**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

** **

# **FORM 10-Q**

# ** **

**(Mark One)**

** **
| **x******                                               | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**   |
|---------------------------------------------------------|------------------------------------------------------------------------------------------------------|
| ** **                                              | ** **                                                                                           | ** ** |
| **FOR THE  QUARTERLY PERIOD ENDED MARCH 31, 2008** |
| ** **                                              | ** **                                                                                           | ** ** |
| **OR**                                                  |
| ** **                                              | ** **                                                                                           | ** ** |
| **o**                                                   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d)   OF THE SECURITIES EXCHANGE ACT OF 1934** |

** **

**CommissionFile Number 1-13953**

 

**W. R. GRACE & CO.**

 

| **Delaware**              | ** ** | **65-0773649**                        |
|---------------------------|------------|---------------------------------------|
| (State of  Incorporation) |       | (I.R.S. Employer  Identification No.) |

 

| **7500  Grace Drive  Columbia, Maryland 21044  (410) 531-4000** |
|-----------------------------------------------------------------|
| (Address and  phone number of  principal executive offices)     |

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 
|   | Yes   x | No   o |
|--------|-------------------|------------------|

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of“large accelerated filer,” “accelerated filer,” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer  x                     |   | Accelerated filer o          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer o                        |   | Smaller reporting  company o |
| (Do not check if a  smaller reporting company) |   |                              |

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).

 
|   | Yes   o | No   x |
|--------|-------------------|------------------|

 

72,108,918 shares of Common Stock, $0.01 par value, were outstanding atApril 30, 2008.

 

 

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# ** **

# **W. R. GRACE & CO. AND SUBSIDIARIES**

# ** **

## Table of Contents

 
|              |                                                                                        | **Page No.** |
|-------------------|---------------------------------------------------------------------------------------------|-------------------|
|              |                                                                                        |              |
| **Part I.**  | **Financial Information**                                                                   | ** **        |
| ** **        | ** **                                                                                  | ** **        |
| Item 1.           | Financial Statements                                                                        | I-1               |
|              |                                                                                        |              |
|              | Report of Independent  Registered Public Accounting Firm                                    | I-2               |
|              |                                                                                        |              |
|              | Consolidated Statements of  Operations                                                      | I-3               |
|              |                                                                                        |              |
|              | Consolidated Statements of  Cash Flows                                                      | I-4               |
|              |                                                                                        |              |
|              | Consolidated Balance Sheets                                                                 | I-5               |
|              |                                                                                        |              |
|              | Consolidated Statements of  Shareholders’ Equity (Deficit)                             | I-6               |
|              |                                                                                        |              |
|              | Consolidated Statements of Comprehensive  Income (Loss)                                     | I-6               |
|              |                                                                                        |              |
|              | Notes to  Consolidated Financial Statements                                                 | I-7               |
|              |                                                                                        |              |
| Item 2.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | I-36              |
|              |                                                                                        |              |
| Item 3.           | Quantitative  and Qualitative Disclosures About Market Risk                                 | I-54              |
|              |                                                                                        |              |
| Item 4.           | Controls and  Procedures                                                                    | I-54              |
|              |                                                                                        |              |
| **Part II.** | **Other Information**                                                                       | ** **        |
| ** **        | ** **                                                                                  | ** **        |
| Item 1.           | Legal Proceedings                                                                           | II-1              |
|              |                                                                                        |              |
| Item  1A.         | Risk Factors                                                                                | II-1              |
|              |                                                                                        |              |
| Item  6.          | Exhibits                                                                                    | II-2              |

 

*Grace**®**, the Grace**®** logo and, except as otherwise indicated, theother trademarks in this Report are trademarks or registered trademarks of W.R. Grace & Co. — Conn. or its subsidiaries in the United States and/orother countries. OCR**®** is a registered trademark of ChevronIntellectual Property, LLC.  As usedherein,**®* * indicates that a trademark is registered inthe United States and/or other countries. Unless the context otherwise indicates, in this document the terms “Grace,”“we,” “us,” “our” or “the company” mean W. R. Grace & Co. and/or itsconsolidated subsidiaries and affiliates. Unless otherwise indicated, the contents of websites mentioned in thisReport are not incorporated by reference or otherwise made a part of thisReport.*

 

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### ** **

### **PART I.  FINANCIAL INFORMATION**

### ** **

**Item1.  FINANCIAL STATEMENTS**

** **

Review by Independent Registered PublicAccounting Firm

 

Withrespect to the interim consolidated financial statements included in thisQuarterly Report on Form 10-Q for the three months ended March 31,2008 and 2007, PricewaterhouseCoopers LLP, the company’s independent registeredpublic accounting firm, has applied limited procedures in accordance withprofessional standards for a review of such information.  Their report on the interim consolidatedfinancial statements, which follows, states that they did not audit and they donot express an opinion on the unaudited interim financial statements.  Accordingly, the degree of reliance on theirreport on the unaudited interim financial statements should be restricted inlight of the limited nature of the review procedures applied.  This report is not considered a “report”within the meaning of Sections 7 and 11 of the Securities Act of 1933, and,therefore, the independent accountants’ liability under Section 11 doesnot extend to it.

 

I-1

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### ** **

### **Reportof Independent Registered Public Accounting Firm**

### ** **

**To the Shareholders and Board of Directors of W. R. Grace &Co.:**

** **

Wehave reviewed the accompanying consolidated balance sheet of W. R. Grace &Co. and its subsidiaries as of March 31, 2008, and the relatedconsolidated statements of operations, cash flows, shareholders’ equity(deficit) and comprehensive income (loss) for each of the three-month periodsended March 31, 2008 and March 31, 2007. These interim financialstatements are the responsibility of the Company’s management.

 

We conducted our review in accordance withthe standards of the Public Company Accounting Oversight Board (United States).A review of interim financial information consists principally of applyinganalytical procedures and making inquiries of persons responsible for financialand accounting matters. It is substantially less in scope than an auditconducted in accordance with the standards of the Public Company AccountingOversight Board (United States), the objective of which is the expression of anopinion regarding the financial statements taken as a whole. Accordingly, we donot express such an opinion.

 

Basedon our review, we are not aware of any material modifications that should bemade to the accompanying interim consolidated financial statements for them tobe in conformity with accounting principles generally accepted in the UnitedStates of America.

 

Theaccompanying interim consolidated financial statements have been preparedassuming that the Company will continue as a going concern.  As discussed in Notes 1 and 2 to the interimconsolidated financial statements, on April 2, 2001, the Company andsubstantially all of its domestic subsidiaries voluntarily filed for protectionunder Chapter 11 of the United States Bankruptcy Code, which raises substantialdoubt about the Company’s ability to continue as a going concern in its presentform.  Management’s intentions withrespect to this matter are also described in Notes 1 and 2.  The accompanying interim consolidatedfinancial statements do not include any adjustments that might result from theoutcome of this uncertainty.

 

Wehave previously audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheet asof December 31, 2007, and the related consolidated statements ofoperations, cash flows, shareholders’ equity (deficit) and comprehensive income(loss) for the year then ended (not presented herein), and in our report dated February 29,2008, we expressed an unqualified opinion on those consolidated financialstatements with an explanatory paragraph relating to the Company’s ability tocontinue as a going concern.  In ouropinion, the information set forth in the accompanying consolidated balancesheet as of December 31, 2007, is fairly stated in all material respectsin relation to the consolidated balance sheet from which it has been derived.

 

 

# **/s/ PricewaterhouseCoopers LLP**

McLean,Virginia

May 9, 2008

 

I-2

----

 

### **W. R. Grace & Co. and Subsidiaries**

**ConsolidatedStatements of Operations (Unaudited)**

*(Inmillions, except per share amounts)*

 
| ** **                                        | ** ** | **Three Months  Ended  March 31,** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                        | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| Net sales                                         |       | **$**                                        | **759.2**  | ** ** | $ | 715.6 |   |
| Cost of goods  sold                               | ** ** | **527.2**                                    | ** ** | 497.7 |   |
| Selling, general  and administrative expenses     | ** ** | **142.8**                                    | ** ** | 135.2 |   |
| Research and  development expenses                | ** ** | **21.7**                                     | ** ** | 18.7 |   |
| Defined benefit  pension expense                  | ** ** | **14.3**                                     | ** ** | 12.7 |   |
| Interest expense  and related financing costs     | ** ** | **15.1**                                     | ** ** | 19.4 |   |
| Provision for  environmental remediation          | ** ** | **5.9**                                      | ** ** | — |   |
| Chapter 11  expenses, net of interest income      |       | **18.4**                                     | ** ** | 17.8 |   |
| Other (income)  expense, net                      | ** ** | **(17.3**                                    | **)**      | (8.0 | ) |
| ** **                                        |       | ** **                                   | **728.1**  | ** ** |   | 693.5 |   |
| Income before  income taxes and minority interest | ** ** | **31.1**                                     | ** ** | 22.1 |   |
| Provision for  income taxes                       | ** ** | **(15.6**                                    | **)**      | (14.9 | ) |
| Minority  interest in consolidated entities       | ** ** | **(1.9**                                     | **)**      | (2.4 | ) |
| **Net  income**                                   | ** ** | **$**                                        | **13.6**   | ** ** | $ | 4.8 |   |
|                                              |       |                                         | ** ** |   |   |
| **Basic  earnings per share:**                    |       |                                         | ** ** |   |   |
| Net income                                        | ** ** | **$**                                        | **0.19**   | ** ** | $ | 0.07 |   |
| Weighted average  number of basic shares          | ** ** | **72.5**                                     | ** ** | 69.4 |   |
|                                              |       |                                         | ** ** |   |   |
| **Diluted  earnings per share:**                  |       |                                         | ** ** |   |   |
| Net income                                        | ** ** | **$**                                        | **0.19**   | ** ** | $ | 0.07 |   |
| Weighted average  number of diluted shares        |       | **73.2**                                     | ** ** | 70.5 |   |

 

The Notes toConsolidated Financial Statements are an integral part of these statements.

