our Thunder Bay facility, under both our current operating scenario and our probability-weighted scenario, indicated that the carrying value of the facility’s assets exceeded their fair value. Therefore, we proceeded with the second step of the impairment analysis in order to measure the amount of the impairment loss. Step 2 compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. Implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. The fair value of the reporting unit is allocated to the assets and liabilities of the reporting unit as if it had been acquired in a business combination. The excess of the fair value of the reporting unit over the amounts allocated to assets and liabilities is the implied fair value of goodwill. Fair value of Thunder Bay’s tangible and intangible assets was determined with the assistance of an independent third party. Our preliminary estimate of the implied fair value of goodwill related to our Thunder Bay facility was approximately $296.0 million; therefore, we recorded a goodwill impairment charge of $200.0 million. This goodwill impairment charge remains subject to finalization of our valuation reports. Any adjustment to our preliminary estimate will be recorded in the fourth quarter. No intangible assets were initially identified as part of our fair value review and is subject to change and finalization in the fourth quarter.

Asset Impairment

In 2003, we idled newsprint production on paper machine No. 3 at our Thunder Bay facility. Based on the continued decline of North American newsprint consumption through the third quarter of 2006, we now have no plans to restart the machine. Accordingly, we recorded a non-cash asset impairment charge of $18.9 million to write down the value of this paper machine to its estimated fair value which was determined using the discounted cash flow method.

During the third quarter of 2006, we decided to close the Benton Harbor operation. This close resulted in a review of the facility’s long-lived assets for impairment. As a result, we recorded a non-cash asset impairment charge of $23.5 million. An additional $4.0 million was also recorded for lease costs, contract termination costs and severance. Inventory write-downs totaling $0.4 million were recorded in cost of sales.

During the second quarter of 2005, we decided to permanently shut the original line at the Benton Harbor operation. This permanent shut resulted in a non-cash asset impairment charge of $11.9 million during the nine months ended September 30, 2005.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements – Unaudited

4. Inventories

		September 30,				December 31,
(Unaudited, in millions)		2006				2005
At lower of cost or market:
Raw materials		$	84.9			$	100.4
Work in process			19.2				30.5
Finished goods			141.4				131.8
Mill stores and other supplies			122.3				114.9
			367.8				377.6
Excess of current cost over LIFO inventory value			(11.8	)			(11.8	)
		$	356.0			$	365.8

5. Other Income, Net

“Other income, net” in the Consolidated Statements of Operations includes the following:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Unaudited, in millions)		2006				2005				2006				2005
Foreign exchange gain (loss)		$	0.7			$	(1.8	)		$	(2.3	)		$	(3.6	)
Interest income			2.0				1.0				4.1				3.2
Income from joint venture			1.0				1.3				5.2				3.1
Charges related to repurchase of debt (See Note 11)			(0.5	)			—				(0.5	)			—
Miscellaneous income, net			1.7				1.4				3.2				4.3
		$	4.9			$	1.9			$	9.7			$	7.0

6. Timberlands Held For Sale

We are currently marketing for sale approximately 35,000 acres of timberlands in the United States and Canada. The sale of these timberlands is expected to be completed in 2006. The $7.9 million of timberlands held for sale on the Consolidated Balance Sheets are carried at cost as we expect the proceeds of the timberland sales to exceed the carrying value. There are no liabilities associated with the timberlands held for sale.

During the three months ended September 30, 2006, we sold approximately 23,000 acres of timberlands and other assets for proceeds of $58.4 million. During the three months ended June 30, 2006, we sold approximately 472,000 acres of timberlands, our Baker Brook sawmill and other assets for proceeds of $201.3 million. During the three months ended March 31, 2006, we sold approximately 24,000 acres of timberlands and our Dégelis sawmill for proceeds of $34.6 million.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements – Unaudited

7. Accumulated Other Comprehensive Loss

The components of “Accumulated other comprehensive loss” in the Consolidated Balance Sheets are as follows:

		September 30,				December 31,
(Unaudited, in millions)		2006				2005
Pension plan additional minimum liabilities (1) (2)		$	(191.2	)		$	(186.1	)
Foreign currency translation (3)			15.5				11.5
Unrealized gain on hedging transactions (4)			0.4				18.6
		$	(175.3	)		$	(156.0	)

8. Loss Per Share

The information required to compute net loss per basic and diluted share is as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Unaudited, in millions)		2006				2005				2006				2005
Basic weighted-average number of common shares outstanding			57.4				57.4				57.4				57.4
Effect of potentially dilutive securities:
Stock options			—				—				—				—
Restricted stock units			—				—				—				—
Diluted weighted-average number of common shares outstanding			57.4				57.4				57.4				57.4

No adjustments to net loss are necessary to compute net loss per basic and diluted share. The dilutive effect of potentially dilutive securities is calculated using the treasury stock method. Options to purchase 5.0 million shares for both the three and nine months ended September 30, 2006, and 5.1 million shares for both the three and nine months ended September 30, 2005, were excluded from the calculation of diluted loss per share as the impact would have been anti-dilutive. In addition, 0.7 million restricted stock units for the three and nine months ended September 30, 2006, were excluded from the calculation of diluted loss per share for the same reason.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements – Unaudited

9. Pension and Postretirement Expense

The components of net periodic benefit costs relating to our pension and other postretirement (“OPEB”) plans are as follows for the three and nine-months ended September 30, 2006 and 2005:

Pension Plans:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Unaudited, in millions)		2006				2005				2006				2005
Components of net periodic benefit cost:
Service cost		$	10.5			$	9.2			$	32.4			$	27.7
Interest cost			29.9				29.4				89.1				86.6
Expected return on plan assets			(30.8	)			(28.5	)			(91.0	)			(84.8	)
Amortization of prior service cost			1.3				1.0				4.1				1.9
Curtailment/settlement loss			8.8				—				13.4				—
Recognized net actuarial loss			8.0				4.1				25.7				12.2
Net periodic benefit cost		$	27.7			$	15.2			$	73.7			$	43.6

OPEB Plans:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Unaudited, in millions)		2006				2005				2006				2005
Components of net periodic benefit cost:
Service cost		$	1.1			$	1.0			$	3.1			$	3.3
Interest cost			3.9				4.3				11.9				13.0
Amortization of prior service cost			(1.5	)			(1.4	)			(4.5	)			(4.1	)
Recognized net actuarial loss			2.1				2.1				6.1				6.4
Curtailment gain			(5.5	)			(5.5	)			(5.7	)			(5.5	)
Net periodic benefit cost		$	0.1			$	0.5			$	10.9			$	13.1

Since the measurement date of our pension and OPEB plans is 90 days prior to the start of our year, curtailment and settlement gains and losses that arise during the year are recorded on a 90-day lag.

During January 2006, Bowater announced its plans to permanently close the Thunder Bay “A” kraft pulp line in the second quarter of 2006 and eliminate approximately 225 positions. Impairment and severance related charges were recorded in the fourth quarter of 2005. In the first quarter of 2006, we recorded a pension plan curtailment loss of $4.6 million and an OPEB plan curtailment gain of $0.2 million in connection with the employee downsizing. Additionally, we recorded in the third quarter of 2006 a pension plan curtailment loss of approximately $0.9 million related to employees accepting a voluntary portion of the severance plan in April 2006. The elimination of employees resulted in a partial plan termination, which will result in a pension plan settlement loss of approximately $12 million in the future (upon settlement of the assets and liabilities).

In May 2006, certain employees received lump-sum payouts from the supplemental executive retirement plan. A settlement loss of $2.3 million was recorded in the third quarter of 2006.

In May 2006, Bowater approved changes to its defined benefit pension plan for its U.S. salaried employees. Benefits for certain employees will be frozen effective January 1, 2007 and will be replaced by a Company

BOWATER INCORPORATED
Notes to Consolidated Financial Statements – Unaudited

contribution to a defined contribution plan. A curtailment loss of $3.9 million was recorded in the third quarter of 2006.

