UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

FOR THE QUARTERLY PERIOD ENDED March 31, 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.)

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 May 1, 2007.

Class		Outstanding
Common Stock, $1.00 Par Value		56,217,139 Shares

 

 

BOWATER INCORPORATED
TABLE OF CONTENTS

		Page Number
PART I            FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Operations for the Three Months Ended March 31, 2007 and 2006			3
Consolidated Balance Sheets at March 31, 2007 and December 31, 2006			4
Consolidated Statements of Stockholders’ Equity for the Three Months Ended March 31, 2007 and 2006			5
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2007 and 2006			6
Notes to Consolidated Financial Statements			7 - 17
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			18 - 32
Item 3. Quantitative and Qualitative Disclosures About Market Risk			32 - 33
Item 4. Controls and Procedures			33
PART II            OTHER INFORMATION
Item 1. Legal Proceedings			34
Item 1A. Risk Factors			34 - 39
Item 5. Other Information			39
Item 6. Exhibits			39
SIGNATURES			40

BOWATER INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in millions of US dollars except per-share amounts)

		Three Months Ended
		March 31,
		2007				2006
Sales		$	771.6			$	893.2
Costs and expenses:
Cost of sales, excluding depreciation, amortization and cost of timber harvested			600.5				680.2
Depreciation, amortization and cost of timber harvested			79.9				81.1
Distribution costs			75.3				82.9
Selling and administrative expense			48.7				38.0
Net gain on disposition of assets			(57.9	)			(28.8	)
Operating income			25.1				39.8
Interest expense			(47.3	)			(49.4	)
Other (expense) income, net			(4.4	)			6.5
Loss before income taxes, minority interests and cumulative effect of accounting change			(26.6	)			(3.1	)
Income tax provision			(1.7	)			(13.1	)
Minority interests, net of tax			(7.1	)			—
Loss before cumulative effect of accounting change			(35.4	)			(16.2	)
Cumulative effect of accounting change, net of tax			—				(2.6	)
Net loss		$	(35.4	)		$	(18.8	)
Loss per share:
Basic loss per common share:
Loss before cumulative effect of accounting change		$	(0.62	)		$	(0.28	)
Cumulative effect of accounting change, net of tax			—				(0.05	)
Net loss		$	(0.62	)		$	(0.33	)
Diluted loss per common share:
Loss before cumulative effect of accounting change		$	(0.62	)		$	(0.28	)
Cumulative effect of accounting change, net of tax			—				(0.05	)
Net loss		$	(0.62	)		$	(0.33	)
Average number of shares outstanding (in millions):
Basic and diluted			57.4				57.4
Dividends declared per common share		$	0.20			$	0.20

See accompanying notes to consolidated financial statements.

BOWATER INCORPORATED
CONSOLIDATED BALANCE SHEETS
(Unaudited, in millions of US dollars except share and per-share amounts)

		March 31,				December 31,
		2007				2006
Assets
Current assets:
Cash and cash equivalents		$	98.3			$	98.9
Accounts receivable, net			414.5				444.5
Inventories			376.9				349.8
Timberlands held for sale			15.6				18.7
Other current assets			54.8				47.1
Total current assets			960.1				959.0
Timber and timberlands			57.2				60.8
Fixed assets, net			2,827.1				2,877.9
Goodwill			590.7				590.2
Other assets			153.8				158.0
Total assets		$	4,588.9			$	4,645.9
Liabilities and shareholders’ equity
Current liabilities:
Current installments of long-term debt		$	15.8			$	14.9
Accounts payable and accrued liabilities			428.5				431.2
Total current liabilities			444.3				446.1
Long-term debt, net of current installments			2,246.0				2,251.6
Pension and other postretirement benefit obligations			634.0				651.1
Other long-term liabilities			90.5				92.5
Deferred income taxes			308.4				313.0
Minority interests in subsidiaries			69.7				59.0
Commitments and contingencies
Shareholders’ equity:
Common stock, $1 par value. Authorized 100,000,000 shares; issued 67,812,567 and 67,585,104 shares at March 31, 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 outstanding at March 31, 2007 and December 31, 2006, respectively			56.8				67.6
Additional paid-in capital			1,645.0				1,630.1
Retained deficit			(120.7	)			(76.0	)
Accumulated other comprehensive loss			(367.2	)			(371.0	)
Treasury stock at cost, 11,598,820 and 11,600,717 shares at March 31, 2007 and December 31, 2006, respectively			(485.7	)			(485.7	)
Total shareholders’ equity			796.0				832.6
Total liabilities and shareholders’ equity		$	4,588.9			$	4,645.9

See accompanying notes to consolidated financial statements.