 

I-3

----

 

**W. R.Grace & Co. and Subsidiaries**

**Consolidated Statements of Cash Flows (Unaudited)**

*(Inmillions)*

 
| ** **                                                                             | ** ** | **Three Months  Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                             | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| **OPERATING  ACTIVITIES**                                                              |       |                                         | ** ** |   |   |
| Net income                                                                             | ** ** | **$**                                        | **13.6**   | ** ** | $ | 4.8 |   |
| Reconciliation  to net cash used for operating activities:                             |       |                                         | ** ** |   |   |
| Depreciation and  amortization                                                         | ** ** | **30.2**                                     | ** ** | 27.6 |   |
| Chapter 11  expenses, net of interest income                                           | ** ** | **18.4**                                     | ** ** | 17.8 |   |
| Provision for  income taxes                                                            | ** ** | **15.6**                                     | ** ** | 14.9 |   |
| Income taxes  paid, net of refunds                                                     | ** ** | **(15.4**                                    | **)**      | (2.5 | ) |
| Minority  interest in consolidated entities                                            | ** ** | **1.9**                                      | ** ** | 2.4 |   |
| Dividends paid  to minority interests in consolidated entities                         | ** ** | **—**                                   | ** ** | (11.8 | ) |
| Interest accrued  on pre-petition liabilities subject to compromise                    | ** ** | **14.3**                                     | ** ** | 19.1 |   |
| Net (gain) loss  on sales of investments and disposals of assets                       | ** ** | **(1.6**                                     | **)**      | (0.2 | ) |
| Defined benefit  pension expense                                                       | ** ** | **14.3**                                     | ** ** | 12.7 |   |
| Payments under  defined benefit pension arrangements                                   | ** ** | **(19.5**                                    | **)**      | (32.4 | ) |
| Net payments  under postretirement benefit plans                                       | ** ** | **(1.1**                                     | **)**      | (0.2 | ) |
| Net income from  life insurance policies                                               | ** ** | **(1.1**                                     | **)**      | (2.0 | ) |
| Provision for  uncollectible receivables                                               | ** ** | **0.4**                                      | ** ** | 0.6 |   |
| Provision for  environmental remediation                                               | ** ** | **5.9**                                      | ** ** | — |   |
| Expenditures for  environmental remediation                                            |       | **(1.3**                                     | **)**      | (2.8 | ) |
| Expenditures for  retained obligations of divested businesses                          | ** ** | **—**                                   | ** ** | (0.4 | ) |
| Changes in  assets and liabilities, excluding effect of foreign currency translation:  |       |                                         | ** ** |   |   |
| Working capital  items (trade accounts receivable, inventories and accounts payable)   | ** ** | **(20.8**                                    | **)**      | (7.1 | ) |
| Other accruals  and non-cash items                                                     | ** ** | **(87.5**                                    | **)**      | (61.0 | ) |
| **Net  cash used for operating activities before Chapter 11 expenses and settlements** | ** ** | **(33.7**                                    | **)**      | (20.5 | ) |
| Cash paid to  resolve contingencies subject to Chapter 11                              | ** ** | **—**                                   | ** ** | (10.3 | ) |
| Chapter 11  expenses paid                                                              | ** ** | **(14.0**                                    | **)**      | (18.2 | ) |
| **Net  cash used for operating activities**                                            | ** ** | **(47.7**                                    | **)**      | (49.0 | ) |
| ** **                                                                             |       |                                         | ** ** |   |   |
| **INVESTING  ACTIVITIES**                                                              |       |                                         | ** ** |   |   |
| Capital  expenditures                                                                  | ** ** | **(25.9**                                    | **)**      | (24.1 | ) |
| Proceeds from  sales of investment securities                                          | ** ** | **33.1**                                     | ** ** | — |   |
| Purchase of  equity investment                                                         | ** ** | **(3.0**                                     | **)**      | — |   |
| Net investment  in life insurance policies                                             | ** ** | **—**                                   | ** ** | 0.2 |   |
| Proceeds from  disposals of assets                                                     | ** ** | **2.5**                                      | ** ** | 0.7 |   |
| **Net  cash provided by (used for) investing activities**                              | ** ** | **6.7**                                      | ** ** | (23.2 | ) |
| ** **                                                                             |       |                                         | ** ** |   |   |
| **FINANCING  ACTIVITIES**                                                              |       |                                         | ** ** |   |   |
| Net (repayments)  borrowings under credit arrangements                                 | ** ** | **(1.5**                                     | **)**      | (1.1 | ) |
| Fees paid under  debtor-in-possession credit facility                                  | ** ** | **(0.7**                                     | **)**      | (0.7 | ) |
| Proceeds from  exercise of stock options                                               | ** ** | **8.9**                                      | ** ** | 14.2 |   |
| **Net  cash provided by financing activities**                                         | ** ** | **6.7**                                      | ** ** | 12.4 |   |
| Effect of  currency exchange rate changes on cash and cash equivalents                 | ** ** | **14.6**                                     | ** ** | 2.8 |   |
| **Decrease  in cash and cash equivalents**                                             | ** ** | **(19.7**                                    | **)**      | (57.0 | ) |
| Cash and cash  equivalents, beginning of period                                        | ** ** | **480.5**                                    | ** ** | 536.3 |   |
| Cash and cash  equivalents, end of period                                              | ** ** | **$**                                        | **460.8**  | ** ** | $ | 479.3 |   |

 

The Notes toConsolidated Financial Statements are an integral part of these statements.

 

I-4

----

 

**W. R.Grace & Co. and Subsidiaries**

**Consolidated BalanceSheets**

*(In millions, except par valueand shares)*

 
| ** **                                                                                                                          | ** ** | **March 31,  2008** |        | **December 31,  2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|-------------|-----------------------------|------------|
| ** **                                                                                                                          | ** ** | **(unaudited)**          |        | ** **                  | ** ** |
| **ASSETS**                                                                                                                          |       |                     |        |                        |       |
| **Current  Assets**                                                                                                                 |       |                     |        |                        |       |
| Cash and cash  equivalents                                                                                                          | ** ** | **$**                    | **460.8**   |                        | $          | 480.5 |   |
| Investment  securities                                                                                                              | ** ** | **64.0**                 |        | 98.3                        |       |
| Cash value of  life insurance policies, net of policy loans                                                                         | ** ** | **78.2**                 |        | 77.1                        |       |
| Trade accounts  receivable, less allowance of $5.6 (2007 - $5.2)                                                                    | ** ** | **488.1**                |        | 500.6                       |       |
| Inventories                                                                                                                         | ** ** | **371.9**                |        | 303.5                       |       |
| Deferred income  taxes                                                                                                              | ** ** | **34.7**                 |        | 37.7                        |       |
| Other current  assets                                                                                                               | ** ** | **90.4**                 |        | 80.8                        |       |
| **Total  Current Assets**                                                                                                           | ** ** | ** **               | **1,588.1** |                        |       | 1,578.5 |   |
| Properties and  equipment, net of accumulated depreciation and amortization of $1,615.8 (2007  - $1,545.0)                          | ** ** | **722.9**                |        | 706.1                       |       |
| Goodwill                                                                                                                            | ** ** | **128.1**                |        | 122.3                       |       |
| Cash value of  life insurance policies, net of policy loans                                                                         | ** ** | **3.9**                  |        | 3.9                         |       |
| Deferred income  taxes                                                                                                              | ** ** | **768.1**                |        | 767.5                       |       |
| Asbestos-related  insurance                                                                                                         | ** ** | **500.0**                |        | 500.0                       |       |
| Overfunded  defined benefit pension plans                                                                                           | ** ** | **75.6**                 |        | 54.1                        |       |
| Other assets                                                                                                                        | ** ** | **140.6**                |        | 136.6                       |       |
| **Total  Assets**                                                                                                                   | ** ** | **$**                    | **3,927.3** |                        | $          | 3,869.0 |   |
|                                                                                                                                |       |                     |        |                        |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY (DEFICIT)**                                                                            |       |                     |        |                        |       |
| **Liabilities  Not Subject to Compromise**                                                                                          |       |                     |        |                        |       |
| **Current  Liabilities**                                                                                                            |       |                     |        |                        |       |
| Debt payable  within one year                                                                                                       | ** ** | **$**                    | **3.2**     |                        | $          | 4.7 |   |
| Accounts payable                                                                                                                    | ** ** | **203.6**                |        | 191.3                       |       |
| Other current  liabilities                                                                                                          | ** ** | **290.5**                |        | 325.1                       |       |
| **Total  Current Liabilities**                                                                                                      | ** ** | **497.3**                |        | 521.1                       |       |
| Debt payable  after one year                                                                                                        | ** ** | **0.3**                  |        | 0.3                         |       |
| Deferred income  taxes                                                                                                              | ** ** | **34.0**                 |        | 32.7                        |       |
| Minority  interest in consolidated entities                                                                                         | ** ** | **71.8**                 |        | 70.8                        |       |
| Underfunded  defined benefit pension plans                                                                                          | ** ** | **192.9**                |        | 169.1                       |       |
| Unfunded  pay-as-you-go defined benefit pension plans                                                                               | ** ** | **140.8**                |        | 137.9                       |       |
| Other  liabilities                                                                                                                  | ** ** | **55.8**                 |        | 46.2                        |       |
| **Total  Liabilities Not Subject to Compromise**                                                                                    | ** ** | ** **               | **992.9**   |                        |       | 978.1 |   |
|                                                                                                                                |       |                     |        |                        |       |
| **Liabilities  Subject to Compromise – Note 2**                                                                                |       |                     |        |                        |       |
| Pre-petition  bank debt plus accrued interest                                                                                       |       | **795.1**                |        | 783.0                       |       |
| Drawn letters of  credit plus accrued interest                                                                                      | ** ** | **27.1**                 |        | 26.9                        |       |
| Income tax  contingencies                                                                                                           | ** ** | **86.3**                 |        | 89.3                        |       |
| Asbestos-related  contingencies                                                                                                     | ** ** | **1,700.0**              |        | 1,700.0                     |       |
| Environmental  contingencies                                                                                                        | ** ** | **373.2**                |        | 368.6                       |       |
| Postretirement  benefits                                                                                                            | ** ** | **170.2**                |        | 172.7                       |       |
| Other  liabilities and accrued interest                                                                                             | ** ** | **139.2**                |        | 137.0                       |       |
| **Total  Liabilities Subject to Compromise**                                                                                        | ** ** | **3,291.1**              |        | 3,277.5                     |       |
| **Total  Liabilities**                                                                                                              | ** ** | ** **               | **4,284.0** |                        |       | 4,255.6 |   |
| **Commitments  and Contingencies**                                                                                                  |       |                     |        |                        |       |
| **Shareholders’  Equity (Deficit)**                                                                                            |       |                     |        |                        |       |
| Common stock  issued, par value $0.01; 300,000,000 shares authorized; outstanding: 2008 –  72,090,418 (2007 – 71,627,901) | ** ** | **0.8**                  |        | 0.8                         |       |
| Paid-in capital                                                                                                                     | ** ** | **434.9**                |        | 431.5                       |       |
| Accumulated  deficit                                                                                                                | ** ** | **(391.5**               | **)**       | (405.1                      | )          |
| Treasury stock,  at cost: shares: 2008 – 4,889,342; (2007 – 5,351,859)                                                    | ** ** | **(58.2**                | **)**       | (63.7                       | )          |
| Accumulated  other comprehensive income (loss)                                                                                      | ** ** | **(342.7**               | **)**       | (350.1                      | )          |
| **Total  Shareholders’ Equity (Deficit)**                                                                                      | ** ** | **(356.7**               | **)**       | (386.6                      | )          |
| **Total  Liabilities and Shareholders’ Equity (Deficit)**                                                                      | ** ** | **$**                    | **3,927.3** | ** **                  | $          | 3,869.0 |   |

