Java, 556 532 517 496 472 433 428 420 418 381 chars
Update 1: replaced 1st StringBuffer by Appendable and 2nd by char[]. Saved 24 chars.
Update 2: found a shorter way to read file into char[]. Saved 15 chars.
Update 3: replaced one if/else by ?: and merged char[] and int declarations. Saved 21 chars.
Update 4: replaced (int)f.length() and c.length by s. Saved 24 chars.
Update 5: made improvements as per hints of Molehill. Major one was hardcoding the char length so that I could get rid of File. Saved 39 chars.
Update 6: minor refactoring. Saved 6 chars.
Update 7: replaced Integer#valueOf() by new Integer() and refactored for loop. Saved 8 chars.
Update 8: Improved neighbour calculation. Saved 2 chars.
Update 9: Optimized file reading since file length is already hardcoded. Saved 37 chars.
import java.io.*;class L{public static void main(String[]a)throws Exception{int i=new Integer(a[1]),j,l,s=3240;int[]p={-82,-81,-80,-1,1,80,81,82};char[]o,c=new char[s];for(new FileReader(a[0]).read(c);i-->0;c=o)for(o=new char[j=s];j-->0;){l=0;for(int n:p)l+=n+j>-1&n+j<s?c[n+j]/88:0;o[j]=c[j]>13?l==3|l+c[j]==90?88:'.':10;}Writer w=new FileWriter("out.txt");w.write(c);w.close();}}
More readable version:
import java.io.*;
class L{
public static void main(String[]a)throws Exception{
int i=new Integer(a[1]),j,l,s=3240;
int[]p={-82,-81,-80,-1,1,80,81,82};
char[]o,c=new char[s];
for(new FileReader(a[0]).read(c);i-->0;c=o)for(o=new char[j=s];j-->0;){
l=0;for(int n:p)l+=n+j>-1&n+j<s?c[n+j]/88:0;
o[j]=c[j]>10?l==3|l+c[j]==90?88:'.':10;
}
Writer w=new FileWriter("out.txt");w.write(c);w.close();
}
}
Closing after writing is absoletely mandatory, else the file is left empty. It would otherwise have saved another 21 chars.
Further I could also save one more char when I use 46 instead of '.', but both javac and Eclipse jerks with a compilation error Possible loss of precision. Weird stuff.
Note: this expects an input file with \n newlines, not \r\n as Windows by default uses!