BOWATER INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited, in millions of US dollars except share and per-share amounts)

For the three months ended March 31, 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 adoption of FIN 48			—				—				—				2.3				—				—				2.3
Dividends on common stock ($0.20 per share)			—				—				—				(11.6	)			—				—				(11.6	)
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			—				—				4.6								—				—				4.6
Restricted stock units vested (5,787 shares, net of shares forfeited for employee withholding taxes)			—				—				(0.3	)			—				—				—				(0.3	)
Treasury stock used for dividend reinvestment plans and to pay employee and director benefits (1,897 shares)			—				—				—				—				—				—				—
Comprehensive loss:
Net loss			—				—				—				(35.4	)			—				—				(35.4	)
Change in unrealized prior service costs, net of tax of $0.9			—				—				—				—				(0.8	)			—				(0.8	)
Change in actuarial gains and losses, net of tax of $2.3			—				—				—				—				7.9				—				7.9
Foreign currency translation			—				—				—				—				(4.2	)			—				(4.2	)
Change in unrealized gain on hedged transactions, net of tax of $0.6			—				—				—				—				0.9				—				0.9
Total comprehensive loss																											(31.6	)
Balance at March 31, 2007		$	67.8			$	56.8			$	1,645.0			$	(120.7	)		$	(367.2	)		$	(485.7	)		$	796.0

For the three months ended March 31, 2006

																		Accumulated
										Additional								Other								Total
		Common				Exchangeable				Paid In				Retained				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
Cumulative adjustment to retained earnings for adoption of SAB 108			—				—				—				8.6				—				—				8.6
Dividends on common stock ($0.20 per share)			—				—				—				(11.5	)			—				—				(11.5	)
Comprehensive loss:
Net loss			—				—				—				(18.8	)			—				—				(18.8	)
Minimum pension liability, net of tax of $0.1			—				—				—				—				(0.1	)			—				(0.1	)
Change in unrealized gain on hedged transactions, net of tax of $6.4			—				—				—				—				(10.4	)			—				(10.4	)
Total comprehensive loss																											(29.3	)
Balance at March 31, 2006		$	67.5			$	68.1			$	1,621.6			$	78.4			$	(166.5	)		$	(485.8	)		$	1,183.3

See accompanying notes to consolidated financial statements.

BOWATER INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in millions of US dollars)

		Three Months Ended
		March 31,				March 31,
		2007				2006
Cash flows from operating activities:
Net loss		$	(35.4	)		$	(18.8	)
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			4.6				(0.9	)
Depreciation, amortization and cost of timber harvested			79.9				81.1
Deferred income taxes			(3.4	)			4.6
Minority interests, net of tax			7.1				—
Net pension (contributions) benefit costs			(10.5	)			4.8
Net gain on disposition of assets			(57.9	)			(28.8	)
Changes in working capital:
Accounts receivable, net			29.9				(26.0	)
Inventories			(27.1	)			(11.6	)
Income taxes receivable and payable			4.7				7.3
Accounts payable and accrued liabilities			(12.1	)			6.9
Other, net			4.5				0.8
Net cash (used for) provided by operating activities			(15.7	)			22.0
Cash flows from investing activities:
Cash invested in fixed assets, timber and timberlands			(25.9	)			(37.5	)
Dispositions of assets, including timber and timberlands			64.6				36.8
Direct acquisition costs related to the proposed merger with Abitibi-Consolidated Inc.			(9.2	)			—
Net cash provided by (used for) investing activities			29.5				(0.7	)
Cash flows from financing activities:
Cash dividends			(11.3	)			(11.5	)
Short-term financing			8.0				201.7
Short-term financing repayments			(8.0	)			(209.0	)
Payments of long-term debt			(3.1	)			(10.0	)
Net cash used for financing activities			(14.4	)			(28.8	)
Net decrease in cash and cash equivalents			(0.6	)			(7.5	)
Cash and cash equivalents:
Beginning of year			98.9				30.1
End of year		$	98.3			$	22.6
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest, including capitalized interest of $0 and $1.3		$	24.4			$	26.0
Income taxes		$	—			$	1.6

See accompanying notes to consolidated financial statements.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

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 March 31, 2007, and the related statements of operations, stockholders’ equity accounts and cash flows for the periods ended March 31, 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 March 31, 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 financial statements and the notes 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. The credit represents the cumulative effect of adoption on prior periods. For additional information regarding this adjustment, refer to Note 8, 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

		March 31,				December 31,
(Unaudited, in millions)		2007				2006
At lower of cost or market:
Raw materials		$	82.0			$	87.7
Work in process			21.7				20.1
Finished goods			153.1				123.0
Mill stores and other supplies			133.5				132.0
			390.3				362.8
Excess of current cost over LIFO inventory value			(13.4	)			(13.0	)
		$	376.9			$	349.8

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

3. Other (Expense) Income, Net

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

		Three Months Ended
		March 31,
(Unaudited, in millions)		2007				2006
Foreign exchange (loss) gain		$	(3.1	)		$	1.8
(Losses) earnings from equity method investments			(1.8	)			2.3
Interest income			1.9				1.1
Miscellaneous (loss) income			(1.4	)			1.3
		$	(4.4	)		$	6.5

4. Timberlands Held for Sale

We are currently marketing for sale approximately 67,600 acres of timberlands in the United States and Canada. We expect sales of these assets to be completed in 2007. Timberlands held for sale are carried on our Consolidated Balance Sheets at cost as we expect the proceeds of the timberland sales to exceed their individual carrying values. There are $4.2 million and $4.8 million at March 31, 2007 and December 31, 2006, respectively, of deferred tax assets associated with these assets held for sale included in deferred income taxes.

