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, 2007

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

BOWATER INCORPORATED

(Exact Name of Registrant as Specified in its Charter)

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

1155 Metcalfe Street, Suite 800; Montreal, Quebec; Canada H3B 5H2

(Address of principal executive offices)(Zip Code)

(514) 875-2160

(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, 2007.

Class		Outstanding at November 1, 2007
Common Stock, $1.00 Par Value		56,302,409 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, 2007 and 2006			3
Consolidated Balance Sheets at September 30, 2007 and December 31, 2006			4
Consolidated Statements of Stockholders’ Equity for the Nine Months Ended September 30, 2007 and 2006			5
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006			6
Notes to Consolidated Financial Statements			7 – 21
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			22 – 40
Item 3. Quantitative and Qualitative Disclosures About Market Risk			41 – 42
Item 4. Controls and Procedures			42
PART II OTHER INFORMATION
Item 1. Legal Proceedings			42
Item 4. Submission of Matters to a Vote of Security Holders			43
Item 6. Exhibits			44
SIGNATURES			45
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

BOWATER INCORPORATED

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Sales		$	814.7			$	875.9			$	2,384.9			$	2,668.5
Costs and expenses:
Cost of sales, excluding depreciation, amortization and cost of timber harvested			672.3				650.7				1,912.3				2,028.6
Depreciation, amortization and cost of timber harvested			79.5				80.8				239.1				243.1
Distribution costs			83.9				83.4				242.0				249.8
Selling and administrative expense			49.8				47.9				144.8				127.2
Arbitration award			28.4				—				28.4				—
Impairment and other related charges			—				246.4				—				246.4
Net gain on disposition of assets			(17.1	)			(54.0	)			(139.6	)			(154.5	)
Operating loss			(82.1	)			(179.3	)			(42.1	)			(72.1	)
Interest expense			(47.3	)			(50.8	)			(141.9	)			(149.5	)
Other (expense) income, net			(16.1	)			4.9				(34.8	)			9.7
Loss before income taxes, minority interests, and cumulative effect of accounting change			(145.5	)			(225.2	)			(218.8	)			(211.9	)
Income tax benefit (provision)			0.4				9.9				(19.2	)			(29.5	)
Minority interests, net of tax			3.0				(0.8	)			(2.1	)			(1.5	)
Loss before cumulative effect of accounting change			(142.1	)			(216.1	)			(240.1	)			(242.9	)
Cumulative effect of accounting change, net of tax			—				—				—				(2.6	)
Net loss		$	(142.1	)		$	(216.1	)		$	(240.1	)		$	(245.5	)
Loss per share:
Basic loss per common share:
Loss before cumulative effect of accounting change		$	(2.47	)		$	(3.76	)		$	(4.18	)		$	(4.23	)
Cumulative effect of accounting change, net of tax			—				—				—				(0.05	)
Net loss		$	(2.47	)		$	(3.76	)		$	(4.18	)		$	(4.28	)
Diluted loss per common share:
Loss before cumulative effect of accounting change		$	(2.47	)		$	(3.76	)		$	(4.18	)		$	(4.23	)
Cumulative effect of accounting change, net of tax			—				—				—				(0.05	)
Net loss		$	(2.47	)		$	(3.76	)		$	(4.18	)		$	(4.28	)
Average number of shares outstanding (in millions):
Basic and diluted			57.5				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,
		2007				2006
Assets
Current assets:
Cash and cash equivalents		$	83.9			$	98.9
Accounts receivable, net			456.7				444.5
Inventories			366.8				349.8
Timberlands held for sale			4.8				18.7
Other current assets			68.5				47.1
Total current assets			980.7				959.0
Timber and timberlands			58.8				60.8
Fixed assets, net			2,737.3				2,877.9
Goodwill			590.7				590.2
Other assets			142.6				158.0
Total assets		$	4,510.1			$	4,645.9
Liabilities and shareholders’ equity
Current liabilities:
Current installments of long-term debt		$	21.7			$	14.9
Short-term bank debt			72.0				—
Accounts payable and accrued liabilities			466.1				431.2
Total current liabilities			559.8				446.1
Long-term debt, net of current installments			2,243.9				2,251.6
Pension and other postretirement benefits obligations			641.1				651.1
Other long-term liabilities			72.1				92.5
Deferred income taxes			349.3				313.0
Minority interests in subsidiaries			77.7				59.0
Commitments and contingencies
Shareholders’ equity:
Common stock, $1 par value. Authorized 100,000,000 shares; issued 67,852,878 and 67,585,104 shares at September 30, 2007 and December 31, 2006, respectively			67.8				67.6
Exchangeable shares, no par value. Unlimited shares authorized; 1,202,154 and 1,423,830 shares outstanding at September 30, 2007 and December 31, 2006, respectively			56.8				67.6
Additional paid-in capital			1,650.5				1,630.1
Retained deficit			(348.8	)			(76.0	)
Accumulated other comprehensive loss			(374.4	)			(371.0	)
Treasury stock at cost, 11,597,419 and 11,600,717 shares at September 30, 2007 and December 31, 2006, respectively			(485.7	)			(485.7	)
Total shareholders’ equity			566.2				832.6
Total liabilities and shareholders’ equity		$	4,510.1			$	4,645.9

See accompanying notes to consolidated financial statements.

BOWATER INCORPORATED

For the nine months ended September 30, 2007

																		Accumulated
										Additional								Other								Total
		Common				Exchangeable				Paid In				Retained				Comprehensive				Treasury				Shareholders’
		Stock				Shares				Capital				Deficit				Loss				Stock				Equity
Balance at December 31, 2006		$	67.6			$	67.6			$	1,630.1			$	(76.0	)		$	(371.0	)		$	(485.7	)		$	832.6
Cumulative adjustment to retained deficit for the adoption of FIN 48			—				—				—				2.3				—				—				2.3
Dividends on common stock ($0.60 per share)			—				—				—				(35.0	)			—				—				(35.0	)
Retraction of exchangeable shares (221,676 shares issued and exchangeable shares retracted)			0.2				(10.8	)			10.6				—				—				—				—
Share-based compensation costs for equity awards			—				—				10.6				—				—				—				10.6
Restricted stock units vested (46,098 shares, net of shares forfeited for employee withholding taxes)			—				—				(0.8	)			—				—				—				(0.8	)
Treasury stock used for dividend reinvestment plans and to pay employee and director benefits (3,298 shares)			—				—				—				—				—				—				—
Comprehensive loss:
Net loss			—				—				—				(240.1	)			—				—				(240.1	)
Change in unrealized prior service costs, net of tax of $2.7			—				—				—				—				(2.2	)			—				(2.2	)
Change in actuarial gains and losses, net of tax of $6.5			—				—				—				—				28.7				—				28.7
Foreign currency translation			—				—				—				—				(30.7	)			—				(30.7	)
Change in unrealized gain on hedged transactions, net of tax of $0.5			—				—				—				—				0.8				—				0.8
Total comprehensive loss																											(243.5	)
Balance at September 30, 2007		$	67.8			$	56.8			$	1,650.5			$	(348.8	)		$	(374.4	)		$	(485.7	)		$	566.2