** **

The Notes toConsolidated Financial Statements are an integral part of these statements.

 

I-5

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**W. R.Grace & Co. and Subsidiaries**

**Consolidated Statementsof Shareholders’ Equity (Deficit) (Unaudited)**

*(In millions)*

 
| ** **                           | ** ** | **Common  Stock  and  Paid-in Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Treasury  Stock** | ** ** | **Accumulated  Other  Comprehensive  Income  (Loss)** | ** ** | **Total  Shareholders’   Equity  (Deficit)** | ** ** |
|--------------------------------------|------------|----------------------------------------------|------------|--------------------------|------------|---------------------|------------|-------------------------------------------------------|------------|--------------------------------------------------------|------------|
| **Balance,  December 31, 2007** |       | $                                            | 432.3      |                     | $          | (405.1              | )          | $                                                     | (63.7      | )                                                      | $          | (350.1 | ) | $ | (386.6 | ) |
| Net income                           |       | —                                       |       | 13.6                     |       | —              |       | —                                                |       | 13.6                                                   |       |
| Stock plan  activity                 |       | 3.4                                          |       | —                   |       | 5.5                 |       | —                                                |       | 8.9                                                    |       |
| Other  comprehensive income (loss)   |       | —                                       |       | —                   |       | —              |       | 7.4                                                   |       | 7.4                                                    |       |
| **Balance,  March 31, 2008**    | ** ** | **$**                                        | **435.7**  | ** **               | **$**      | **(391.5**          | **)**      | **$**                                                 | **(58.2**  | **)**                                                  | **$**      | **(342.7** | **)** | **$** | **(356.7** | **)** |

** **

**W. R. Grace & Co. andSubsidiaries**

**Consolidated Statements of Comprehensive Income(Loss) (Unaudited)**

*(In millions)*

 
| ** **                                                                                 | ** ** | **Three Months  Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| **Net  income**                                                                            | ** ** | **$**                                        | **13.6**   |   | $ | 4.8 |   |
|                                                                                       |       |                                         |       |   |   |
| **Other  comprehensive income (loss):**                                                    |       |                                         |       |   |   |
| Foreign currency  translation adjustments                                                  | ** ** | **1.9**                                      |       | 5.7 |   |
| Gain (loss) from  hedging activities, net of income taxes                                  | ** ** | **2.2**                                      |       | 1.1 |   |
| Defined benefit  pension and other postretirement plans, net of income taxes (see Note 12) | ** ** | **3.3**                                      |       | (0.4 | ) |
| Total other  comprehensive income (loss)                                                   | ** ** | **$**                                        | **7.4**    | ** ** | $ | 6.4 | ** ** |
| **Comprehensive  income (loss)**                                                           | ** ** | **$**                                        | **21.0**   | ** ** | $ | 11.2 | ** ** |

** **

The Notes toConsolidated Financial Statements are an integral part of these statements.

 

I-6

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**W. R. Grace & Co. andSubsidiaries**

**Notes to Consolidated Financial Statements (Unaudited)**

** **

**1.****             ****Basis of Presentation and Summaryof Significant Accounting and Financial Reporting Policies**

 

W. R. Grace &Co., through its subsidiaries, is engaged in specialty chemicals and specialtymaterials businesses on a worldwide basis through two operating segments: “GraceDavison,” which includes specialty catalysts and materials used in a wide rangeof energy, refining, consumer, industrial, packaging and life sciencesapplications; and “Grace Construction Products,” which includes specialtychemicals and materials used in commercial, infrastructure and residentialconstruction.

 

W. R. Grace &Co. conducts substantially all of its business through a direct, wholly-ownedsubsidiary,W. R. Grace & Co.-Conn. (“Grace-Conn.”). Grace-Conn. ownssubstantially all of the assets, properties and rights of W. R. Grace &Co. on a consolidated basis, either directly or through subsidiaries.

 

As used in these notes,the term “Company” refers to W. R. Grace & Co. The term “Grace” refersto the Company and/or one or more of its subsidiaries and, in certain cases,their respective predecessors.

 

***Voluntary Bankruptcy Filing***– During 2000 and the first quarter of2001, Grace experienced several adverse developments in its asbestos-relatedlitigation, including: a significant increase in personal injury claims, higherthan expected costs to resolve personal injury and certain property damageclaims, and class action lawsuits alleging damages from Zonolite AtticInsulation (“ZAI”), a former Grace attic insulation product.

 

After a thorough reviewof these developments, Grace’s Board of Directors concluded that a federalcourt-supervised bankruptcy process provided the best forum available to achievefairness in resolving these claims and on April 2, 2001 (the “FilingDate”), Grace and 61 of its United States subsidiaries and affiliates,including Grace-Conn. (collectively, the “Debtors”), filed voluntary petitionsfor reorganization (the “Filing”) under Chapter 11 of the United StatesBankruptcy Code in the United States Bankruptcy Court for the District ofDelaware (the “Bankruptcy Court”). The cases were consolidated and are beingjointly administered under case number 01-01139 (the “Chapter 11 Cases”). Grace’snon-U.S. subsidiaries and certain of its U.S. subsidiaries were not included inthe Filing.

 

Under Chapter 11, theDebtors have continued to operate their businesses as debtors-in-possessionunder court protection from creditors and claimants, while using the Chapter 11process to develop and implement a plan for addressing the asbestos-relatedclaims. Since the Filing, all motions necessary to conduct normal businessactivities have been approved by the Bankruptcy Court. (See Note 2 for Chapter11-Related Information.)

* *

***Basis of Presentation*******– The interim Consolidated Financial Statementspresented herein are unaudited and should be read in conjunction with theConsolidated Financial Statements presented in the Company’s 2007 Annual Reporton Form 10-K.  Such interimConsolidated Financial Statements reflect all adjustments that, in the opinionof management, are necessary for a fair presentation of the results of theinterim periods presented; all such adjustments are of a normal recurringnature. Potential accounting adjustments discovered during normal reporting andaccounting processes are evaluated on the basis of materiality, bothindividually and in the aggregate, and are recorded in the accounting perioddiscovered, unless a restatement of a prior period is necessary. Allsignificant intercompany accounts and transactions have been eliminated.

 

The results of operations for the three-month interim period ended March 31,2008 are not necessarily indicative of the results of operations for the yearending December 31, 2008.

 

***Reclassifications*******–****Certainamounts in prior years’ Consolidated Financial Statements have beenreclassified to conform to the 2008 presentation.  In the fourth quarter of 2007, Gracecompleted the transfer of its packaging technologies product group to the GraceDavison segment in an effort to capture operating synergies. All 2007 segmentinformation herein has been retrospectively restated to reflect thisrealignment of the packaging technologies product group.  The former Grace Performance Chemicalssegment has been renamed “Grace Construction Products” as a result of thetransfer.  Other than the realignment ofoperating segments, reclassifications have not 

 

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materially affectedpreviously reported amounts in the Consolidated Financial Statements.

 

***Use of Estimates*******–****Thepreparation of financial statements in conformity with U.S. generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amount of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the Consolidated FinancialStatements, and the reported amounts of revenues and expenses for the periodspresented. Actual amounts could differ from those estimates, and thedifferences could be material.  Changesin estimates are recorded in the period identified.  Grace’s accounting measurements that are mostaffected by management’s estimates of future events are:

 

·                  Contingent liabilities, which depend on an assessment of theprobability of loss and an estimate of ultimate resolution cost, such asasbestos-related matters (see Notes 2 and 3), environmental remediation (seeNote 13), income taxes (see Note 4), and litigation (see Note 13);

 

·                  Pension and postretirement liabilities that depend on assumptionsregarding participant life spans, future inflation, discount rates and totalreturns on invested funds (see Note 14); and

 

·                  Realization values of net deferred tax assets and insurancereceivables, which depend on projections of future income and cash flows andassessments of insurance coverage and insurer solvency.