During the three months ended March 31, 2007, we sold approximately 52,200 acres of timberlands and other assets for proceeds of $64.6 million. During the three months ended March 31, 2006, we sold approximately 24,300 acres of timberlands and other assets for proceeds of $36.8 million.

5. Accumulated Other Comprehensive Loss

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

		March 31,				December 31,
(Unaudited, in millions)		2007				2006
Unrealized prior service costs (1)		$	(24.0	)		$	(23.2	)
Unrealized actuarial gains and losses (2)			(351.0	)			(358.9	)
Unrealized transition obligation (3)			(0.1	)			(0.1	)
Foreign currency translation (4)			7.8				12.0
Unrealized gain on hedging transactions (5)			0.1				(0.8	)
		$	(367.2	)		$	(371.0	)

(1)		Net of deferred tax benefit of $2.4 million and $1.5 million, respectively. Net of minority interest of $2.3 million and $2.4 million, respectively.
(2)		Net of deferred tax benefit of $107.3 million and $109.6 million, respectively. Net of minority interest of $5.0 million and $5.2 million, respectively.
(3)		Net of deferred tax benefit of $0.1 million and $0.1 million, respectively.
(4)		No tax effect is recorded for foreign currency translation since the foreign net assets translated are deemed indefinitely invested.
(5)		Net of deferred taxes of $0.1 million and a deferred tax benefit of $0.5 million, respectively.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

6. Loss Per Share

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

		Three Months Ended
		March 31,
(Unaudited, in millions)		2007				2006
Basic weighted-average number of common shares outstanding			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

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 and 4.9 million shares for the three months ended March 31, 2007 and March 31, 2006, respectively, 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 the three months ended March 31, 2007 were excluded from the calculation of diluted loss per share for the same reason.

7. Pension and Other Postretirement Expense

The components of net periodic benefit costs relating to Bowater’s pension and other postretirement plans are as follows for the three months ended March 31, 2007 and 2006:

		Pension Plans								Other Postretirement Plans
		Three Months Ended								Three Months Ended
		March 31,								March 31,
(Unaudited, in millions)		2007				2006				2007				2006
Components of net periodic benefit cost:
Service cost		$	9.1			$	10.9			$	0.5			$	1.0
Interest cost			30.3				29.2				3.1				4.0
Expected return on plan assets			(32.1	)			(29.6	)			—				—
Amortization of prior service cost (credit)			1.1				1.4				(2.8	)			(1.5	)
Recognized net actuarial loss			6.8				8.9				1.6				2.0
Curtailments and settlements			4.5				4.6				(3.2	)			(0.2	)
Net periodic benefit cost (credit)		$	19.7			$	25.4			$	(0.8	)		$	5.3

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

In October 2006, Bowater approved changes to its other postretirement plan for its 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. A curtailment gain of $3.2 million was recorded in the first quarter of 2007.

In December 2006, certain employees received lump-sum payouts from two of our retirement pension plans. Accordingly, we recorded settlement losses of $4.5 million in the first quarter of 2007.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

The curtailment loss of $4.6 million and curtailment gain of $0.2 million included in net periodic benefit cost in the first quarter of 2006 is due to the reduction of employees at our Thunder Bay “A” kraft pulp mill.

In January and March 2007, certain employees received lump-sum payouts from two of our retirement pension plans. As a result, we will record settlement losses of $1.1 million in the second quarter of 2007.

In February 2007, the 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 will be eliminated and a curtailment loss of approximately $2.9 million will be recorded in the second quarter of 2007. This event will also result in a settlement loss at the time the benefits are paid.

8. Income Taxes

The income tax 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
		March 31,
(Unaudited, in millions)		2007				2006
Loss before income taxes, minority interest and cumulative effect of accounting change		$	(26.6	)		$	(3.1	)
Expected income tax benefit			9.3				1.1
Increase (decrease) in income taxes resulting from:
Valuation allowance (1)			(13.0	)			(13.5	)
Foreign exchange			(0.8	)			(3.0	)
State income taxes, net of federal income tax benefit			(0.1	)			(0.8	)
Foreign taxes			0.5				1.0
Other, net			2.4				2.1
Income tax provision		$	(1.7	)		$	(13.1	)

(1)		During the first quarter of 2007 and 2006, income tax benefits of approximately $13.0 million and $13.5 million generated on our current quarter Canadian operating losses were entirely offset by tax charges to increase our valuation allowance related to these tax benefits.