In June 2006, Bowater approved changes to its defined benefit pension plan for its Canadian salaried employees. Benefits for certain employees will be frozen effective January 1, 2008 and will be replaced by a Company contribution to a defined contribution plan. A curtailment loss of approximately $1.7 million was recorded in the third quarter of 2006.

In June 2006, Bowater approved changes to its OPEB plan for Canadian salaried employees. The OPEB plan was redesigned to phase out OPEB costs by the end of 2010 by increasing the retirees’ contributions from 20% to 100% over a four-year period beginning January 1, 2007. A curtailment gain of approximately $5.5 million was recorded in the third quarter of 2006.

In August 2006, certain employees received lump-sum payouts from the supplemental executive retirement plan. A settlement loss of approximately $0.3 million will be recorded in the fourth quarter of 2006.

In August 2006, accrued benefits from the director’s retirement plan were converted to the director’s deferred fee plan for certain directors in the form of stock based units. This conversion was treated as a settlement, and therefore, a settlement gain of approximately $0.1 million will be recorded in the fourth quarter of 2006.

Excluding the effect of the curtailment and settlement gains and losses noted above, these initiatives will result in a reduction of our previously calculated 2006 net periodic benefit costs of approximately $6.2 million ($5.8 million for pension and $0.4 million for OPEB). Approximately $2.3 million and $2.8 million of this reduction was recognized during the three and nine months ended September 30, 2006, respectively. The remainder will be recognized in the fourth quarter of 2006.

The OPEB curtailment gain of $5.5 million recorded in the third quarter of 2005 is associated with changes to certain post-retirement benefits in Canada.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements – Unaudited

10. Income Taxes

The income tax benefit (provision) attributable to loss before income taxes, minority interests and cumulative effect of accounting change differs from the amounts computed by applying the United States federal statutory income tax rate of 35% as a result of the following:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Unaudited, in millions)		2006				2005				2006				2005
Loss before income taxes, minority interests and cumulative effect of accounting change		$	(225.2	)		$	(3.1	)		$	(211.9	)		$	(19.9	)
Expected income tax benefit			78.9				1.1				74.2				7.0
Increase (decrease) in income taxes resulting from:
Valuation allowance (1)			(18.2	)			(5.1	)			(73.8	)			(5.1	)
Tax reserve adjustment (2)			17.5				13.2				17.5				13.2
Foreign taxes (3)			1.0				1.5				36.9				7.6
Goodwill (4)			(70.0	)			—				(78.6	)			—
Foreign exchange			(2.1	)			(17.2	)			(23.4	)			(9.4	)
Other, net			2.8				(8.0	)			17.7				(14.4	)
Income tax benefit (provision)		$	9.9			$	(14.5	)		$	(29.5	)		$	(1.1	)

11. Long-term and Short-term Debt

BOWATER INCORPORATED
Notes to Consolidated Financial Statements – Unaudited

On May 31, 2006, we entered into (i) a five year Credit Agreement among Bowater Incorporated (“Bowater”) as Borrower, several lenders, and Wachovia Bank, National Association, as Administrative Agent (the “US Credit Agreement”) and (ii) a 364-day Credit Agreement, along with its subsidiary Bowater Canadian Forest Products Inc. (“BCFPI”), among BCFPI as Borrower, Bowater as parent Guarantor, several lenders, and The Bank of Nova Scotia as Administrative Agent (the “Canadian Credit Agreement”).

The US Credit Agreement provides for a $415 million revolving credit facility with a scheduled maturity date of May 25, 2011. The US Credit Agreement is guaranteed by certain of our wholly-owned subsidiaries in the United States, and is secured by (i) liens on the inventory, accounts receivable and deposit accounts of Bowater and the guarantors (ii) pledges of 65% of the stock of certain of our foreign subsidiaries, and (iii) pledges of the stock of our U.S. subsidiaries that do not own mills or converting facilities. Availability under the US Credit Agreement is limited to 90% of the net consolidated book value of our accounts receivable and inventory, excluding BCFPI and its subsidiaries.