For the nine months ended September 30, 2006

																		Accumulated
										Additional				Retained				Other								Total
		Common				Exchangeable				Paid In				Earnings				Comprehensive				Treasury				Shareholders’
		Stock				Shares				Capital				(Deficit)				Loss				Stock				Equity
Balance at December 31, 2005		$	67.5			$	68.1			$	1,621.6			$	100.1			$	(156.0	)		$	(485.8	)		$	1,215.5
Cumulative adjustment to retained earnings for adoption of SAB 108			—				—				—				8.6				—				—				8.6
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
Share-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			$	(171.5	)		$	(175.3	)		$	(485.8	)		$	929.8

See accompanying notes to consolidated financial statements.

BOWATER INCORPORATED

		Nine Months Ended
		September 30,
		2007				2006
Cash flows from operating activities:
Net loss		$	(240.1	)		$	(245.5	)
Adjustments to reconcile net loss to net cash (used for) provided by operating activities:
Cumulative effect of accounting change, net of tax			—				2.6
Share-based compensation			10.1				1.8
Depreciation, amortization and cost of timber harvested			239.1				243.1
Impairment and other related charges			—				246.4
Deferred income taxes			31.4				21.6
Minority interests, net of tax			2.1				1.5
Net pension (contributions) benefit costs			(26.6	)			(25.9	)
Net gain on disposition of assets			(139.6	)			(154.5	)
Changes in working capital:
Accounts receivable, net			(12.1	)			(51.4	)
Inventories			(17.0	)			6.8
Income taxes receivable and payable			0.1				11.2
Accounts payable and accrued liabilities			34.6				21.2
Other, net			4.1				(10.6	)
Net cash (used for) provided by operating activities			(113.9	)			68.3
Cash flows from investing activities:
Cash invested in fixed assets, timber and timberlands			(72.6	)			(138.0	)
Dispositions of assets, including timber and timberlands			166.6				296.5
Direct acquisition costs related to the merger with Abitibi-Consolidated Inc.			(17.2	)			—
Net cash provided by investing activities			76.8				158.5
Cash flows from financing activities:
Cash dividends			(34.9	)			(34.7	)
Short-term financing			80.0				370.9
Short-term financing repayments			(8.0	)			(432.5	)
Repurchase of long-term debt			—				(17.5	)
Payments of long-term debt			(15.0	)			(22.3	)
Net cash provided by (used for) financing activities			22.1				(136.1	)
Net (decrease) increase in cash and cash equivalents			(15.0	)			90.7
Cash and cash equivalents:
Beginning of period			98.9				30.1
End of period		$	83.9			$	120.8
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest, including capitalized interest of $0.3 and $2.8, respectively		$	119.9			$	129.6
Income taxes		$	—			$	6.8

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, 2007, and the related statements of operations, stockholders’ equity and cash flows for the periods ended September 30, 2007 and 2006 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, 2007 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 estimates included in our most recent Annual Report on Form 10-K. Certain prior-year amounts in the notes to the consolidated financial statements have been reclassified to conform to the 2007 presentation. The reclassifications had no effect on total shareholders’ equity or net loss.
		On January 1, 2007, we adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-An Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for the uncertainty in income taxes recognized by prescribing the threshold a tax position is required to meet before being recognized in the financial statements. As a result of the adoption, we recorded a $2.3 million credit to our opening retained deficit balance in 2007. The credit represents the cumulative effect of adoption on prior periods. For additional information regarding this adjustment, refer to Note 9, Income Taxes.
		In December 2006, we adopted the provisions of Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). We elected, as allowed under SAB 108, to reflect the effect of initially applying this guidance by adjusting the carrying amount of the impacted liabilities as of the beginning of 2006 and recording an offsetting adjustment to the opening balance of our retained earnings in 2006. We recorded a cumulative adjustment to increase our retained earnings by $8.6 million for the adoption of SAB 108.
2.		Inventories

		September				December 31,
(Unaudited, in millions)		30,2007				2006
At lower of cost or market:
Raw materials		$	57.3			$	87.7
Work in process			18.0				20.1
Finished goods			155.9				123.0
Mill stores and other supplies			149.0				132.0
			380.2				362.8
Excess of current cost over LIFO inventory value			(13.4	)			(13.0	)
		$	366.8			$	349.8

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

3.		Timberlands Held for Sale
		We are currently marketing for sale approximately 17,600 acres of timberlands in the United States and Canada. The sale of these timberlands is expected to be completed in 2007 and 2008. Timberlands held for sale are carried on our Consolidated Balance Sheets at cost as we expect the proceeds of the timberland sales to exceed the individual carrying values of the timberlands sold. Included in deferred income taxes are $1.1 million and $4.8 million at September 30, 2007 and December 31, 2006, respectively, of deferred tax liabilities associated with these timberlands held for sale.
		During the three months ended September 30, 2007, we sold approximately 11,400 acres of timberlands and other assets for proceeds of approximately $19.2 million. During the nine months ended September 30, 2007, we sold approximately 119,200 acres of timberlands and other assets for proceeds of approximately $166.6 million.
		During the three months ended September 30, 2006, we sold approximately 23,000 acres of timberlands and other assets for proceeds of approximately $58.4 million. During the nine months ended September 30, 2006, we sold approximately 519,000 acres of timberlands, our Dégelis and Baker Brook sawmills and other assets for proceeds of approximately $296.5 million.
4.		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)		2007				2006
Unrealized prior service costs (1)		$	(25.4	)		$	(23.2	)
Unrealized actuarial gains and losses (2)			(330.2	)			(358.9	)
Unrealized transition obligation (3)			(0.1	)			(0.1	)
Foreign currency translation (4)			(18.7	)			12.0
Unrealized loss on hedging transactions (5)			—				(0.8	)
		$	(374.4	)		$	(371.0	)

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

5.		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)		2007				2006				2007				2006
Basic weighted-average number of common shares outstanding			57.5				57.4				57.4				57.4
Effect of potentially dilutive securities:
Stock options			—				—				—				—
Restricted stock units			—				—				—				—
Diluted weighted-average number of common shares outstanding			57.5				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 4.8 million shares for both the three and nine months ended September 30, 2007, and 5.0 million shares for both the three and nine months ended September 30, 2006, were excluded from the calculation of diluted loss per share as the impact would have been anti-dilutive. In addition, 1.0 million restricted stock units for both the three and nine months ended September 30, 2007, and 0.7 million restricted stock units for both the three and nine months ended September 30, 2006 were excluded from the calculation of diluted loss per share for the same reason.