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 is $28.3 million, which includes 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 $23.1 million, which includes $0.6 million of interest. If recognized, these items would impact the Consolidated Statement of Operations and our effective tax rate. We anticipate that the total amount of unrecognized tax benefits will decrease by approximately $7.0 million to $8.5 million during the next twelve months due to certain U.S. statutes of limitations closing, primarily in the third quarter of 2007. The approximately $7.0 million to $8.5 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 2003-2006.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

9. 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 enter into and designate Canadian dollar forward contracts to hedge certain of our forecasted Canadian dollar cash outflows at the Canadian mill operations, which we believe are likely to occur. Hedging contracts outstanding at March 31, 2007 have been established to hedge forecasted transactions through the second quarter of 2007. Hedge ineffectiveness associated with these 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 attempt 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 $0.1 million of pre-tax gains were recognized for the three months ended March 31, 2007 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 $0.8 million of pre-tax gains were recognized for the three months ended March 31, 2007 for contracts that we entered into in 2006 and 2007 to economically hedge forecasted transactions expected to occur through February 2008.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

Information regarding our outstanding Canadian dollar, 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 Of
										U.S.$/CDN$
										and U.S.$/GBP$
		Notional				Asset /(Liability)				Exchange Rates
(Unaudited, in millions of U.S. dollars		Amount of								and Natural Gas
except rates and prices)		Derivatives				Fair Market Value				Index Prices
As of March 31, 2007:
Foreign Currency Exchange Agreements:
Canadian dollar
Due in 2007		$	8.0			$	0.2			$	.8444 – .8444
British pound sterling
Due in 2007		$	38.9			$	0.1			$	1.9553 – 1.9732
Natural Gas Swap Agreements:
Due in 2007		$	7.7			$	0.8			$	5.78 – 8.72
Due in 2008		$	0.1			$	—			$	8.45 – 9.00
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 22% of our derivative financial instruments.

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

		Three Months Ended
		March 31,
(Unaudited, in millions)		2007				2006
Gains (losses) reclassified on matured cash flow hedges		$	1.3			$	(17.6	)
Unrealized gains for change in value on outstanding cash flow hedges			0.2				0.8
			1.5				(16.8	)
Income tax (provision) benefit			(0.6	)			6.4
Net decrease (increase) in “Accumulated other comprehensive loss”		$	0.9			$	(10.4	)

We expect to reclassify gains of $0.2 million ($0.1 million, net of tax) from “Accumulated other comprehensive loss” to the Consolidated Statement of Operations during the next twelve months as the forecasted transactions occur.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

10.		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.
		There have been no other material developments to the legal proceedings described in our Annual Report on Form 10-K filed on March 1, 2007.

11.		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.
		The following table details the share-based compensation expense (excluding the cumulative effect of accounting change) recorded in the Consolidated Statements of Operations by award:

		Three Months Ended
		March 31,
(Unaudited, in millions)		2007				2006
Stock Options		$	0.3			$	—
Restricted Stock Units			4.2				—
EPRs			0.1				(0.9	)
Share-based compensation expense (income)		$	4.6			$	(0.9	)

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

		Three Months Ended
		March 31,
(Unaudited, in millions)		2007				2006
Stock Options		$	(0.2	)		$	—
Restricted Stock Units			(1.1	)			—
EPRs			—				0.3
Tax (benefit) provision		$	(1.3	)		$	0.3

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

Stock Options

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. No stock options were granted in the first three months of 2006.

A summary of option activity under our stock plans as of and for the three months ended March 31, 2007 is presented below:

										Weighted
										Average								Aggregate
		Number Of				Weighted				Remaining								Intrinsic
		Options				Average				Contractual								Value
(Unaudited)		(000’s)				Exercise 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			(212	)			41.88
Outstanding at March 31, 2007			4,842			$	43.28				4.9							$	—
Exercisable at March 31, 2007			4,465			$	44.63				4.5							$	—

In accordance with SFAS 123R, we estimated the fair value of each stock option granted during the three months ended March 31, 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 three months ended March 31, 2007 was $9.08.

During the three months ended March 31, 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 the first quarter of 2007 or 2006.

As of March 31, 2007, there was $2.2 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 2.2 years.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

Restricted Stock Units

On January 30, 2007, we granted 327,945 restricted stock units (“RSUs”), all of which were 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 were performance-based awards. These awards vest upon closing of the merger of Bowater and Abitibi-Consolidated Inc. (“Abitibi”), or upon cancellation of the merger if the cancellation is due to a failure to receive regulatory approval or Abitibi’s acts or failures to act. Accounting guidance dictates that, for purposes of recognizing compensation expense for this type of award, the business combination is not considered “probable” until the date the merger is consummated. As vesting of these awards is predicated upon close of the merger or other events related to the business combination, no compensation expense will be recorded for these awards until consummation of the merger. In the event of the consummation of the merger, $1.0 million of compensation expense will be immediately recognized. 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 were performance-based awards. The vesting of these awards is contingent upon the realization of certain synergies within two years of consummation of the AbitbiBowater merger. 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 months ended March 31, 2007, nor were these awards included in our outstanding RSUs at the end of the period.

No restricted stock units were granted during the first three months of 2006.

A summary of the status of our restricted stock units as of March 31, 2007, and changes during the three months ended March 31, 2007, is presented below:

						Weighted Average
		Number Of Units				Fair Value at Grant
(Unaudited)		(000’s)				Date
Outstanding at December 31, 2006			665			$	26.11
Granted during the period			364				27.85
Vested during the period			—				26.35
Forfeited during the period			(4	)			26.59
Outstanding at March 31, 2007			1,025			$	26.72

As of March 31, 2007, there was $14.9 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 1.5 years. The total fair value of restricted stock units vested during the first three months of 2007 was minimal.

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

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. As of March 31, 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.