 

The accuracy ofmanagement’s estimates may be materially affected by the uncertainties arisingunder Grace’s Chapter 11 proceeding.

 

***Effect of New Accounting Standards*******– In September 2006, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards (“SFAS”) No. 157, “Fair Value Measurements.”  SFAS No. 157 defines fair value,establishes a framework for measuring fair value, and expands disclosures aboutfair value measurements.  In February 2008,the FASB issued FASB Staff Position (“FSP”) 157-1, “Application of FASBStatement No. 157 to FASB Statement No. 13 and Other AccountingPronouncements That Address Fair Value Measurements for Purposes of LeaseClassification or Measurement under Statement 13”, and FSP 157-2, “EffectiveDate of FASB Statement No. 157”. FSP 157-1 amends SFAS No. 157 to remove certain leasing transactionsfrom its scope.  FSP 157-2 delays theeffective date of SFAS No. 157 for all non-financial assets andnon-financial liabilities, except for items that are recognized or disclosed atfair value in the financial statements on a recurring basis (at leastannually), until fiscal years beginning after November 15, 2008.  Grace has adopted SFAS No. 157 and therelated FSPs in the first quarter of 2008, and the adoption for Grace’sfinancial assets and liabilities did not have a material impact on itsConsolidated Financial Statements.  Gracedoes not believe the adoption of SFAS No. 157 for its non-financial assetsand liabilities, effective January 1, 2009, will have a material impact onits Consolidated Financial Statements. See Note 6 for further discussion of SFAS No. 157.

 

In March 2008, the FASB issued SFAS No. 161 “Disclosuresabout Derivative Instruments and Hedging Activities - an amendment of FASBStatement No. 133.”  SFAS No. 161expands the current disclosure framework by requiring entities to providequalitative disclosures about the objectives and strategies for usingderivatives, quantitative data about the fair value of and gains and losses onderivative contracts, and details of credit-risk-related contingent features intheir hedged positions.  SFAS No. 161is effective for fiscal years beginning after November 15, 2008.

 

In February 2007, the FASB issued SFAS No. 159, “The FairValue Option for Financial Assets and Financial Liabilities.”  SFAS No. 159 permits entities to measuremany financial instruments and certain other items at fair value.  SFAS No. 159 is effective for the firstquarter of 2008.  Grace has elected notto measure eligible financial assets and liabilities at fair value that are notcurrently required to be so measured.

 

In November 2006,the FASB Emerging Issues Task Force (“EITF”) promulgated Issue No. 06-10, “Accountingfor Deferred Compensation and Postretirement Benefit Aspects of CollateralAssignment Split-Dollar Life Insurance Arrangement.”  This Issue specifies that if a companyprovides a benefit to an employee under a collateral assignment split-dollarlife insurance arrangement that extends to postretirement periods or providesan employee with a death benefit, it would have to recognize a liability and relatedcompensation costs.  Grace adopted EITF06-10 in 

 

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the first quarterof 2008, and it had no impact to the Consolidated Financial Statements.

 

In December 2007,the FASB issued SFAS No. 141(R), “Business Combinations.”  SFAS No. 141(R) will require theacquirer in a business combination to recognize the assets acquired, theliabilities assumed, and any noncontrolling interest in the acquiree at theacquisition date, measured at their fair values as of that date, withacquisition-related costs recognized separately from the acquisition.  SFAS No. 141(R) appliesprospectively to business combinations occurring on or after the beginning ofthe first annual reporting period beginning on or after December 15, 2008.

 

In December 2007,the FASB issued SFAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements.”  SFAS No. 160establishes new accounting and reporting standards for the noncontrollinginterest in a subsidiary and for the deconsolidation of a subsidiary.  SFAS No. 160 is effective for fiscalyears beginning on or after December 15, 2008.

 

**2.****             ****Chapter 11 - Related Information**

*** ***

***Official Parties to Grace’s Chapter 11 Proceedings*****–**Three creditors’ committees, tworepresenting asbestos claimants, the Official Committee of Asbestos PersonalInjury Claimants (the “PI Committee”) and the Official Committee of AsbestosProperty Damage Claimants (the “PD Committee”), and a third representing othergeneral unsecured creditors, and the Official Committee of Equity SecurityHolders (the “Equity Committee”), have been appointed in the Chapter 11 Cases.These committees, and a legal representative of future asbestos claimants (the “FCR”),have the right to be heard on all matters that come before the Bankruptcy Courtand have important roles in the Chapter 11 Cases. The Debtors are required tobear certain costs and expenses of the committees and of the FCR, includingthose of their counsel and financial advisors.

 

As discussed below, the Debtors, supported bythe committee representing general unsecured creditors and the EquityCommittee, as co-proponents, have filed a plan of reorganization with theBankruptcy Court.  The PI Committee andthe FCR, as co-proponents, also have filed a separate plan of reorganizationwith the Bankruptcy Court.  Each of theseplans of reorganization is designed to address all pending and futureasbestos-related claims and all other pre-petition claims as outlined therein.  Subsequent to these filings, on April 6,2008, the Debtors, the Equity Committee, the PI Committee and the FCR enteredinto an agreement in principle that would settle all present and futureasbestos-related personal injury claims. The committee representing general unsecured creditors and the PD Committeeare not parties to this agreement in principle. The Debtors, Equity Committee, PI Committee and FCR contemplate that ajoint plan of reorganization reflecting the terms of the agreement in principlewould be filed with the Bankruptcy Court and would supersede the existing planson file.

 

***Plans of Reorganization*****-******OnNovember 13, 2004, Grace filed a plan of reorganization, as well asseveral associated documents, including a disclosure statement, trustdistribution procedures, exhibits and other supporting documents, with theBankruptcy Court.  On January 13,2005, Grace filed an amended plan of reorganization (the “Debtors Plan”) andrelated documents to address certain objections of creditors and otherinterested parties.  At the time it wasfiled, the Debtors Plan was supported by the committee representing generalunsecured creditors and the Equity Committee, but was not supported by the PICommittee, the PD Committee or the FCR.

 

On July 26, 2007, the Bankruptcy Court terminated Grace’sexclusive rights to propose a plan of reorganization and solicit votesthereon.  As a result of the terminationof these rights, any party-in-interest may propose a competing plan ofreorganization.

 

On November 5, 2007,the PI Committee and the FCR filed a proposed plan of reorganization (the “PIPlan”, and with the Debtors Plan, the “Plans”) with the Bankruptcy Court.  Copies of the Plans are available from theBankruptcy Court.  The filing did notinclude a disclosure statement, trust distribution procedures, exhibits orother supporting documents.

 

On April 6, 2008,the Debtors reached an agreement in principle with the PI Committee, the FCR,and the Equity Committee that would settle all present and futureasbestos-related personal injury claims, as further described below (the “PISettlement”).  The PI Settlementcontemplates that the Debtors, the PI Committee, the FCR and the EquityCommittee would file a new joint plan of reorganization with the BankruptcyCourt reflecting the terms and conditions of the PI Settlement.  The drafting and negotiation of the jointplan and related documentation is in progress. The committee 

 

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representinggeneral unsecured creditors and the PD Committee are not parties to the PI Settlement.  Neither the PI Settlement nor a joint plan ofreorganization reflecting its terms has been filed with the Bankruptcy Court.

 

TheBankruptcy Court had previously entered a case management order for estimatingliability for pending and future asbestos personal injury claims.  A trial for estimating liability for such claims began in January 2008but was suspended in April 2008 as a result of the PI Settlement.

 

Any plan ofreorganization, including either of the Plans, a plan reflecting the PI Settlementand any plan of reorganization that may be filed in the future by aparty-in-interest, will become effective only after a vote of eligiblecreditors and with the approval of the Bankruptcy Court and the U.S. DistrictCourt for the District of Delaware. Votes on a plan of reorganization may not be solicited until theBankruptcy Court approves a related disclosure statement.

 

Each of the Plans and the PISettlement assumes that Cryovac, Inc. (“Cryovac”), a wholly-ownedsubsidiary of Sealed Air Corporation (“Sealed Air”), will pay $512.5 million incash (plus interest at 5.5% compounded annually from December 21, 2002)and will issue 18 million shares (reflecting a two-for-one stock split) ofcommon stock of Sealed Air to an asbestos trust pursuant to the terms of asettlement agreement resolving asbestos-related, successor liability andfraudulent transfer claims against Sealed Air and Cryovac, as further describedbelow (the “Sealed Air Settlement”).  Thevalue of the Sealed Air Settlement changes daily with the accrual of interestand the trading value of Sealed Air common stock. The Sealed Air Settlement hasbeen approved by the Bankruptcy Court, but remains subject to the fulfillmentof specified conditions.

 

Each of the Plans and the PISettlement contemplate that a trust would be established under Section 524(g) of theBankruptcy Code (the “Asbestos Trust”) to which asbestos-related personalinjury claims would be channeled for resolution.

 

The Debtors Plan and the PI Plan are designed to address all pendingand future asbestos-related claims and all other pre-petition claims asoutlined respectively, therein.  However,it is possible that neither of the Plans, nor any plan that may be filed ascontemplated by the PI Settlement, will be approved by the Bankruptcy Court.  If a new joint plan of reorganizationreflecting the PI Settlement is not filed with the Bankruptcy Court, theDebtors would expect to resume the estimation trial, that was suspended inApril due to the PI Settlement, to determine the amount of its asbestos-relatedliabilities.  Therefore, until anultimate plan of reorganization is confirmed, the interests of the holders ofCompany common stock remain subject to substantial dilution or cancellation,and the value of asbestos claims and non-asbestos claims could be materiallydifferent from that reflected in Grace’s balance sheet.  The value of Company common stock and theextent of any recovery by non-asbestos-related creditors will dependprincipally on the amount of Grace’s asbestos-related liability under aconfirmed plan of reorganization.