6.		Other (Expense) Income, Net
		“Other (expense) income, net” in the Consolidated Statements of Operations includes the following:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Unaudited, in millions)		2007				2006				2007				2006
Foreign exchange (losses) gains		$	(17.4	)		$	0.7			$	(37.0	)		$	(2.3	)
(Losses) earnings from equity method investments			(1.9	)			1.0				(4.6	)			5.2
Interest income			2.2				2.0				5.7				4.1
Charges for repurchase of debt (Note 11)			—				(0.5	)			—				(0.5	)
Miscellaneous income, net			1.0				1.7				1.1				3.2
		$	(16.1	)		$	4.9			$	(34.8	)		$	9.7

7.		Impairment and Other Related Charges
		Goodwill Impairment
		During the third quarter of 2006, we realigned our organizational structure to move from a divisional organization to a functional organization that supports and focuses on our multi-product line manufacturing and sales across our mill base. As a result of this organizational realignment, we now manage our business based on the products that we manufacture and sell to external customers and, therefore, our reportable segments and goodwill reporting units changed. Prior to the reallocation of goodwill to our new reporting units, we performed an interim test for impairment. As a result of this review, we recorded a charge of $200.0 million attributable to an impairment of goodwill at our Thunder Bay facility. Additional information regarding this impairment charge can be found in our Annual Report on Form 10-K filed on March 13, 2007.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

		Asset Impairment
		Based on the continued decline of North American newsprint consumption through the third quarter of 2006, we could no longer foresee the restart of paper machine No. 3 at our Thunder Bay facility, which had been idled since 2003. Accordingly, we recorded a non-cash asset impairment charge of $18.9 million in the third quarter of 2006 to write down the carrying value of the 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 our 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.
8.		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, 2007 and 2006:
		Pension Plans:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Unaudited, in millions)		2007				2006				2007				2006
Components of net periodic benefit cost:
Service cost		$	9.1			$	10.5			$	27.4			$	32.4
Interest cost			32.8				29.9				94.7				89.1
Expected return on plan assets			(35.1	)			(30.8	)			(100.6	)			(91.0	)
Amortization of prior service cost			1.2				1.3				3.5				4.1
Amortization of net actuarial loss			6.8				8.0				20.6				25.7
Special termination benefits			2.7				—				6.7				—
Curtailment and settlement losses, net			5.1				8.8				12.5				13.4
Net periodic benefit cost		$	22.6			$	27.7			$	64.8			$	73.7

OPEB Plans:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Unaudited, in millions)		2007				2006				2007				2006
Components of net periodic benefit cost:
Service cost		$	0.5			$	1.1			$	1.7			$	3.1
Interest cost			3.2				3.9				9.3				11.9
Amortization of prior service credit			(2.8	)			(1.5	)			(8.5	)			(4.5	)
Amortization of net actuarial loss			1.6				2.1				4.8				6.1
Curtailment and settlement gains			—				(5.5	)			(3.5	)			(5.7	)
Net periodic benefit cost		$	2.5			$	0.1			$	3.8			$	10.9

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

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

Events Impacting Net Periodic Benefit Cost for the Three and Nine Months Ended September 30, 2007

In October 2006, we approved changes to the other postretirement plan for our U.S. salaried employees. Benefits for employees were either eliminated or reduced depending on whether the employee met certain age and years of service criteria. As a result, a curtailment gain of $3.2 million was included in the net periodic benefit cost of our OPEB plans during the nine months ended September 30, 2007.

In February 2007, union members at our Thunder Bay, Ontario facility ratified a new labor agreement. As a result of a mill-wide restructuring of this facility, 157 jobs were eliminated. A curtailment loss of approximately $1.8 million and the cost of special termination benefits of $4.0 million were included in the net periodic benefit cost of our pension plans during the nine months ended September 30, 2007, and a curtailment gain of $0.3 million was included in the net periodic benefit cost of our OPEB plans during the nine months ended September 30, 2007 as a result of the employee reduction. This event will also result in a settlement loss at the time the benefits are paid.

In May 2007, union members at our Gatineau, Quebec facility ratified a new labor agreement. As a result of a mill-wide restructuring of this facility, 143 jobs were eliminated. A curtailment loss of approximately $1.7 million and special termination benefits of approximately $2.7 million were included in the net periodic benefit cost of our pension plans for the three and nine months ended September 30, 2007 as a result of the employee reduction.

In June 2007, union members at our Dolbeau, Quebec facility ratified a new labor agreement. As a result of a mill-wide restructuring of this facility, 130 jobs were eliminated. A curtailment loss of approximately $2.6 million was included in the net periodic benefit cost of our pension plans for the three and nine months ended September 30, 2007 as a result of the employee reduction. Additionally, special termination benefits of approximately $2.7 million will be included in the net periodic benefit cost of our pension plans for the fourth quarter of 2007.

At various dates from December 2006 to June 2007, certain employees received lump-sum payouts from two of our retirement pension plans. Accordingly, settlement losses of $0.8 million and $6.4 million were included in the net periodic benefit cost of our pension plans during the three and nine months ended September 30, 2007, respectively.

Events Impacting Net Periodic Benefit Cost for the Three and Nine Months Ended September 30, 2006

As a result of the reduction of employees at our Thunder Bay “A” kraft pulp mill, curtailment losses of $0.9 million and $5.5 million were included in the net periodic benefit cost of our pension plans during the three and nine months ended September 30, 2006, respectively. In addition, a curtailment gain of $0.2 million was included in net periodic benefit cost for our OPEB plans during the nine months ended September 30, 2006. This event resulted in a partial plan termination and will result in a settlement loss when the assets and liabilities are eventually settled.