Information with respect to rights granted under the EPR Plan as of March 31, 2007 is as follows:

										Weighted
										Average
						Weighted				Remaining								Aggregate
		Number of				Average				Contractual								Intrinsic
		Rights				Exercise				Term								Value
(Unaudited)		(000’s)				Price				(years)								($000)
Outstanding at December 31, 2006			2,010			$	47.91
Granted during the period			—				—
Settled during the period			—				—
Canceled during the period			(100	)			38.93
Outstanding at March 31, 2007			1,910			$	48.14				3.4							$	—
Exercisable at March 31, 2007			1,910			$	48.14				3.4							$	—

12.		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 $6.8 million of the investor notes’ principal balance at March 31, 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 $31.7 million and obligations of approximately $27.3 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.
13.		Segment Information
		During the third quarter of 2006, we announced that we were realigning 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 changed. Our new reportable segments are coated papers, specialty papers, newsprint, market pulp, and lumber. Prior year information has been recast to the current year presentation of our reportable segments.
		None of the income or loss items following “Operating income” 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

BOWATER INCORPORATED
Notes to Consolidated Financial Statements — Unaudited

or credits are not allocated to the segments. Share-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 goodwill, 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 “Corporate and Other.”

The following tables summarize information about segment profit and loss for the three months ended March 31, 2007 and 2006 and segment assets as of March 31, 2007 and December 31, 2006:

						Coated				Specialty								Market								Corporate				Consolidated
(Unaudited, in millions)						Papers				Papers				Newsprint				Pulp				Lumber				and Other				Total
Sales
First Quarter			2007			$	128.5			$	141.2			$	302.9			$	133.1			$	62.8			$	3.1			$	771.6
First Quarter			2006				152.9				130.9				373.5				129.4				96.5				10.0				893.2
Operating Income (loss)(1)
First Quarter			2007			$	8.6			$	(8.7	)		$	(4.1	)		$	18.7			$	(13.6	)		$	24.2			$	25.1
First Quarter			2006				21.7				(8.2	)			17.8				0.3				1.3				6.9				39.8

14.		Combination with Abitibi-Consolidated Inc.
		In January 2007, Bowater and Abitibi announced a definitive agreement to combine in an all-stock “merger of equals” (the combined company is referred to as “AbitibiBowater”). The definitive agreement was amended on May 7, 2007. The combination has been approved unanimously by the Boards of Directors of both companies, which received fairness opinions from their respective financial advisors. The combination is subject to approval by the shareholders of both companies, regulatory approvals, and customary closing conditions. The combination is expected to be completed in the third quarter of 2007. Abitibi and Bowater will continue to operate separately until the transaction closes. In connection with this announced combination, we have approved a retention and severance program for approximately 320 Bowater employees who may be impacted by the pending combination with Abitibi. This program provides a retention bonus for employees who remain with Bowater through the closing of the combination or its cancellation for any reason and an additional retention bonus for employees who remain with Bowater for a transition period following closing of the combination. The costs associated with these programs are expensed as incurred. Also in connection with the combination, we have incurred $12.6 million in direct acquisition costs as of March 31, 2007. These costs have been capitalized in our Consolidated Balance Sheet under the assumption that Bowater will be deemed the acquirer in this combination for accounting purposes.

BOWATER INCORPORATED AND SUBSIDIARIES

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

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. Forward looking statements also include statements concerning our pending combination with Abitibi-Consolidated Inc. (“Abitibi”), including statements about the expected timing of such transaction, conditions to closing and anticipated post-closing operations and results. 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 “Item 1A—Risk Factors” in Part II of this Form 10-Q and from time to time, in Bowater’s other 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 Bowater believes are widely accepted and accurate; however, Bowater has 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 on 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. Bowater’s 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

We manage our business based on the products that we manufacture and sell to external customers. Our primary product lines include—coated papers, specialty papers, newsprint, market pulp, and lumber.

Our net loss for the first quarter of 2007 was $35.4 million, or $0.62 per diluted share, as compared to a net loss of $18.8 million, or $0.33 per diluted share, for the same period in 2006.

Our sales in the first quarter of 2007 were $771.6 million, a decrease of $121.6 million from the first quarter of 2006 sales of $893.2 million. Average transaction prices decreased for all of our major products except market pulp, and shipments decreased for all of our major products except specialty papers. The increase in the shipments of specialty

BOWATER INCORPORATED AND SUBSIDIARIES

papers was due primarily to the conversion of a newsprint machine at our Calhoun facility in July 2006 to produce a lightly coated freesheet hybrid product. Shipments of newsprint were significantly lower in the first quarter of 2007 compared to the first quarter of 2006 due to the curtailment of paper production at our Thunder Bay, Ontario facility beginning in September 2006 and at our Gatineau, Quebec facility and at a number of other locations beginning in March 2007 in response to a decreased demand for our product along with an increase in production costs due to the rising costs of energy and recycled fiber. We will resume operation of one of the idled paper machines at our Thunder Bay, Ontario facility during May 2007. We believe this facility’s quality assets and multiple fiber furnishes, combined with current initiatives to create a significantly improved cost structure, makes it well positioned to produce lightweight specialty grades. Shipments of market pulp decreased in the first quarter of 2007 compared to the same time period in 2006 due to the permanent closure of our Thunder Bay “A” kraft pulp mill in May 2006 and increased internal consumption of pulp. Shipments of lumber were lower in the first quarter of 2007 as compared to the first quarter of 2006 due to weak demand in the housing construction market, the sale of our Baker Brook and Degelis sawmills in 2006, and the impact of quotas imposed by the Softwood Lumber Agreement in January 2007.