The Canadian Credit Agreement provides for a $165 million revolving credit facility with a maturity date of May 29, 2007, subject to annual extensions. The Canadian Credit Agreement is secured by liens on the inventory, accounts receivable and deposit accounts of BCFPI. Availability under the Canadian Credit Agreement is limited to 65% of the net book value of the accounts receivable and inventory of BCFPI and its subsidiaries. Financial covenants under both the US Credit Agreement and Canadian Credit Agreement are based upon our consolidated financial results and consist of the following two ratios:

•		a maximum ratio of senior secured indebtedness (including all advances and letters of credit under the US and Canadian facilities, and any other indebtedness secured by assets of Bowater and its subsidiaries) to EBITDA (generally defined as net income, excluding extraordinary, non-recurring or non-cash items and gains (or losses) on asset dispositions, plus income taxes plus depreciation plus interest expense) of 1.25 to 1; and
•		a minimum ratio of EBITDA (defined as EBITDA, plus gains (or minus losses) from asset dispositions) to interest expense of 2.00 to 1.

We believe we are in compliance with all of our covenants and other requirements set forth in our credit facilities.

During August 2006, we repurchased approximately $15.6 million of our $250 million floating rate notes due March 15, 2010 for total cash consideration of approximately $15.8 million or a 1.4% premium over face value. During September 2006, we repurchased approximately $1.9 million of our $250 million 9% notes due August 1, 2009 for total cash consideration of approximately $2.0 million or a 3.7% premium over face value. In conjunction with these transactions, we recorded charges of approximately $0.5 million for premiums, fees and unamortized deferred financing fees. These charges for the early extinguishment of debt are included in “Other income, net” on the accompanying Consolidated Statements of Operations. The repurchases change long-term debt maturities in Year 2009 from $263.7 million to $261.8 million and in Year 2010 from $368.0 million to $352.4 million (See “Note 13. Long-Term and Short-Term Debt and Off-Balance Sheet Arrangements” in Item 8 of Bowater’s Annual Report on Form 10-K for the year ended December 31, 2005).

During November 2006, we repurchased $95.3 million face value of our Series A, 10.625% notes due June 15, 2010 for total cash consideration of approximately $102.7 million or a 7.8% premium over face value. This repurchased debt had a book carrying value of $108.2 million and was comprised of the $95.3 million face value, plus $12.9 million related to the revaluation of Series A debt from the acquisition of Avenor in 1998. In addition to the premium charges of $7.4 million, we expect to record charges of approximately $0.1 million for unamortized deferred financing fees in the fourth quarter. We also expect to record a gain on the extinguishment of debt of approximately $12.9 million in the fourth quarter of 2006 associated with the revaluation of the debt as discussed above. Therefore, the net impact for the extinguishment of the Series A notes will be a net gain of approximately $5.4 million. The repurchase further reduces long-term debt maturities in Year 2010 to $257.1 million.

12. Commitments and Contingencies

Bowater is involved in various legal proceedings relating to contracts, commercial disputes, taxes, environmental issues, employment and workers’ compensation claims and other matters. We periodically review the status of these proceedings with both inside and outside counsel. We believe that the ultimate disposition of these matters

BOWATER INCORPORATED
Notes to Consolidated Financial Statements – Unaudited

will not have a material adverse effect on our financial condition, but it could have a material adverse effect on the results of operations in a given quarter or the year.

There have been no material developments to those legal proceedings described in our annual report on Form 10-K filed on March 13, 2006 and our quarterly report on Form 10-Q filed on August 4, 2006.

Lumber Duties

On October 12, 2006, an agreement regarding Canada’s softwood lumber exports to the United States became effective. The agreement provides for a return of a portion of the duties imposed by the United States. Through September 30, 2006, we paid duties totaling approximately $113.1 million. On November 10, 2006, Bowater received a refund of $103.9 million from Export Development Corporation (EDC), which purchased our rights associated with the refund of the duties. The amount of the refund represents substantially all of the funds that we expect to receive under the terms of its agreement with EDC. Our agreement with the EDC stipulates that we may have to refund the lumber duties to the EDC if the Canadian Government does not pass the final legislation and if the U.S. Customs and Border Patrol does not pay the EDC.