In May 2006, certain employees received lump-sum payouts from the supplemental executive retirement plan. A settlement loss of $2.3 million was included in net periodic benefit cost for our pension plans during the three and nine months ended September 30, 2006.

In May 2006, we approved changes to our defined benefit pension plan for our U.S. salaried employees. Benefits for certain employees were frozen effective January 1, 2007 and were replaced with a Company contribution to a defined contribution plan. A curtailment loss of $3.9 million was included in net periodic benefit cost for our pension plans during the three and nine months ended September 30, 2006.

In June 2006, we approved changes to our defined benefit pension plan for our Canadian salaried employees. Benefits for certain employees will be frozen 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 included in net periodic benefit cost for our pension plans during the three and nine months ended September 30, 2006.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

In June 2006, we approved changes to our 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 included in net periodic benefit cost for our OPEB plans during the three and nine months ended September 30, 2006.

9.		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)		2007				2006				2007				2006
Loss before income taxes, minority interests and cumulative effect of accounting change		$	(145.5	)		$	(225.2	)		$	(218.8	)		$	(211.9	)
Expected income tax benefit			50.9				78.9				76.6				74.2
Increase (decrease) in income taxes resulting from:
Valuation allowance (1)			(34.1	)			(18.2	)			(71.4	)			(73.8	)
Tax reserves (2)			5.3				17.5				5.3				17.5
Goodwill (3)			—				(78.6	)			—				(78.6	)
Foreign exchange			(16.3	)			7.7				(33.6	)			(13.6	)
State income taxes, net of federal income tax benefit			0.5				(0.2	)			0.1				(2.1	)
Foreign taxes (4)			(2.1	)			(7.2	)			8.7				39.6
Other, net			(3.8	)			10.0				(4.9	)			7.3
Income tax benefit (provision)		$	0.4			$	9.9			$	(19.2	)		$	(29.5	)

We adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, we decreased our liability for unrecognized tax benefits by $2.3 million, which was accounted for as a decrease to our January 1, 2007 retained deficit balance. Our liability for unrecognized tax benefits as of January 1, 2007 was $28.3 million, which included interest of $0.6 million. We recognize interest and penalties accrued related to unrecognized tax benefits as components of income tax expense. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is $18.4 million. If recognized, these items would impact the Consolidated Statements of Operations and our effective tax rate. We anticipate that the total amount

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

of unrecognized tax benefits will decrease by approximately $6.0 million to $7.0 million during the next twelve months due to certain U.S. statutes of limitations closing, primarily in the third quarter of 2008. The approximately $6.0 million to $7.0 million of unrecognized tax benefits is attributable to various U.S. income tax issues. We remain subject to income tax examination in Canada for tax years 2002-2006, in Korea for tax years 2005-2006 and in the U.S. for tax years 2004-2006.

10.		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. Counterparty risk is limited to institutions with long-term debt ratings of A or better for North American financial institutions or ratings of AA or better for international institutions.
		For derivatives that qualify for hedge accounting (currently only the Canadian dollar forward contracts), we designate the derivative as a cash flow hedge at the inception of the hedge. We formally document all relationships between the hedging instruments and the hedged items, as well as our risk-management objectives and strategies for undertaking the various hedge transactions. We link all hedges that are designated as cash flow hedges to forecasted transactions. Under the terms of our risk management policy, we may enter into derivative contracts to hedge forecasted transactions for a period not to exceed two years. 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 the hedged items. If it is determined that a derivative is no longer highly effective as a hedge, we discontinue hedge accounting prospectively.
		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 U.S. and Canadian dollar exchange rate fluctuations, we periodically enter into and designate Canadian dollar forward contracts to hedge certain of the forecasted Canadian dollar cash outflows at our Canadian mill operations, which we believe are likely to occur. There were no hedging contracts outstanding at September 30, 2007. Hedge ineffectiveness associated with our Canadian dollar forward contracts was not material for the periods presented in our Consolidated Financial Statements.
		British Pound Sterling Forward Contracts
		We have entered into sales agreements denominated in British pound sterling. Beginning in the first quarter of 2007, we entered into currency forward contracts to partially limit our exposure to British pound sterling-U.S. dollar exchange rate fluctuations. These currency forward contracts, which do not currently meet the requirements for hedge accounting treatment, have been recorded at fair value in the Consolidated Statement of Operations. As a result, approximately $0.2 million and $0.9 million of pre-tax losses were recognized for the three and nine months ended September 30, 2007, respectively, for contracts that we entered into to economically hedge forecasted transactions expected to occur through December 31, 2007.
		Natural Gas Swap Agreements
		Beginning in the third quarter of 2006, we entered into natural gas swap agreements under our natural gas hedging program for the purpose of reducing the risk inherent in fluctuating natural gas prices. Our hedged natural gas costs are billed to us based on a publicly traded index plus a fixed amount. The natural gas swap agreements allow us to minimize the effect of fluctuations in those indices by contractually exchanging the publicly traded index upon which we are billed for a fixed index of natural gas cost. The swap agreements, which do not currently meet the requirements for hedge accounting treatment, have been recorded at fair value in the Consolidated Statement of Operations. As a result, approximately $0.6 million and $0.5 million of pre-tax losses were recognized for the three and nine months ended September 30, 2007, respectively, for contracts that we entered into in 2006 and 2007 to economically hedge forecasted transactions expected to occur through September 2008.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

Information regarding our outstanding British pound sterling and natural gas swap contracts’ notional amount, fair market value, and range of exchange rates or natural gas price index prices 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.

										Range
										OfUSD/CAD and
										USD/GBP
		Notional								Exchange Rates
(Unaudited, in millions of U.S. dollars		Amountof				Asset /(Liability)				and Natural Gas
except rates and prices)		Derivatives				Fair Market Value				Index Prices
As of September 30, 2007:
Foreign Currency Exchange Agreements:
British pound sterling
Due in 2007		$	20.1			$	(0.7	)		$	1.9553 – 1.9976
Natural Gas Swap Agreements:
Due in 2007		$	4.7			$	(0.7	)		$	6.34 – 9.53
Due in 2008		$	4.5			$	(0.1	)		$	6.34 – 9.87
As of December 31, 2006:
Foreign Currency Exchange Agreements:
Canadian dollar
Due in 2007		$	76.0			$	(0.4	)		$	.8592 – .8801
Natural Gas Swap Agreements:
Due in 2007		$	9.0			$	(1.1	)		$	5.87 – 8.98

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 individual financial institution holds more than 35% of our derivative financial instruments.