 

***Debtors Plan of Reorganization*****-** Under the terms of the Debtors Plan, claims will besatisfied under the Chapter 11 Cases as follows:

 

Asbestos-Related Claimsand Costs

 

All pending and futureasbestos-related claims would be channeled to the Asbestos Trust forresolution.  The Debtors Plancontemplates that the Bankruptcy Court will conduct hearings to determine,among other things, the amount that would need to be paid into the AsbestosTrust on the effective date of the Debtors Plan to satisfy Grace’sasbestos-related liabilities and trust administration costs and expenses overtime.  The Asbestos Trust would utilize specifiedtrust distribution procedures to satisfy the following allowed asbestos-relatedclaims and costs:

 

·                  “PI-SE Claims” —Personal Injury-Symptomatic Eligible claims — in order to qualify for thisclass, claims would have to meet specified exposure and medical criteria andclaimants would have to prove that their health is impaired due to meaningfulexposure to asbestos-containing products formerly manufactured by Grace;

 

·                  “PI-AO Claims” —Personal Injury-Asymptomatic and Other claims — this class would contain allasbestos-related personal injury claims against Grace that did not meet thespecific requirements to be PI-SE Claims, but did meet certain other specifiedexposure and medical criteria;

 

·                  “PD Claims” —Property Damage, including ZAI, claims — in order to qualify for this class,claimants would have to prove Grace liability for loss of property value orremediation costs related to products formerly manufactured by Grace thatclaimants allege contained asbestos; and

 

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·                  Trustadministration costs and legal expenses.

 

Theclaims arising from such proceedings would be subject to this classificationprocess.

 

Asbestospersonal injury claimants, including holders of both PI-SE Claims and PI-AOClaims, would have the option either to litigate their claims against the AsbestosTrust in federal court in Delaware or, if they meet specified eligibilitycriteria, accept a settlement amount based on the severity of theircondition.  Holders of PD Claims would berequired to present allowed claims to the Asbestos Trust or litigate theirclaims against the Asbestos Trust in federal court in Delaware.  The Debtors Plan provides that, as acondition precedent to confirmation, the maximum estimated aggregate fundingamount for all asbestos-related liabilities (PI-SE Claims, PI-AO Claims and PDClaims) and trust administration costs and expenses as determined by theBankruptcy Court cannot exceed $1,613 million, which Grace believes would fundover $2 billion in claims, costs and expenses over time.

 

PI-SEClaims, PD Claims and related trust administration costs and expenses would befunded with (1) cashand shares of Sealed Air common stock pursuant to the Sealed Air Settlement; and (2) Company common stock.  The number of shares of Company common stockrequired to satisfy these claims will depend on the price of Company commonstock on the effective date of the Debtors Plan, liability measures approved bythe Bankruptcy Court, and the value of the Sealed Air Settlement.

 

PI-AOClaims would be funded with warrants exercisable for that number of shares ofCompany common stock which, when added to the shares issued directly to theAsbestos Trust on the effective date of the Debtors Plan, would represent 50.1%of Grace’s voting securities. If the common stock issuable upon exercise of thewarrants is insufficient to pay all PI-AO Claims (the liability for which isuncapped under the Debtors Plan), then Grace would pay any additionalliabilities in cash.

 

Theamounts to fund PI-SE Claims, PD Claims and trust administration costs andexpenses would be capped at the amount determined by the Bankruptcy Court.  Amounts required to fund PI-AO Claims wouldnot be capped, so if the amount funded in respect thereof later proved to beinadequate, Grace would be responsible for contributing additional funds intothe Asbestos Trust to satisfy PI-AO Claims. Because of the number and nature of the uncertainties involved, Grace isunable to determine the extent to which, if any, the liability for PI-AO Claimsmay exceed the amount funded into the Asbestos Trust in respect thereof.

 

**Other Claims**

** **

Allallowed administrative or priority claims would be paid 100% in cash and allgeneral unsecured claims, other than those covered by the Asbestos Trust, wouldbe paid 85% in cash and 15% in Company common stock. Grace estimates thatclaims with a recorded value of approximately $1,390 million, includinginterest accrued through March 31, 2008, would be satisfied in this mannerat the effective date of the Debtors Plan. Grace would finance these paymentswith cash on hand, cashfrom Fresenius Medical Care Holdings, Inc.(“Fresenius”) paid in settlement of asbestos and other Grace-related claims asdescribed below (the “Fresenius Settlement”), new Grace debt, and Companycommon stock.  Grace would satisfy othernon-asbestos related liabilities and claims (primarily certain environmental,tax, pension and retirement medical obligations) as they become due and payableover time using cash flow from operations, insurance proceeds frompolicies and settlements covering asbestos-related liabilities, and new creditfacilities. Proceeds from availableproduct liability insurance applicable to asbestos-related claims wouldsupplement operating cash flow to service new debt and liabilities not paid onthe effective date of the Debtors Plan.

 

**Effect on Company Common Stock**

** **

The Debtors Plan providesthat Company common stock will remain outstanding at the effective date of theDebtors Plan, but that the interests of existing shareholders would be subjectto dilution by additional shares of common stock issued under the Debtors Plan.In addition, in order to preserve significant tax benefits from net operatingloss carryforwards (“NOLs”) and certain future deductions, which are subject toelimination or limitation in the event of a change in control (as defined bythe Internal Revenue Code) of Grace, the Debtors Plan places restrictions onthe purchase of Company common stock. The restrictions would prohibit (withoutthe consent of Grace), for a period of three years after the effective date ofthe Debtors Plan, a person or entity from acquiring more than 4.75% of theoutstanding Company common stock or, for those persons already holding morethan 4.75%, prohibit 

 

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them from increasing ordecreasing their holdings. The Bankruptcy Court has approved the tradingrestrictions described above, excluding the restriction on sales, until theeffective date of the Debtors Plan.

 

The PI and PD Committees and the FCR have challenged the confirmabilityof the Debtors Plan, arguing that the Debtors Plan impairs the rights ofasbestos creditors and impermissibly denies them voting rights, and haveasserted that Grace’s asbestos-related liabilities exceed the fair value ofGrace’s assets.

 

***PI Committee and FCR Plan of Reorganization*****-********Under the terms of the PI Plan, allpending and future asbestos-related personal injury claims and demands (“PIClaims”) would be channeled to the Asbestos Trust for resolution.  The PI Plan contemplates that the BankruptcyCourt would determine, among other things, an estimate of the value of all PIClaims.  The PI Plan assumes that:  cash would be available from insurers; cashwould be available from Fresenius pursuant to the Fresenius Settlement; andcash and shares of Sealed Air common stock would be available from Cryovacpursuant to the Sealed Air Settlement. As a condition precedent to the PI Plan, the Bankruptcy Court mustdetermine that the estimated value of all PI Claims, excluding to the extentapplicable, post-petition interest, is not less than $4 billion.  If the amount available for distributionpursuant to the PI Plan is more than the principal amount of creditors’ claims,creditors entitled to post-petition interest would be paid such interest in theform of Company equity securities****andany remaining value would be available to current Company shareholders in theform of new Company equity securities.

 

Under the terms of the PIPlan, claims would be satisfied under the Chapter 11 Cases as follows:

 

Asbestos-Related PersonalInjury Claims and Costs (PI Claims)

*** ***

All pending and future PIClaims would be channeled to the Asbestos Trust for resolution.  The PI Plan provides that claims arising fromsuch proceedings would be subject to specified trust distribution procedures,which have not been filed with the Bankruptcy Court.

 

In order to satisfy allowed PI Claims and the related trustadministration costs and expenses, on the effective date ofthe PI Plan, the Asbestos Trust would be funded with:  (1) cash; (2) cash and shares ofSealed Air common stock pursuant to the Sealed Air Settlement; (3) personalinjury liability insurance, unless it is valued at more than $500 million, inwhich case it would remain with Grace; and (4) Company equitysecurities.  The value of Company equitysecurities contributed to the Asbestos Trust would depend on the enterprisevalue of Grace, the value of Grace’s personal injury liability insurance andthe value of the Sealed Air Settlement.

 

Asbestos-Related PropertyDamage Claims excluding ZAI (non-ZAI PD Claims)

* *

Settled asbestos-relatedproperty damage claims excluding ZAI (“non-ZAI PD Claims”) would be paid in acombination of cash and Company equity securities on the effective date of the PI Plan.  Onthe effective date of the PI Plan, Grace would establish a reserve consistingof cash and Company equity securities with a value equal to the estimatedamount of unresolved non-ZAI PD Claims.  Unresolvednon-ZAI PD Claims would remain in the mediation and litigation process and would be paid in cash and Companyequity securities from the reserve.  If the reserve did not have sufficientassets to pay all unresolved non-ZAI PD Claims once the amounts weredetermined, Grace would be liable to pay any amounts not funded from the reserve.

 

ZAI Claims

*** ***

ZAI claims would remainin the litigation process and would bepaid by Grace, if required.

 

Certain EnvironmentalClaims

*** ***

Certainallowed environmental claims would be paid in cash and Company equitysecurities on the effective date of the PI Plan.  On theeffective date of the PI Plan, Grace would establish a reserve consisting ofcash and Company equity securities with a value equal to the estimated amountof unresolved environmental claims.  Unresolvedenvironmental claims would be determined by the Bankruptcy Court and would be paid in cash and Companyequity securities from the reserve.  If the reserve did not have sufficientassets to pay all unresolved environmental claims once the amounts were determined, Gracewould be liable to pay any amounts not funded from the reserve.