The agreement also provides for softwood lumber to be subject to one of two ongoing border measures, depending on the province of first manufacture. Beginning October 12, 2006, softwood lumber exports from all provinces (other than Maritime Provinces) will be subject to an export tax varying up to a maximum of 22.5% depending upon lumber prices and each province’s quantity of exports (Option A). We have been notified that the export tax for the Province of Quebec for October 2006 will be 5% as the export quantities shipped in October were well below the quota amounts. We anticipate paying an export tax of 15% for the rest of the fourth quarter, but that rate is subject to adjustment once actual quantities shipped are known. Bowater may receive a partial refund of the taxes it pays under Option A based on the difference between (i) the Option A export tax we paid and (ii) the Option B tax that would have applied provided total exports from the Option B province do not exceed the maximum Option B export volumes that would have been in place, but will not be able to determine the amount of this refund, if any, until December 2006 at the earliest. Beginning January 1, 2007, exports from certain provinces will instead be subject to volume limitations based on each province’s share of U.S. consumption and a combined export tax of up to 5% (Option B).

13. Financial Instruments

Bowater utilizes certain derivative instruments to enhance its ability to manage risk relating to cash flow exposure. Derivative instruments are entered into for periods consistent with related underlying cash flow exposures and do not constitute positions independent of those exposures. We do not enter into contracts for speculative purposes; however, we do, from time to time enter into commodity and currency option contracts that are not accounted for as accounting hedges.

Canadian Dollar Forward Contracts

We pay a significant portion of the operating expenses of our Canadian mill sites in Canadian dollars. To reduce our exposure to United States and Canadian dollar exchange rate fluctuations, we enter into and designate Canadian dollar forward contracts to hedge certain of our forecasted Canadian dollar cash outflows at the Canadian mill operations. On the date in which the derivative contract is entered we designate the derivative as a cash flow hedge.

We formally document all relationships between hedging instruments and hedged items, as well as our risk-management objectives and strategies for undertaking various hedge transactions. We link all hedges that are designated as cash flow hedges to forecasted transactions. The minimum time period we have hedged transactions is one month, and the maximum time period is two years. Our outstanding hedging contracts continue into the fourth quarter of 2006. We also assess, both at the inception of the hedge and on an on-going basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge, we discontinue hedge accounting prospectively. Hedge ineffectiveness associated with these Canadian dollar forward contracts and natural gas forward contracts was not material for the periods presented.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements – Unaudited

Natural Gas Hedging Instruments

During the third quarter of 2006, we entered into commodity swap agreements under our natural gas hedging program for the purpose of reducing the risk inherent in fluctuating natural gas prices. These swap agreements, which did not qualify for hedge accounting treatment during the third quarter, are considered financial hedges of our natural gas purchases and have been marked-to-market in the Consolidated Statements of Operations. As a result, approximately $0.1 million of pre-tax losses were recognized in earnings as of September 30, 2006.

The carrying amount of our derivative financial instruments approximates fair market value. Information regarding our Canadian dollar and natural gas swap contracts’ notional amount, fair market value, and range of exchange rates or natural gas prices of the contracts is summarized in the table below. The notional amount of these contracts represents the amount of foreign currencies or natural gas to be purchased or sold at maturity and does not represent our exposure on these contracts. The fair value of derivative financial instruments is based on current termination values or quoted market prices of comparable contracts.