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)		2007				2006				2007				2006
(Gains) losses reclassified to earnings on matured cash flow hedges		$	—			$	(5.0	)		$	1.1			$	(34.2	)
Unrealized gains for change in value on outstanding cash flow hedges			—				0.5				0.2				4.9
			—				(4.5	)			1.3				(29.3	)
Income tax benefit (provision)			—				1.7				(0.5	)			11.1
Net (increase) decrease in “Accumulated other comprehensive loss”		$	—			$	(2.8	)		$	0.8			$	(18.2	)

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

11.		Long-term and Short-term Debt
		In order for Bowater to maintain compliance with our U.S. and Canadian credit facilities subsequent to the consummation of the combination with Abitibi-Consolidated Inc. (“Abitibi”) (See Note 16), these facilities were amended in July 2007. The amendment permits a structure that allows AbitibiBowater to become a party to the credit facilities. All existing debt structures remain intact subsequent to consummation of the merger; however, there are restrictions on the amount of cash that can be transferred from Bowater to AbitibiBowater.
		On November 2, 2007, we obtained an amendment to our US and Canadian credit facilities allowing us to adjust 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) for non-recurring gains or losses without limitation. In addition, the minimum ratio of EBITDA (defined as EBITDA, plus gains (or minus losses) from asset dispositions) to interest expense was lowered from 2.00 to 1 to 1.50 to 1 effective October 1, 2007, increasing gradually back up to 2.00 to 1 by October 1, 2008.
		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 (expense) income, net” on the accompanying Consolidated Statement of Operations.
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 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.
		On September 30, 2005, the Ministry of Justice of the Province of Quebec (MOJ) cited one of our subsidiaries, Bowater Canadian Forest Products, Inc. (“BCFPI”), in connection with effluent water quality of the Dolbeau mill.  BCFPI settled this citation on March 29, 2007, by agreeing to pay a fine and costs totaling CDN$158,000.  The Dolbeau mill has taken steps to improve its effluent quality and has experienced only two other exceedences since January 1, 2005.
		On June 18, 2007, The Levin Group, L.P. filed a complaint against Bowater in the Supreme Court of New York, New York County, asserting claims for breach of contract and related claims relating to certain advisory services purported to have been provided by the plaintiff in connection with the combination with Abitibi. The complaint seeks damages of no less than $70 million, related costs and such other relief as the court deems just and proper. The management of AbitibiBowater believes this claim is entirely without merit and intends to contest this matter.
		On September 7, 2007, BCFPI received a decision in an arbitration related to the 1998 sale to Weyerhaeuser Company (“Weyerhaeuser”) of Bowater’s former pulp and paper facility in Dryden, Ontario. As reported in our Annual Report on Form 10-K, BCFPI and Weyerhaeuser had been arbitrating a claim regarding the cost of certain environmental matters related to the mill. The arbitrators awarded Weyerhaeuser approximately $42.9 million (CDN $44.0 million), including interest. As a result of the arbitrator’s decision, which is binding upon Bowater and not subject to appeal, we recorded a pre-tax charge of $28.4 million (CDN $29.1 million) during the three and nine months ended September 30, 2007. We had previously established a reserve of approximately $14.5 million (CDN $14.9 million) in connection with these environmental matters at the time of the sale.
		There have been no other material developments to those legal proceedings described in our Annual Report on Form 10-K filed on March 13, 2007.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

13.		Share-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. These plans are described more fully in our 2006 Annual Report on Form 10-K.
		Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123R, “Share-based Payments” and related interpretations (“SFAS 123R”). The adoption of SFAS 123R resulted in a charge for the 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.

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Unaudited, in millions)		2007				2006				2007				2006
Stock options		$	0.2			$	0.2			$	0.8			$	0.4
Restricted stock units			2.4				2.9				9.8				4.8
EPRs			(0.8	)			(0.5	)			(0.5	)			(3.4	)
Stock-based compensation expense		$	1.8			$	2.6			$	10.1			$	1.8

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

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

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Unaudited, in millions)		2007				2006				2007				2006
Stock options		$	(0.1	)		$	—			$	(0.4	)		$	(0.1	)
Restricted stock units			(0.6	)			(0.7	)			(2.6	)			(1.1	)
EPRs			0.2				0.1				0.1				0.8
Tax benefit		$	(0.5	)		$	(0.6	)		$	(2.9	)		$	(0.4	)

		Stock Options
		On September 26, 2007, the terms of all outstanding stock options granted in 2006 (315,848 stock options) were modified to allow for accelerated vesting in full upon a grantee’s involuntary termination without cause. The modification was treated as a cancellation of the 2006 awards and a new grant of the modified awards. We have reversed cumulative compensation expense recognized through the date of the modification for those stock option grants for which future vesting was considered improbable under the original terms of the grant, but considered probable under the modified terms (“Type III Modifications”). Subsequent to the date of modification, we began recognizing compensation expense associated with the 24,850 stock options identified as Type III Modifications over the requisite service periods (based on the expected vesting date for each applicable grantee). Most of the modified stock options (290,998 stock options) were granted to employees who will continue to be employed by Bowater subsequent to the combination with Abitibi. Future vesting of those stock options was considered probable under the original terms of the grant and is still considered probable under the modified terms (“Type I Modification”). As such, the original compensation expense will continue to be recognized over the requisite service period, which did not change as a result of the modification. The modification resulted in a net decrease of $0.1 million of compensation expense recognized during the three and nine months ended September 30, 2007.
		On January 30, 2007, we granted 72,146 stock options. The awards cliff vest after three years and allow for accelerated vesting upon a grantee’s retirement. We have recognized compensation expense based on the requisite service period, which is less than three years for certain employees who are eligible for retirement as of the date of the grant or become eligible for retirement during the vesting period. We issued 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 and for the nine months ended September 30, 2007 is presented below:

										Weighted
						Weighted				Average				Aggregate
		Number Of				Average				Remaining				Intrinsic
		Options				Exercise				Contractual				Value
(Unaudited)		(000’s)				Price				Life (years)				($000)
Outstanding at December 31, 2006			4,982			$	43.45
Granted during the period			72				27.87
Exercised during the period			—				—
Canceled during the period			(255	)			42.72
Outstanding at September 30, 2007			4,799			$	43.25				4.4			$	—
Exercisable at September 30, 2007			4,505			$	44.29				4.1			$	—

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

		In accordance with SFAS 123R, we estimated the fair value of each stock option granted during the nine months ended September 30, 2007 on the date of grant using a Black-Scholes option-pricing formula, applying weighted-average assumptions which are consistent with the assumptions described in “Note 21 Share-Based Compensation” included in our most recent Annual Report on Form 10-K, and amortize that value to expense over the option’s requisite service period using the straight-line attribution approach. The weighted-average fair value of options granted during the nine months ended September 30, 2007 was $9.08.
		During the three and nine months ended September 30, 2007 and 2006, all vested options had a strike price greater than the closing price of our common stock (i.e., were “out-of-the-money”), and there were no stock option exercises during those periods.
		As of September 30, 2007, there was $1.6 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 1.6 years.
		Restricted Stock Units
		On September 26, 2007, the terms of all outstanding performance-based and service-based restricted stock units (“RSUs”) granted in 2006 except the awards granted on May 10, 2006 that cliff vest over 20 months were modified (205,707 RSUs) to allow for accelerated vesting in full upon a grantee’s involuntary termination without cause and to remove any performance conditions from the awards. The modification was treated as a cancellation of the 2006 awards and a new grant of the modified awards. We have reversed cumulative compensation expense recognized through the date of modification for those RSUs identified as Type III Modifications. Subsequent to the date of modification, we began recognizing compensation expense associated with the 64,929 RSUs identified as Type III Modifications over the requisite service periods (based on the expected vesting date for each applicable grantee). Most of the modified RSUs (140,778 RSUs) were granted to employees who will continue to be employed by Bowater subsequent to the combination with Abitibi. As such, those RSUs are Type I Modifications, and the original compensation expense will continue to be recognized over the original requisite service period. The modification resulted in a net decrease of $0.4 million of compensation expense recognized during the three and nine months ended September 30, 2007.
		On January 30, 2007, we granted 327,945 RSUs, all of which are service-based awards. The awards cliff vest after three years and allow for accelerated vesting upon a grantee’s retirement. We have recognized compensation expense based on the requisite service period, which is less than three years for certain employees who are eligible for retirement as of the date of the grant or will become eligible for retirement during the vesting period.
		On February 7, 2007, we granted 36,101 RSUs, all of which are performance-based awards. These awards vested upon closing of the merger of Bowater and Abitibi. Accounting guidance dictates that, for purposes of recognizing compensation expense for this type of award, the business combination with Abitibi was not considered “probable” until the date the merger was consummated. As vesting of these awards was predicated upon close of the merger, which occurred on October 29, 2007, no compensation expense was recorded for these awards in the three and nine months ended September 30, 2007. As a result of the consummation of the merger, compensation expense of $1.0 million was recognized on October 29, 2007 and will be reflected in our results for the year ended December 31, 2007. These awards are included in our outstanding RSUs at the end of the period.
		On March 23, 2007, we granted 54,200 RSUs, all of which are performance-based awards. The vesting of these awards is contingent upon the realization of certain synergies within two years of consummation of the merger of Bowater and Abitibi. The key terms and conditions of these RSUs have not been finalized; therefore a grant date for FAS 123R purposes has not occurred. As such, no compensation expense was recorded during the three and nine months ended September 30, 2007, nor were these awards included in our outstanding RSUs at the end of the period.
		On June 27, 2007, we granted 1,897 RSUs, all of which are service-based awards that cliff vest after three years.

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 are performance-based awards. The performance-based awards cliff vest after 32 months. The remaining shares, which are service-based awards, cliff vest after 32 months (178,342 shares), 20 months (503,657 shares) or 12 months (50,000 shares).
		A summary of the status of our restricted stock units as of and for the nine months ended September 30, 2007, is presented below:

						Weighted Average
						Fair Value at
		Number Of Units				Modification or
(Unaudited)		(000’s)				Grant Date
Outstanding at December 31, 2006			665			$	24.92
Granted during the period			366				27.84
Vested during the period			(64	)			26.38
Canceled during the period			(13	)			26.83
Outstanding at September 30, 2007			954			$	25.92

		As of September 30, 2007, there was $8.8 million of unrecognized compensation cost related to restricted stock units granted under our stock plans, excluding those granted on February 7, 2007 (discussed above). This unrecognized cost is expected to be recognized over a weighted-average period of one year. The total fair value of restricted stock units vested during the first nine months of 2007 was $1.4 million.
		Equity Participation Rights
		EPRs confer the right to receive cash based on the appreciation of Bowater’s (and subsequent to the merger, AbitibiBowater’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 (adjusted by the Bowater exchange ratio of 0.52 on October 29, 2007). 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. As of September 30, 2007, the fair value of our EPRs liability is $0.1 million. The assumptions used to value the liability are consistent with those used in the past. There have been no significant changes to the number of EPRs outstanding or exercisable since December 31, 2006. Refer to our most recent Annual Report on Form 10-K for additional details.
14.		Off-Balance Sheet Debt Guarantees
		In connection with our 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 $6.6 million of the investor notes’ principal balance at September 30, 2007. 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 $30.4 million and obligations of approximately $26.3 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, neither of which has ever occurred.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

15.		Segment Information
		We manage our business based on the products that we manufacture and sell to external customers. Our reportable segments are coated papers, specialty papers, newsprint, market pulp, and lumber.
		None of the income or loss items following “Operating loss” in our Consolidated Statements of Operations are allocated to our segments, since those items are reviewed separately by Bowater’s management. For the same reason, impairments, employee termination costs, gains on dispositions of assets and other discretionary charges or credits are not allocated to the segments. Share-based compensation expense is, however, allocated to our segments. We also allocate depreciation expense to our segments, although the related fixed assets are not allocated to segment assets.
		The following tables summarize information about segment profit and loss for the three and nine months ended September 30, 2007 and 2006:

						Coated				Specialty								Market								Corporate				Consolidated
(Unaudited, in millions)						Papers				Papers				Newsprint				Pulp				Lumber				and Other				Total
Sales
Third quarter			2007			$	152.4			$	141.3			$	295.8			$	159.7			$	62.3			$	3.2			$	814.7
Third quarter			2006				154.4				153.9				349.1				144.2				71.1				3.2				875.9
Year to date			2007				410.3				433.9				911.7				430.5				189.1				9.4				2,384.9
Year to date			2006				463.5				426.6				1,089.9				410.3				261.6				16.6				2,668.5
Operating income (loss) (1)
Third quarter			2007			$	13.1			$	(19.8	)		$	(39.5	)		$	29.3			$	(10.6	)		$	(54.6	)		$	(82.1	)
Third quarter			2006				15.6				(1.4	)			30.9				17.4				(17.4	)			(224.4	)			(179.3	)
Year to date			2007				26.6				(39.6	)			(55.2	)			66.5				(31.7	)			(8.7	)			(42.1	)
Year to date			2006				60.3				(26.8	)			67.1				16.1				(20.9	)			(167.9	)			(72.1	)

16.		Combination with Abitibi-Consolidated Inc.
		On October 29, 2007, Bowater and Abitibi combined in an all-stock “merger of equals” (the combined company, which was formed in connection with the combination, is AbitibiBowater Inc.). In connection with the review and approval of the transaction by the Canadian government, AbitibiBowater agreed, among other things, for a period of three years after closing, to maintain its headquarters in Montreal, Canada; to maintain at least five Canadians on its Board of Directors; and to apply for listing of its common stock on the Toronto Stock Exchange (TSX). In connection with the review and approval of the transaction by the U.S. Department of Justice, AbitibiBowater agreed, among other things, to divest one newsprint mill, Abitibi’s mill in Snowflake, Arizona. Abitibi and Bowater continued to operate separately until October 29, 2007.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

		On October 29, 2007, each share of Bowater common stock issued and outstanding was exchanged for 0.52 of a share of AbitibiBowater common stock and an amendment to the articles of Bowater Canada was filed so that each Bowater exchangeable share issued and outstanding will be exchanged into 0.52 of a Bowater Canada exchangeable share, which will be exchangeable for shares of AbitibiBowater common stock. Bowater’s treasury stock was canceled. Bowater’s outstanding stock options, RSUs and EPRs, whether vested or unvested, were converted into stock options, RSUs and EPRs with respect to AbitibiBowater’s common stock at an exchange ratio of 0.52. Similarly, the exercise price of the converted stock options or base prices of the EPRs were adjusted by dividing the price by the Bowater exchange ratio of 0.52.
		In connection with this combination, we approved a retention and severance program for approximately 320 Bowater employees who could possibly be impacted by the combination with Abitibi. This program provides a retention bonus for employees who remain with Bowater through the closing of the combination and an additional retention bonus for employees who remain with Bowater for a transition period following the closing of the combination. The costs associated with these programs are expensed as incurred. Also in connection with the combination, we have capitalized $17.5 million of direct acquisition costs in our Consolidated Balance Sheet as of September 30, 2007 as Bowater is the accounting acquirer of Abitibi. Subsequent to the merger, AbitibiBowater is considered to be a continuation of Bowater for accounting purposes and therefore will become the accounting acquirer of Abitibi.

BOWATER INCORPORATED

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management’s Discussion and Analysis includes the accounts of Bowater Incorporated and subsidiaries (“Bowater,” also referred to as “we” or “our”).

Cautionary Statements Regarding Forward-Looking Information and Use of Third Party Data

Statements contained in this Form 10-Q that do not constitute historical financial results or other factual information are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, for example, statements about our business outlook, assessment of market conditions, strategies, future plans, future sales and shipments, prices for our major products, inventory levels, cost reduction measures, manufacturing performance, product mix, capital spending and tax and exchange rates. These forward-looking statements are not guarantees of future performance. These statements are based on management’s expectations that involve a number of business risks and uncertainties, any of which could cause actual results to differ materially from those expressed in or implied by the forward-looking statements. In addition to specific factors described in connection with any particular forward-looking statement, factors that could cause actual results to differ materially include, but are not limited to, those described under the caption “Risk Factors” from time to time, in our filings with the Securities and Exchange Commission. In addition, other risks could adversely affect us, as it is not possible for us to predict or assess all risks. We disclaim any obligation to publicly update or revise any forward-looking statements even if our situation changes in the future.

Information about industry or general economic conditions contained in this report is derived from third party sources (i.e., the Pulp and Paper Products Council; RISI, Inc.; and certain trade publications) that we believe are widely accepted and accurate; however, we have not independently verified this information and cannot provide assurances of its accuracy.

Accounting Policies and Estimates

The following discussion and analysis provides information that we believe is useful in understanding our operating results, cash flows and financial condition and should be read in conjunction with our unaudited Consolidated Financial Statements included in this quarterly report. Our significant accounting policies are described in Note 2 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2006. Our critical accounting estimates are described under the caption “Critical Accounting Estimates” in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2006.

The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates, assumptions and judgments and rely on projections of future results of operations and cash flows. We base our estimates and assumptions on historical data and other assumptions that we believe are reasonable under the circumstances. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities in our financial statements. In addition, they affect the reported amounts of revenues and expenses during the reporting period.

Our judgments are based on our assessment as to the effect certain estimates, assumptions of future trends or events may have on the financial condition and results of operations reported in our Consolidated Financial Statements. It is important that the reader of our financial statements understand that actual results could differ materially from these estimates, assumptions, projections and judgments.

Overview of Financial Performance

Our net loss for the third quarter of 2007 was $142.1 million, or $2.47 per diluted share, as compared to a net loss of $216.1 million, or $3.76 per diluted share, for the same period in 2006.

Our sales in the third quarter of 2007 were $814.7 million, a decrease of $61.2 million compared to the third quarter of 2006 sales of $875.9 million. Average transaction prices decreased for all of our paper products, and shipments decreased for all of our major products except coated papers. Shipments of coated paper increased primarily due to

BOWATER INCORPORATED

increased demand as a result of capacity closures by some of our North American competitors and reduced offshore imports. The increased coated paper shipments were more than offset by a reduction in average coated paper transaction prices, resulting in a slight decrease in sales for the third quarter of 2007 compared to the same period of 2006. Shipments of newsprint were significantly lower in the third quarter of 2007 compared to the third quarter of 2006 due to the continued decline of North American newsprint consumption. We have increased our exports of newsprint into areas where market conditions are stronger, but those export sales have only partially offset the effects of the North American decline. As such, we continue to curtail paper production at several facilities. We indefinitely idled paper machine no. 3 at our Gatineau, Quebec facility beginning in March 2007 and indefinitely idled paper machine no. 2 at our Dolbeau, Quebec facility beginning in late May 2007. Shipments of market pulp were slightly lower in the third quarter of 2007 as compared to the third quarter of 2006. However, the increase in average transaction prices for market pulp resulted in an increase of sales of 10.7% for the third quarter 2007 compared to the same period in 2006. Shipments of lumber were lower in the third quarter of 2007 as compared to the third quarter of 2006 due to weak demand in the U.S. housing market and the impact of quotas imposed by the Softwood Lumber Agreement in January 2007.