Our costs decreased $79.7 million during the first quarter of 2007 as compared to the same time period in 2006, primarily due to lower volumes, lower labor, energy, and maintenance costs, a weaker Canadian dollar (which decreased from an average rate of US$0.8664 to US$0.8533), and the benefits of our cost reduction initiatives. These lower costs were partially offset by reduced benefits from our Canadian dollar hedging program, higher wood costs, particularly recycled fiber costs, and higher chemical costs. Additional information regarding the changes in our manufacturing and other costs is included below in the section “Consolidated Results of Operations.” In addition, we recorded a net gain on the disposition of assets of $57.9 million in the first quarter of 2007, primarily associated with our ongoing land sales program.

Business Strategy and Outlook

We continue to focus on improving our product mix. North American newsprint demand declined during the first quarter of 2007 and there is no indication of whether, or at what level, demand may stabilize. As a result of the changes in customer demand, we indefinitely idled paper machine no. 3 at our Gatineau, Quebec facility and curtailed production at various other facilities in March 2007. We will continue to evaluate our production options and focus on increasing production of our more profitable product lines. For example, we recently announced that paper machine no. 4 at our Thunder Bay, Ontario facility, which was idled in September 2006, will resume operation in May 2007 to produce specialty papers. As a result of the reduced newsprint demand, we took approximately 63,000 metric tons of downtime in the first quarter of 2007, including approximately 10,000 metric tons as a result of a major rebuild of a paper machine at our Calhoun mill. We believe our operations are positioned to deliver quality products and that capital reinvestment in the business can be held to appropriate levels.

We expect to spend approximately $125 million on capital projects during the remaining nine months of 2007. Spending in 2007 is expected to be $75 million lower than in 2006. This reduction in capital spending reflects our disciplined approach to limit capital expenditures to those that are expected to achieve the highest return on our assets.

We have rigorously evaluated our strategic options. This evaluation resulted in our announcement, on January 29, 2007, that we have entered into an agreement to combine with Abitibi in a merger of equals. The combination, if completed, would have a material impact on our results of operations, financial condition and liquidity going forward. Management believes that, as a result of the merger, the combined company would be operationally and financially stronger and better able to meet changing customer needs while competing more effectively in the global marketplace. We expect that the combination would generate approximately $250 million of cost synergies from improved efficiencies in such areas as production, selling, administrative, distribution and procurement costs. We expect to complete the combination in the third quarter of 2007, subject to the conditions described in our Annual Report on Form 10-K for the year ended 2006. In connection with this announced merger, we have approved a retention and severance program for approximately 320 Bowater employees who may be impacted by the pending merger with Abitibi. This program provides a retention bonus for employees who remain with Bowater through the closing of the merger or its cancellation and an additional retention bonus for employees who remain with Bowater for a transition period following closing of the merger.

BOWATER INCORPORATED AND SUBSIDIARIES

Business and Financial Review

Consolidated Results of Operations

		Three Months Ended
		March 31,
(In millions)		2007				2006				Change
Sales		$	771.6			$	893.2			$	(121.6	)
Operating income			25.1				39.8				(14.7	)
Significant items that improved (lowered) operating income:
Product pricing										$	(13.5	)
Shipment volume											(108.1	)
Change in total sales											(121.6	)
Manufacturing costs											83.7
Employee termination costs											(2.8	)
Change in total manufacturing costs and depreciation, amortization, and cost of timber harvested											80.9
Distribution costs											7.6
Selling and administrative expenses											(10.7	)
Gain on disposition of assets											29.1
										$	(14.7	)

Three months ended March 31, 2007 versus March 31, 2006

Sales decreased in the first quarter of 2007 as compared to the first quarter of 2006 due primarily to lower transaction prices for coated papers, specialty papers, newsprint and lumber and decreased shipments of coated papers, newsprint, market pulp and lumber, partially offset by higher transaction prices for market pulp and higher shipments of specialty papers as further noted in the “Segment Results of Operations” section.

Operating income decreased in the first quarter of 2007 as compared to the first quarter of 2006. The above table analyzes the major items that decreased operating income. A brief explanation of these major items follows:

Product pricing for our coated papers, specialty papers, newsprint, and lumber product groups was lower in the first quarter of 2007 as compared to the first quarter of 2006. Please refer to the discussion of “Segment Results of Operations” for a more detailed analysis of product pricing.

Shipment volume for our coated papers, newsprint, market pulp and lumber product groups was lower in the first quarter of 2007 as compared to the first quarter of 2006. Please refer to the discussion of “Segment Results of Operations” for a more detailed analysis of shipments.