						Net				Range Of
						Asset/(Liability)				U.S.$/CDN$
		Notional								Exchange Rates
As of September 30, 2006		Amount of				Fair Market				and Natural
(Unaudited, in millions of U.S. dollars)		Derivatives				Value				Gas Prices
Foreign Currency Exchange Agreements
Buy Currency:
Canadian dollar
Due in 2006		$	40.0			$	0.6				.8811-.8923
Natural Gas Swap Agreements:
Due in 2006		$	0.3			$	—			$	7.10 - 8.00
Due in 2007			0.7				(0.1	)			7.40 - 8.62
		$	1.0			$	(0.1	)		$	7.10 - 8.62

The counterparties to our derivative financial instruments are substantial and creditworthy multi-national financial institutions. The risk of counterparty nonperformance is considered to be remote, and no one financial institution has more than 39% of our derivative financial instruments.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements – Unaudited

The components of the cash flow hedges included in “Accumulated other comprehensive loss” are as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Unaudited, in millions)		2006				2005				2006				2005
Gains reclassified to earnings on matured cash flow hedges		$	(5.0	)		$	(21.7	)		$	(34.2	)		$	(78.5	)
Unrealized gains (losses) for change in value on unmatured cash flow hedges			0.5				16.5				4.9				2.1
			(4.5	)			(5.2	)			(29.3	)			(76.4	)
Income tax benefit			1.7				1.9				11.1				29.0
Net increase in “Accumulated other comprehensive loss”		$	(2.8	)		$	(3.3	)		$	(18.2	)		$	(47.4	)

14. Off-Balance Sheet Debt Guarantees

In connection with Bowater’s 1999 land sale and note monetization, we guarantee 25% of the outstanding investor notes principal balance of Timber Note Holdings LLC, one of our Qualified Special Purpose Entities (QSPEs). Bowater guarantees approximately $7.7 million of the investor notes principal balance at September 30, 2006. This guarantee is proportionately reduced by annual principal repayments on the investor notes (annual minimum repayments of $2.0 million) through 2008. The remaining investor notes’ principal amount is to be repaid in 2009. Timber Note Holdings LLC has assets of approximately $34.0 million and obligations of approximately $31.1 million, which include the investor notes. Bowater would be required to perform on the guarantee if the QSPE were to default on the investor notes or if there were a default on the notes receivable.

15. Segment Information

During the third quarter of 2006, Bowater announced that it was realigning its organizational structure to move from a division-based organization to one organized by function that supports and focuses on our multi-line manufacturing and sales across our mill base. As a result of this organizational realignment, our reportable segments have been changed based on how we internally manage our business, which is based on products that we manufacture and sell to external customers. Our primary product lines include—coated papers, specialty papers, newsprint, market pulp, and lumber. The segment information presented herein reflects our new reportable segments and prior year information has been recast to the current year presentation.

None of the income or loss items following “Operating (loss) income” in our Consolidated Statements of Operations are allocated to our segments, since they are reviewed separately by Bowater’s management. For the same reason, impairments, severance, gains on dispositions of assets and other discretionary charges or credits are not allocated to the segments. Stock-based compensation expense is, however, allocated to our segments. We also allocated depreciation expense to our segments, although the related fixed assets are not allocated to segment assets.

Only assets which are identifiable by segment and reviewed by our management are allocated to segment assets. Allocated assets include trade accounts receivable, finished goods inventory at our paper mills and all inventory at our sawmills. All other assets are not identifiable by segment and are included in our Corporate and Other segment.

The following tables summarize information about segment profit and loss for the three and nine months ended September 30, 2006 and 2005 and segment assets as of September 30, 2006 and December 31, 2005:

BOWATER INCORPORATED
Notes to Consolidated Financial Statements – Unaudited

						Coated				Specialty								Market								Corporate				Consolidated
(Unaudited, in millions)						Papers				Papers				Newsprint				Pulp				Lumber				and Other				Total
Net Sales
Third Quarter			2006			$	154.4			$	153.9			$	349.1			$	144.2			$	71.1			$	3.2			$	875.9
Third Quarter			2005				165.7				124.9				347.9				127.4				95.9				11.1				872.9
Nine Months			2006			$	463.5			$	426.6			$	1,089.9			$	410.3			$	261.6			$	16.6			$	2,668.5
Nine Months			2005				464.1				358.0				1,055.1				408.2				298.0				24.0				2,607.4