Our costs increased $21.6 million during the third quarter of 2007 as compared to the same time period in 2006. The increase in costs was primarily due to a stronger Canadian dollar (which compared to the U.S. dollar was on average 7.3% higher in the third quarter of 2007 compared to the third quarter of 2006, from an average rate of US$0.8919 to US$0.9568), higher wood costs (particularly recycled fiber), higher maintenance costs and reduced benefits from our Canadian dollar hedging program. These higher costs were only partially offset by lower costs resulting from reduced shipment volumes and lower labor, energy and chemicals costs. As a result, our operating costs per ton increased for all our paper grades, except coated paper which is manufactured solely in the U.S., when compared to the third quarter of 2006. Direct costs per ton, net of recycled fiber costs and the impact of the stronger Canadian dollar, decreased in the third quarter of 2007 as compared to the third quarter of 2006 for all of our paper grades as a result of our commitment to our operational improvement program and the progress we have made in reducing our controllable costs. Specifically, our Thunder Bay mill lowered its costs to produce paper and pulp by approximately $40 per metric ton since last September, despite the rapid strengthening of the Canadian dollar and the significant increase in the cost of recycled wood fiber. Substantial improvement at Thunder Bay was achieved prior to June 2007 and realized during the third quarter. Additional information regarding the changes in our manufacturing and other costs is included below in the section “Consolidated Results of Operations.” In addition, on September 7, 2007, Bowater Canadian Forest Products Inc., a subsidiary of Bowater, received a decision from an arbitration related to the 1998 sale to Weyerhaeuser Company (“Weyerhaeuser”) of Bowater’s former pulp and paper facility in Dryden, Ontario. As reported in our most recent Annual Report on Form 10-K, Bowater and Weyerhaeuser had been arbitrating a claim regarding the cost of certain environmental matters related to the mill. The arbitrators in the matter awarded Weyerhaeuser a final and unappealable judgment of approximately $42.9 million, including interest, which was paid in the third quarter of 2007 and resulted in a pre-tax charge of $28.4 million. We had previously established a reserve of approximately $14.5 million (CDN $14.9 million) in connection with these environmental matters at the time of the sale.

Business Strategy and Outlook

Our focus is on improving our product mix and reducing our operating costs per ton. North American newsprint demand declined significantly during the first nine months of 2007, and there is no clear indication as to the level at which demand will stabilize. As a result of the reduction in domestic customer demand, we indefinitely idled paper machine no. 3 at our Gatineau, Quebec facility in March 2007 and curtailed production at various other facilities throughout the first nine months of 2007. We reduced production of newsprint by approximately 186,000 metric tons in the first nine months of 2007, including approximately 10,000 metric tons as a result of a major rebuild of a paper machine at our Calhoun mill. In addition, we indefinitely idled paper machine no. 2 at our Dolbeau, Quebec facility in late May 2007. We will continue to evaluate our production options and focus on increasing production of our more profitable product lines from our lower cost sites. For example, we converted a newsprint machine to produce specialties at our Calhoun facility in July 2006, and we increased production of specialty papers at our Thunder Bay facility in the third quarter of 2007.

We expect to spend approximately $30 million on capital projects during the remaining three months of 2007 compared to depreciation of approximately $80 million. Spending in 2007 is expected to be approximately $90

BOWATER INCORPORATED

million lower than in 2006. This reduction in capital spending reflects our disciplined approach to limit capital expenditures beyond those required for normal preservation and maintenance of our assets to those that are expected to achieve the highest rate of return.

On October 29, 2007, we combined with Abitibi-Consolidated Inc. (“Abitibi”) in a merger of equals. In connection with the review and approval of the transaction by the Canadian government, the newly formed jointly combined company, AbitibiBowater Inc., agreed, among other things, for a period of three years after closing, to maintain its headquarters in Montreal, Canada; to maintain at least five Canadians on its Board of Directors; and to apply for listing of its common stock on the Toronto Stock Exchange (TSX). In connection with the review and approval of the transaction by the antitrust division of the U.S. Department of Justice, AbitibiBowater Inc., agreed, among other things, to sell Abitibi’s Snowflake, Arizona newsprint mill and certain related assets. The combination with Abitibi could have a material impact on our results of operations, financial condition and liquidity going forward. We expect that the combination will generate approximately $250 million of annual cost synergies for AbitibiBowater, a portion of which are expected to impact Bowater. Annual cost synergies are expected to arise from improved efficiencies in such areas as production, selling, administrative, distribution and procurement costs.

Business and Financial Review

Consolidated Results of Operations

		Three Months Ended												Nine Months Ended
		September 30,												September 30,
(In millions)		2007				2006				Change				2007				2006				Change
Sales		$	814.7			$	875.9			$	(61.2	)		$	2,384.9			$	2,668.5			$	(283.6	)
Operating loss			(82.1	)			(179.3	)			97.2				(42.1	)			(72.1	)			30.0
Significant items that impacted operating loss:
Product pricing										$	(30.4	)										$	(75.9	)
Shipment volume											(30.8	)											(207.7	)
Change in total sales											(61.2	)											(283.6	)
Manufacturing costs											(14.1	)											135.5
Employee termination costs — manufacturing											(6.2	)											(15.2	)
Change in total manufacturing costs and depreciation, amortization, and cost of timber harvested											(20.3	)											120.3
Distribution costs											(0.5	)											7.8
Selling and administrative expenses											(6.9	)											(16.8	)
Employee termination costs — selling and administrative											5.0												(0.8	)
Arbitration award											(28.4	)											(28.4	)
Impairment and other related charges											246.4												246.4
Gain on disposition of assets											(36.9	)										$	(14.9	)
										$	97.2											$	30.0