Manufacturing costs were lower in the first quarter of 2007 as compared to the first quarter of 2006 resulting primarily from lower volumes ($61.2 million), lower labor ($12.6 million), energy ($8.9 million), and maintenance costs ($7.0 million), a weaker Canadian dollar ($4.0 million) and the benefits of our cost reduction initiatives, partially offset by reduced benefits from our Canadian dollar hedging program ($18.8 million), higher wood costs ($8.6 million), and higher chemical costs ($1.2 million).

Employee termination costs were higher in the first quarter of 2007 due to severance and pension settlement losses that exceeded the pension curtailment losses recorded in the first quarter of 2006. Please refer to the discussion of “Corporate and Other” for a more detailed analysis of employee termination costs.

BOWATER INCORPORATED AND SUBSIDIARIES

Distribution costs were lower in the first quarter of 2007 as compared to the first quarter of 2006, primarily as a result of the reduced shipments of product and reduced lumber duties.

Gain on disposition of assets relates primarily to land sales. The increase is due to higher land sales in the first quarter of 2007 compared to the first quarter of 2006.

Segment Results of Operations

During the third quarter of 2006, we announced that we had realigned our organizational structure to move from a divisional organization to a functional organization 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 to reflect how we internally manage our business. This Management’s Discussion and Analysis reflects our new reportable segments which are coated papers, specialty papers, newsprint, market pulp, and lumber. Prior year information has been recast to the current year presentation.

In general, our products are globally traded commodities. Pricing and the level of shipments of these products will continue to be influenced by the balance between supply and demand as affected by global economic conditions, changes in consumption and capacity, the level of customer and producer inventories and fluctuations in currency exchange rates.

BOWATER INCORPORATED AND SUBSIDIARIES

Coated Papers

		Three Months Ended March 31,
		2007				2006				2007 vs. 2006
Average price (per short ton)		$	710			$	795			$	(85	)
Shipments (thousands of short tons)			181.1				192.4				(11.3	)
Downtime (thousands of short tons)			10.1				16.8				(6.7	)
Inventory at end of the quarter (thousands of short tons)			50.5				46.3				4.2
(In millions)
Sales		$	128.5			$	152.9			$	(24.4	)
Segment income			8.6				21.7				(13.1	)
Significant items that improved (lowered) segment income:
Product pricing										$	(14.8	)
Shipment volume											(9.6	)
Change in total sales											(24.4	)
Manufacturing costs											10.7
Distribution costs											0.3
Selling and administrative expenses											0.3
										$	(13.1	)

Three months ended March 31, 2007 versus March 31, 2006

Sales decreased in the first quarter of 2007 as compared to the first quarter of 2006 primarily as a result of decreased product pricing in coated papers and slightly lower shipments. Our average transaction price decreased 10.7% and our coated mechanical papers shipments decreased 5.9% in the first quarter of 2007 as compared to the first quarter of 2006. North American demand for coated mechanical papers was down significantly in January, but we saw slight demand increases in February and March. The demand increases in February and March only partially offset the decline in January. The upcoming postal rate increase in May 2007 is expected to have a negative impact on demand for coated mechanical grades for a short period of time. Typically, customers adopt cost-containment measures such as shifting to different basis weights or grades of paper such as supercalendered grades following a postal rate increase.

Segment income decreased in the first quarter of 2007 as compared to the first quarter of 2006 primarily as a result of lower sales, as noted above. These declines were partially offset by lower manufacturing costs including lower volumes ($6.3 million), lower maintenance ($1.6 million), energy ($0.7 million) and chemical costs ($0.6 million) and lower depreciation ($0.9 million). These decreased manufacturing costs were partially offset by higher labor ($1.3 million) and wood costs ($0.4 million).

Coated Papers Third Party Data: U.S. consumer magazine advertising pages increased 1.0% in the three months ended March 31, 2007 compared to the three months ended March 31, 2006. North American demand for coated mechanical papers decreased 0.6 % in the three months ended March 31, 2007 compared to the same period in 2006.

BOWATER INCORPORATED AND SUBSIDIARIES

Specialty Papers

		Three Months Ended March 31,
		2007				2006				2007 vs. 2006
Average price (per short ton)		$	653			$	655			$	(2	)
Shipments (thousands of short tons)			216.3				199.8				16.5
Downtime (thousands of short tons)			5.8				—				5.8
Inventory at end of the quarter (thousands of short tons)			56.5				34.9				21.6
(In millions)
Sales		$	141.2			$	130.9			$	10.3
Segment loss			(8.7	)			(8.2	)			(0.5	)
Significant items that improved (lowered) segment loss:
Product pricing										$	(0.7	)
Shipment volume											11.0
Change in total sales											10.3
Manufacturing costs											(9.1	)
Distribution costs											(1.8	)
Selling and administrative expenses											0.1
										$	(0.5	)

Three months ended March 31, 2007 versus March 31, 2006

Sales increased in the first quarter of 2007 as compared to the first quarter of 2006 primarily as a result of an 8.3% increase in shipments of specialty papers partially offset by a slight decrease in product pricing. We continue to shift machine capacity from newsprint to specialty papers. We announced that paper machine No. 4 at our Thunder Bay, Ontario facility will resume operation in May 2007. The quality assets and unique multiple fiber furnishes available at this mill provide us with the opportunity to produce a variety of specialty grades. As discussed in the “Coated Papers” section, we expect the postal rate increase in May to have a short-term impact on demand for our specialty products as customers adopt cost-containment measures such as shifting to different basis weights or grades of paper such as supercalendered grades following a postal rate increase.