 

Other Claims

*** ***

Allallowed administrative or priority claims would be paid in cash (either on theeffective date of the PI Plan or as they become due and payable overtime).  General unsecured claims, otherthan those covered by the Asbestos Trust, would be paid in 

 

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cash(either on the effective date of the PI Plan or as they become due and payableover time) and Company equity securities. Certain environmental and general unsecured claims would be reinstatedand the holders of such claims would retain all legal and other rights to whichthey are entitled under such claims. Other non-asbestos-related liabilities and claims (primarily certain taxclaims and employee-related claims such as pension and retirement medicalobligations) would be paid in cash as they become due and payable over time.

 

Effect on Company CommonStock

* *

Outstanding Companycommon stock would be cancelled at the effective date of the PI Plan.

 

***PI Settlement*****-********Under the terms of the PI Settlement, theDebtors, the PI Committee, the FCR, and the Equity Committee would file a jointplan of reorganization.  Under this plan,all present and future PI Claims would be channeled to the Asbestos Trust forresolution.

 

The Asbestos Trust wouldbe funded with

 

·                  $250 million in cash;

 

·                  a warrant to acquire 10 million shares of Company common stock at anexercise price of $17.00 per share, expiring one year from the effective dateof a plan of reorganization;

 

·                  all of the Debtors’ insurance policies and proceeds, includinginterest, received after the date of the PI Settlement, that are available forpayment of PI Claims;

 

·                  cash and shares of Sealed Air common stock to be paid to the AsbestosTrust by Cryovac, Inc. pursuant to the Sealed Air Settlement;

 

·                  the proceeds of the payment received by Grace pursuant to the Fresenius Settlement; and

 

·                  deferred payments by Grace-Conn. of $110 million per year for fiveyears beginning in 2019, and $100 million per year for 10 years beginning in2024, that would be subordinate to any bank debt or bonds outstanding,guaranteed by the Company and secured by the Company’s obligation to issue50.1% of its outstanding common stock to the Asbestos Trust in the event ofdefault.

 

Under the terms of the PISettlement, claims would be satisfied under the Chapter 11 Cases as follows:

 

Asbestos-Related PersonalInjury Claims (PI Claims)

*** ***

All pending and future PIClaims would be channeled to the Asbestos Trust for resolution.  The Asbestos Trust would pay claims fromtrust assets in accordance with a trust agreement and trust distributionprocedures established by the PI Committee and the FCR, subject to the approvalof the Bankruptcy Court.

 

Asbestos-Related PropertyDamage Claims, excluding ZAI (non-ZAIPD Claims)

* *

Settled non-ZAI PD Claims would be paid incash on the effective date of a planof reorganization.  A plan ofreorganization would set forth procedures for the allowance or disallowance ofall non-ZAI PD Claims that aredisputed as of the effective date of the plan.

 

ZAI Claims

*** ***

The PI Settlementcontemplates that the Bankruptcy Court would estimate the value of all ZAIclaims prior to or in connection with the confirmation of a plan ofreorganization.  ZAI claims would be paidup to the amount of the estimate in cash.

 

Other Claims

*** ***

Allallowed administrative or priority claims would be paid in cash.  Secured claims would be paid in cash or byreinstatement.  Allowed general unsecuredclaims would be paid in cash, including any post-petition interest asfollows:  (i) for holders of pre-petition bank creditfacilities, post-petition interest at the rate of 6.09% from the Filing Datethrough December 31, 2005 and thereafter at floating prime, in each casecompounded quarterly; and (ii) for all other unsecured claims that are notsubject to a settlement agreement providing otherwise, interest at 4.19%,compounded annually, or if pursuant to an existing contract, interest at thenon-default contract rate.  The generalunsecured creditors holding pre-petition bank credit facilities have requestedpost-petition interest greater than that reflected above that, if paid, couldbe material.  Unsecured employee-related claims such as pension, retirement medicalobligations and workers compensation claims, would be reinstated.

 

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Effect on Company commonstock

* *

The PI Settlement assumesthat Company common stock will remain outstanding at the effective date of aplan of reorganization, but that the interests of existing shareholders wouldbe subject to dilution by additional shares of Company common stock issuedunder the warrant or in the event of default in respect of the deferredpayments by Grace-Conn. under the Company’s security obligation.

 

***Claims Filings*****– The Bankruptcy Court established a bar date of March 31,2003 for claims of general unsecured creditors, asbestos-related propertydamage claims (other than ZAI claims) and medical monitoring claims related toasbestos. The bar date did not apply to asbestos-related personal injury claimsor claims related to ZAI.

 

Approximately 14,900proofs of claim were filed by the March 31, 2003 bar date. Of theseclaims, approximately 9,400 were non-asbestos related, approximately 4,300 werefor asbestos-related property damage, and approximately 1,000 were for medicalmonitoring. The medical monitoring claims were made by individuals who allegeexposure to asbestos through Grace’s products or operations. These claims, ifsustained, would require Grace to fund ongoing health monitoring costs forqualified claimants.  In addition,approximately 800 proofs of claim were filed after the bar date.

 

Approximately 7,000 ofthe non-asbestos related claims involve claims by employees or former employeesfor future retirement benefits such as pension and retiree medical coverage.Grace views most of these claims as contingent and has proposed a plan ofreorganization that would retain such benefits. The remaining non-asbestos claims include claims for payment of goodsand services, taxes, product warranties, principal and interest underpre-petition credit facilities, amounts due under leases and other contracts,leases and other executory contracts rejected in the Bankruptcy Court, environmentalremediation, pending non-asbestos-related litigation, and non-asbestos-relatedpersonal injury.  Claims forindemnification or contribution to actual or potential codefendants inasbestos-related and other litigation were also filed.

 

The Debtors have analyzedthe claims filed pursuant to the March 31, 2003 bar date and have foundthat many are duplicates, represent the same claim filed against more than oneof the Debtors, lack any supporting documentation, or provide insufficientsupporting documentation. As of March 31, 2008, of the approximately 4,035asbestos property damage claims filed, 275 claims have been resolved,approximately 3,570 claims have been expunged or withdrawn by claimants,leaving approximately 190 claims to be addressed through the property damagecase management order approved by the Bankruptcy Court.  As of March 31,2008, of the approximately 3,265 non-asbestos claims filed, approximately 1,850have been expunged or withdrawn by claimants, approximately 1,145 have beenresolved, and an additional approximately 270 claims are to be addressedthrough the claim objection process and the dispute resolution proceduresapproved by the Bankruptcy Court.

 

Grace believes that itsrecorded liabilities for claims subject to the March 31, 2003 bar daterepresent a reasonable estimate of the ultimate allowable amount for claimsthat are not in dispute or have been submitted with sufficient information toboth evaluate the merit and estimate the value of the claim. Theasbestos-related claims are considered as part of Grace’s overall asbestosliability and are being accounted for in accordance with the conditionsprecedent under the Debtors Plan, as described in “Accounting Impact” below.Grace expects to adjust its recorded asbestos-related liability asnecessary:  to reflect rulings made bythe Bankruptcy Court; when a new joint plan of reorganization is filed toreflect the terms of the PI Settlement; and when significant uncertainties havebeen resolved.  Such adjustments may bematerial to Grace’s consolidated financial position and results of operations.

 

***Litigation Proceedings in Bankruptcy Court*****– In September 2000, Grace was namedin a purported class action lawsuit filed in California Superior Court for theCounty of San Francisco, alleging that the 1996 reorganization involving apredecessor of Grace and Fresenius AG and the 1998 reorganization involving apredecessor of Grace and Sealed Air were fraudulent transfers *(Abner, et al., v. W.R. Grace & Co., et al.)*.The Bankruptcy Court authorized the PI and PD Committees to proceed with claimsagainst Fresenius and Sealed Air and Cryovac on behalf of the Debtors’bankruptcy estate.

 

On November 29,2002, Sealed Air (and Cryovac) and Fresenius each announced that they hadreached agreements in principle with the PI and PD Committees to settleasbestos, successor liability and fraudulent transfer claims related to suchtransactions (the “litigation settlement agreements”). Under the terms of theFresenius Settlement, subject to the fulfillment of certain conditions,Fresenius would pay $115.0 million to the Debtors’ estate as directed by theBankruptcy 

 

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Court upon confirmationof the Debtors’ plan of reorganization. In July 2003, the FreseniusSettlement was approved by the Bankruptcy Court. Under the terms of the SealedAir Settlement, subject to the fulfillment of certain conditions, Cryovac wouldmake a payment of $512.5 million (plus interest at 5.5% compounded annually,commencing on December 21, 2002) and nine million shares (now 18 millionshares to reflect a two-for-one stock split) of Sealed Air common stock(collectively valued at $1,134.4 million as of March 31, 2008), asdirected by the Bankruptcy Court upon confirmation of a plan of reorganization.In June 2005, the Sealed Air Settlement was approved by the BankruptcyCourt.

 

***Accounting Impact*** – The accompanying Consolidated Financial Statementshave been prepared in accordance with Statement of Position 90-7 (“SOP 90-7”), “FinancialReporting by Entities in Reorganization Under the Bankruptcy Code,” promulgatedby the American Institute of Certified Public Accountants. SOP 90-7 requiresthat financial statements of debtors-in-possession be prepared on a goingconcern basis, which contemplates continuity of operations, realization ofassets and liquidation of liabilities in the ordinary course of business.  However, as a result of the Filing, therealization of certain of the Debtors’ assets and the liquidation of certain ofthe Debtors’ liabilities are subject to significant uncertainty. Whileoperating as debtors-in-possession, the Debtors may sell or otherwise disposeof assets and liquidate or settle liabilities for amounts other than thosereflected in the Consolidated Financial Statements. Further, the ultimate planof reorganization could materially change the amounts and classificationsreported in the Consolidated Financial Statements.

 

Pursuant to SOP 90-7,Grace’s pre-petition and future liabilities that are subject to compromise arerequired to be reported separately on the balance sheet at an estimate of theamount that will ultimately be allowed by the Bankruptcy Court. As of March 31,2008, such pre-petition liabilities include fixed obligations (such as debt andcontractual commitments), as well as estimates of costs related to contingentliabilities (such as asbestos-related litigation, environmental remediation,and other claims). Obligations of Grace subsidiaries not covered by the Filingcontinue to be classified on the Consolidated Balance Sheets based uponmaturity datesor the expected dates of payment. SOP 90-7 also requires separatereporting of certain expenses, realized gains and losses, and provisions forlosses related to the Filing as reorganization items.  Grace presents reorganization items as “Chapter11 expenses, net of interest income,” a separate caption in its ConsolidatedStatements of Operations.

 

Grace has not recordedthe benefit of any assets that may be available to fund asbestos-related andother liabilities under the litigation settlements with Sealed Air andFresenius, as such agreements are subject to conditions, which, althoughexpected to be met, have not been satisfied and confirmed by the BankruptcyCourt. The value available under these litigation settlement agreements asmeasured at March 31, 2008, was $1,249.4 million comprised of $115.0million in cash from Fresenius and $1,134.4 million in cash and stock fromCryovac. Payments under the Sealed Air Settlement will be made directly to theAsbestos Trust by Cryovac.

 

Grace’s ConsolidatedBalance Sheets separately identify the liabilities that are “subject tocompromise” as a result of the Chapter 11 proceedings. In Grace’s case, “liabilitiessubject to compromise” represent both pre-petition and future liabilities asdetermined under U.S. generally accepted accounting principles. The bases forthe asbestos-related liability component of “liabilities subject to compromise”are described in Note 3.  Changes to therecorded amount of such liabilities will be based on developments in theChapter 11 Cases and management’s assessment of the claim amounts that willultimately be allowed by the Bankruptcy Court. Changes to pre-petitionliabilities subsequent to the Filing Date reflect: 1) cash payments underapproved court orders; 2) the terms of Grace’s proposed plan of reorganization,as discussed above, including the accrual of interest on pre-petition debt andother fixed obligations; 3) accruals for employee-related programs; and 4)changes in estimates related to other pre-petition contingent liabilities.

 

I-15

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Components of liabilitiessubject to compromise are as follows:

 
| ** **                                     | ** ** | **March 31,  2008** | ** **  | **December 31,  2007** | ** ** |
|------------------------------------------------|------------|--------------------------|-------------|-----------------------------|------------|
| *(In  millions)*                               | ** ** | ** **               | ** **  | ** **                  |       |   |   |
| Pre-petition bank  debt plus accrued interest  | ** ** | **$**                    | **795.1**   | ** **                  | $          | 783.0 |   |
| Drawn letters of  credit plus accrued interest | ** ** | **27.1**                 | ** **  | 26.9                        |       |
| Asbestos-related  contingencies                | ** ** | **1,700.0**              | ** **  | 1,700.0                     |       |
| Income taxes(1)                                | ** ** | **86.3**                 | ** **  | 89.3                        |       |
| Environmental  contingencies                   | ** ** | **373.2**                | ** **  | 368.6                       |       |
| Postretirement  benefits other than pension    | ** ** | **82.7**                 | ** **  | 84.0                        |       |
| Unfunded special  pension arrangements         | ** ** | **99.8**                 | ** **  | 100.8                       |       |
| Retained  obligations of divested businesses   | ** ** | **31.0**                 | ** **  | 30.9                        |       |
| Accounts payable                               | ** ** | **31.7**                 | ** **  | 31.7                        |       |
| Other accrued  liabilities                     | ** ** | **76.5**                 | ** **  | 74.4                        |       |
| Reclassification  to current liabilities(2)    | ** ** | **(12.3**                | **)**       | (12.1                       | )          |
| **Total  Liabilities Subject to Compromise**   | ** ** | **$**                    | **3,291.1** | ** **                  | $          | 3,277.5 |   |

 

----

*(1)**             **Amounts as of March 31,2008 and December 31, 2007 are net of expected refunds of $77.7 millionand $76.4 million, respectively.*

 

*(2)**             **As of March 31,2008 and December 31, 2007, approximately $12.3 million and $12.1 million,respectively, of certain pension and postretirement benefit obligations subjectto compromise have been presented in other current liabilities in theConsolidated Balance Sheet in accordance with SFAS No. 158.*

 

Note that the unfundedspecial pension arrangements reflected above exclude non-U.S. pension plans andqualified U.S. pension plans that became underfunded subsequent to the Filing.Contributions to qualified U.S. pension plans are subject to Bankruptcy Courtapproval.

 

***Change in Liabilities Subject to Compromise***

*** ***

The following table is a reconciliation of the changes in pre-filingdate liability balances for the period from the Filing Date through March 31,2008.

 
| ** **                                                                                           | ** ** | **Cumulative  Since Filing** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| *(In  millions)*                                                                                     |       |                              |       |   |
| Balance, Filing  Date April 2, 2001                                                             |       | $                                 | 2,366.0    |   |
| Cash  disbursements and/or reclassifications under Bankruptcy Court orders:                          |       |                              |       |
| Freight and  distribution order                                                                      |       | (5.7                              | )          |
| Trade accounts  payable order                                                                        |       | (9.1                              | )          |
| Resolution of  contingencies subject to Chapter 11                                                   |       | (130.0                            | )          |
| Other court  orders including employee wages and benefits, sales and use tax, and customer  programs |       | (357.5                            | )          |
| Expense/(income)  items:                                                                             |       |                              |       |
| Interest on  pre-petition liabilities                                                                |       | 360.1                             |       |
| Employee-related  accruals                                                                           |       | 60.7                              |       |
| Provision for  asbestos-related contingencies                                                        |       | 744.8                             |       |
| Provision for  environmental contingencies                                                           |       | 318.5                             |       |
| Provision for  income tax contingencies                                                              |       | (18.7                             | )          |
| Balance sheet  reclassifications                                                                     |       | (38.0                             | )          |
| Balance, end of  period                                                                              |       | $                                 | 3,291.1    |   |

 

Additional liabilitiessubject to compromise may arise due to the rejection of executory contracts orunexpired leases, or as a result of the Bankruptcy Court’s allowance ofcontingent or disputed claims.

 

For the holders of pre-petition bank credit facilities, beginning January 1,2006, Grace agreed to pay interest on pre-petition bank debt at the prime rate,adjusted for periodic changes, and compounded quarterly. The effective ratesfor the quarters ended March 31, 2008 and 2007 were 6.22% and 8.25%,respectively.  From the Filing Datethrough December 31, 2005, Grace accrued interest on pre-petition bankdebt at a negotiated fixed annual rate of 6.09%, compounded quarterly.  The holders of pre-petition bank creditfacilities have requested post-petition interest greater than that reflected inthe rates specified above that, if paid, could be material.

 

For the holders of claims who, but for the Chapter 11 filing, would beentitled under a contract or otherwise to accrue or be paid interest on suchclaim in a non-default (or non-overdue payment) situation under applicablenon-bankruptcy law, Grace accrues interest at the rate provided in the contractbetween the Grace entity and the claimant or such rate as may otherwise applyunder applicable non-bankruptcy law.

 

For all otherholders of allowed general unsecured claims, Grace accrues interest at a rateof 4.19% per annum, compounded annually, unless otherwise negotiated during theclaim settlement process.

 

I-16

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***Chapter 11 Expenses***

 
| ** **                         | ** ** | **Three Months  Ended  March 31,** | ** ** |
|------------------------------------|------------|----------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| *(In millions)*               | ** ** | ** **                                   | ** ** | ** ** |   |   |   |
| Legal and  financial advisory fees | ** ** | **$**                                        | **18.7**   | ** ** | $ | 20.1 |   |
| Interest income                    | ** ** | **(0.3**                                     | **)**      | (2.3 | ) |
| Chapter 11  expenses, net          | ** ** | **$**                                        | **18.4**   | ** ** | $ | 17.8 |   |

 

Pursuant to SOP 90-7,interest income earned on the Debtors’ cash balances must be offset againstChapter 11 expenses. In the first quarter of 2008, interest income was reducedby a $1.2 million charge related to the change in fair value of investmentsecurities held by the Debtors.

 

***Condensed Financial Information of the Debtors***

 

**W. R. Grace & Co. –Chapter 11 Filing Entities**

**Debtor-in-Possession**

**Statements of Operations**

 
| ** **                                                                                                          | ** ** | **Three Months  Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                          | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| *(In  millions) (unaudited)*                                                                                        | ** ** | ** **                                   | ** ** | ** ** |   |   |   |
| Net sales,  including intercompany                                                                                  | ** ** | **$**                                        | **376.4**  | ** ** | $ | 354.5 |   |
| Cost of goods  sold, including intercompany, exclusive of depreciation and amortization  shown separately below     | ** ** | **282.4**                                    | ** ** | 259.2 |   |
| Selling, general  and administrative expenses, exclusive of defined benefit pension expense  shown separately below | ** ** | **71.4**                                     | ** ** | 73.0 |   |
| Research and  development expenses                                                                                  | ** ** | **12.1**                                     | ** ** | 11.1 |   |
| Depreciation and  amortization                                                                                      | ** ** | **14.6**                                     | ** ** | 13.6 |   |
| Defined benefit  pension expense                                                                                    | ** ** | **9.6**                                      | ** ** | 9.1 |   |
| Interest expense  and related financing costs                                                                       | ** ** | **14.9**                                     | ** ** | 19.3 |   |
| Other (income)  expense, net                                                                                        | ** ** | **(34.0**                                    | **)**      | (12.0 | ) |
| Provision for  environmental remediation                                                                            | ** ** | **5.9**                                      | ** ** | — |   |
| Chapter 11  expenses, net of interest income                                                                        | ** ** | **18.4**                                     | ** ** | 17.7 |   |
| ** **                                                                                                          |       | ** **                                   | **395.3**  | ** ** |   | 391.0 |   |
| Loss before  income taxes and equity in net income of non-filing entities                                           | ** ** | **(18.9**                                    | **)**      | (36.5 | ) |
| Benefit from  (provision for) income taxes                                                                          | ** ** | **(0.4**                                     | **)**      | 3.4 |   |
| Loss before  equity in net income of non-filing entities                                                            | ** ** | **(19.3**                                    | **)**      | (33.1 | ) |
| Equity in net  income of non-filing entities                                                                        | ** ** | **32.9**                                     | ** ** | 37.9 |   |
| **N****et income**                                                                                                  | ** ** | **$**                                        | **13.6**   | ** ** | $ | 4.8 |   |