Segment loss increased in the first quarter of 2007 as compared to the first quarter of 2006 primarily as a result of higher manufacturing costs and higher distribution costs, partially offset by increased sales discussed above. The higher manufacturing costs consisted of higher wood and fiber costs ($4.5 million), reduced benefits from our Canadian dollar hedging program ($4.1 million), higher volumes ($3.6 million), and higher depreciation ($3.0 million), partially offset by lower energy costs ($5.5 million) and a weaker Canadian dollar ($1.2 million).

Inventory levels were higher at the end of the first quarter of 2007 as compared to the first quarter of 2006 due to increased capacity and a weaker market.

Specialty Papers Third Party Data: North American demand for supercalendered high gloss papers was up 6.0%; for lightweight or directory grades was up 5.3%; and for standard uncoated mechanical papers was down 5.1 % in the three months ended March 31, 2007 compared to the same period in 2006.

BOWATER INCORPORATED AND SUBSIDIARIES

Newsprint

		Three Months Ended March 31,
		2007				2006				2007 vs. 2006
Average price (per metric ton)		$	618			$	622			$	(4	)
Shipments (thousands of metric tons)			489.9				600.4				(110.5	)
Downtime (thousands of metric tons)			63.0				42.1				20.9
Inventory at end of the quarter (thousands of metric tons)			93.5				75.7				17.8
(In millions)
Sales		$	302.9			$	373.5			$	(70.6	)
Segment (loss) income			(4.1	)			17.8				(21.9	)
Significant items that improved (lowered) segment (loss) income:
Product pricing										$	(1.2	)
Shipment volume											(69.4	)
Change in total sales											(70.6	)
Manufacturing costs											44.1
Distribution costs											3.5
Selling and administrative expenses											1.1
										$	(21.9	)

Three months ended March 31, 2007 versus March 31, 2006

Sales decreased in the first quarter of 2007 as compared to the first quarter of 2006 primarily as a result of slightly lower product pricing and lower shipments of newsprint. Our average newsprint transaction price for all markets was slightly lower in the first quarter of 2007 compared to the first quarter of 2006. The slight decrease reflects a $30 per metric ton reduction in North American newsprint pricing, offset by modest increases in the international markets. Newsprint shipments were 18.4% lower in the first quarter of 2007 when compared to the first quarter of 2006 as we continue to match production to our orders and continue the shift of machine capacity from newsprint to specialties. Additionally, we temporarily curtailed production at our Gatineau and other facilities in the first quarter of 2007 due to weak demand of newsprint. In the first quarter of 2007, we had total downtime of 63,000 metric tons, including 10,000 metric tons of maintenance downtime primarily related to a major machine rebuild at one of our sites. We will continue to match production to our orders.

Segment income decreased to a segment loss in the first quarter of 2007 as compared to the first quarter of 2006 primarily as a result of lower sales noted above, partially offset by lower manufacturing and distribution costs. Manufacturing costs were lower as a result of lower volumes ($39.9 million), lower labor ($6.3 million) and maintenance costs ($4.6 million), lower depreciation expense ($3.3 million), and a weaker Canadian dollar ($1.4 million), partially offset by higher wood costs, particularly increased recycled fiber costs ($9.5 million), reduced benefits from our Canadian dollar hedging program ($7.5 million), and higher chemical costs ($1.4 million).

Inventory levels increased 23.5% at the end of the first quarter of 2007 as compared to the same period in 2006 due to higher mill and export warehouse inventory levels.

Newsprint Third Party Data: In the three months ended March 31, 2007, total U.S. demand and consumption of newsprint decreased 12.6% and 12.2%, respectively, as compared to the same period last year. North American net exports of newsprint were 4.3% higher than 2006 levels. Total inventories (North American mills and users) at

BOWATER INCORPORATED AND SUBSIDIARIES

March 31, 2007 were 1.3 million metric tons, or 4.2%, higher than March, 31 2006. At March 31, 2007 and 2006, the days of supply at the U.S. daily newspapers was 42 days. The North American operating rate was 94% for the three months ended March 31, 2007. Newspaper advertising linage declined 6.3% when compared to the first quarter of 2006.

Market Pulp

		Three Months Ended March 31,
		2007				2006				2007 vs. 2006
Average price (per metric ton)		$	629			$	523			$	106
Shipments (thousands of metric tons)			211.7				247.4				(35.7	)
Downtime (thousands of metric tons)			6.5				4.1				2.4
Inventory at end of the quarter (thousands of metric tons)			54.6				86.3				(31.7	)
(In millions)
Sales		$	133.1			$	129.4			$	3.7
Segment income			18.7				0.3				18.4
Significant items that improved (lowered) segment income:
Product pricing										$	21.5
Shipment volume											(17.8	)
Change in total sales											3.7
Manufacturing costs											15.3
Distribution costs											0.3
Selling and administrative expenses											(0.9	)
										$	18.4