 

**W. R. Grace & Co. – Chapter 11 FilingEntities**

**Debtor-in-Possession**

**Condensed Statements of Cash Flows**

 
| ** **                                                                                     | ** ** | **Three Months  Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| *(**In millions) (unaudited)*                                                                  |       |                                         | ** ** |   |   |
| **Operating  Activities**                                                                      |       |                                         | ** ** |   |   |
| Net income                                                                                     | ** ** | **$**                                        | **13.6**   | ** ** | $ | 4.8 |   |
| Reconciliation  to net cash used for operating activities:                                     |       |                                         | ** ** |   |   |
| Chapter 11  expenses, net of interest income                                                   | ** ** | **18.4**                                     | ** ** | 17.7 |   |
| (Benefit from)  provision for income taxes                                                     | ** ** | **0.4**                                      | ** ** | (3.4 | ) |
| Equity in net  income of non-filing entities                                                   | ** ** | **(32.9**                                    | **)**      | (37.9 | ) |
| Depreciation and  amortization                                                                 | ** ** | **14.6**                                     | ** ** | 13.6 |   |
| Interest on  pre-petition liabilities subject to compromise                                    | ** ** | **14.3**                                     | ** ** | 19.1 |   |
| Provision for  environmental remediation                                                       | ** ** | **5.9**                                      | ** ** | — |   |
| Other non-cash  items, net                                                                     | ** ** | **(2.7**                                     | **)**      | (2.2 | ) |
| Contributions to  defined benefit pension plans                                                | ** ** | **(16.1**                                    | **)**      | (17.5 | ) |
| Cash paid to  resolve contingencies subject to Chapter 11                                      | ** ** | **—**                                   | ** ** | (10.3 | ) |
| Chapter 11  expenses paid                                                                      | ** ** | **(14.0**                                    | **)**      | (18.2 | ) |
| Changes in other  assets and liabilities, excluding the effect of businesses acquired/divested | ** ** | **(76.6**                                    | **)**      | (58.9 | ) |
| **Net  cash used for operating activities**                                                    | ** ** | **(75.1**                                    | **)**      | (93.2 | ) |
| **Investing  Activities**                                                                      |       |                                         | ** ** |   |   |
| Capital  expenditures                                                                          | ** ** | **(16.3**                                    | **)**      | (15.9 | ) |
| Loan repayments  and other                                                                     | ** ** | **56.0**                                     | ** ** | 59.2 |   |
| **Net  cash provided by investing activities**                                                 | ** ** | **39.7**                                     | ** ** | 43.3 |   |
| **Net  cash provided by financing activities**                                                 | ** ** | **8.2**                                      | ** ** | 13.5 |   |
| **Net decrease  in cash and cash equivalents**                                                 | ** ** | **(27.2**                                    | **)**      | (36.4 | ) |
| Cash and cash  equivalents, beginning of period                                                | ** ** | **206.8**                                    | ** ** | 233.8 |   |
| Cash and cash  equivalents, end of period                                                      | ** ** | **$**                                        | **179.6**  | ** ** | $ | 197.4 |   |

 

I-17

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**W. R. Grace & Co. – Chapter11 Filing Entities**

**Debtor-in-Possession**

**Balance Sheets**

 
| ** **                                                     | ** ** | **March 31,  2008** | ** **  | **December 31,  2007** | ** ** |
|----------------------------------------------------------------|------------|--------------------------|-------------|-----------------------------|------------|
| *(In  millions) (unaudited)*                                   | ** ** | ** **               | ** **  | ** **                  | ** ** |
| **ASSETS**                                                     | ** ** | ** **               | ** **  | ** **                  | ** ** |
| **Current  Assets**                                            | ** ** | ** **               | ** **  | ** **                  | ** ** |
| Cash and cash  equivalents                                     | ** ** | **$**                    | **179.6**   |                        | $          | 206.8 |   |
| Investment  securities                                         | ** ** | **64.0**                 |        | 98.3                        |       |
| Cash value of  life insurance policies, net of policy loans    | ** ** | **78.2**                 |        | 77.1                        |       |
| Trade accounts  receivable, net                                | ** ** | **112.3**                |        | 108.3                       |       |
| Receivables from  non-filing entities, net                     | ** ** | **108.4**                |        | 103.2                       |       |
| Inventories                                                    | ** ** | **96.1**                 |        | 82.6                        |       |
| Other current  assets                                          | ** ** | **51.9**                 |        | 47.1                        |       |
| **Total  Current Assets**                                      | ** ** | **690.5**                |        | 723.4                       |       |
| Properties and  equipment, net                                 | ** ** | **403.2**                |        | 403.8                       |       |
| Cash value of  life insurance policies, net of policy loans    | ** ** | **3.9**                  |        | 3.9                         |       |
| Deferred income  taxes                                         | ** ** | **754.5**                |        | 745.7                       |       |
| Asbestos-related  insurance                                    | ** ** | **500.0**                |        | 500.0                       |       |
| Loans receivable  from non-filing entities, net                | ** ** | **542.3**                |        | 524.2                       |       |
| Investment in  non-filing entities                             | ** ** | **446.1**                |        | 395.4                       |       |
| Overfunded  defined benefit pension plans                      | ** ** | **1.1**                  |        | 1.5                         |       |
| Other assets                                                   | ** ** | **77.7**                 |        | 77.7                        |       |
| **Total  Assets**                                              | ** ** | **$**                    | **3,419.3** |                        | $          | 3,375.6 |   |
| ** **                                                     |       |                     |        |                        |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY (DEFICIT)**       |       |                     |        |                        |       |
| **Liabilities  Not Subject to Compromise**                     |       |                     |        |                        |       |
| Current  liabilities                                           | ** ** | **$**                    | **190.4**   |                        | $          | 224.0 |   |
| Minority  interest in consolidated entities                    | ** ** | **63.5**                 |        | 62.1                        |       |
| Underfunded  defined benefit pension plans                     | ** ** | **182.4**                |        | 159.6                       |       |
| Other  liabilities                                             | ** ** | **48.6**                 |        | 39.0                        |       |
| **Total  Liabilities Not Subject to Compromise**               | ** ** | **484.9**                |        | 484.7                       |       |
| **Liabilities  Subject to Compromise**                         | ** ** | **3,291.1**              |        | 3,277.5                     |       |
| **Total  Liabilities**                                         | ** ** | **3,776.0**              |        | 3,762.2                     |       |
| **Shareholders’  Equity (Deficit)**                       | ** ** | **(356.7**               | **)**       | (386.6                      | )          |
| **Total  Liabilities and Shareholders’ Equity (Deficit)** | ** ** | **$**                    | **3,419.3** |                        | $          | 3,375.6 |   |

 

In addition to Grace’sfinancial reporting obligations as prescribed by the U.S. Securities andExchange Commission (“SEC”), the Debtors are also required, under the rules andregulations of the Bankruptcy Code, to periodically file certain statements andschedules and a monthly operating report with the Bankruptcy Court. Thisinformation is available to the public through the Bankruptcy Court. Thisinformation is prepared in a format that may not be comparable to informationin Grace’s quarterly and annual financial statements as filed with the SEC. Themonthly operating reports are not audited, do not purport to represent thefinancial position or results of operations of Grace on a consolidated basis,and should not be relied on for such purposes.

 

# **3.**              Asbestos-RelatedLitigation

 

Grace is a defendant inproperty damage and personal injury lawsuits relating to previously-soldasbestos-containing products. As of the Filing Date, Grace was a defendant in65,656 asbestos-related lawsuits, 17 involving claims for property damage (oneof which has since been dismissed), and the remainder involving 129,191 claimsfor personal injury. Due to the Filing, holders of asbestos-related claims arestayed from continuing to prosecute pending litigation and from commencing newlawsuits against the Debtors. The PI and PD Committees, representing theinterests of property damage and personal injury claimants, respectively, andthe FCR, representing the interests of future personal injury claimants, havebeen appointed in the Chapter 11 Cases. Grace’s obligations with respect topresent and future claims will be determined through the Chapter 11 process.

 

***Property DamageLitigation***–******The plaintiffsin asbestos property damage lawsuits generally seek to have the defendants payfor the cost of removing, containing or repairing the asbestos-containingmaterials in the affected buildings. Various factors can affect the merit andvalue of property damage claims, including legal defenses, productidentification, the amount and type of product involved, the age, type, sizeand use of the building, the legal status of the claimant, the jurisdictionalhistory of prior cases, the court in which the case is pending, and thedifficulty of asbestos abatement, if necessary.

 

Out of 380 asbestos property damage cases (which involved thousands ofbuildings) filed prior to the Filing Date, 140 were dismissed without paymentof any damages or settlement amounts; judgments after trial were entered infavor of Grace in nine cases (excluding cases settled following appeals ofjudgments in favor of Grace); judgments after trial were entered in favor ofthe plaintiffs in eight cases (one of which is on appeal) for a total of $86.1million; 207 property damage cases were settled for a total of $696.8 million;and 16 cases remain 

 

I-18

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outstanding (including the one on appeal). Of the 16 remaining cases,eight relate to ZAI and eight relate to a number of former asbestos-containingproducts (two of which also are alleged to involve ZAI).

 

Approximately 4,035 additional property damage claims were filed priorto the March 31, 2003 claims bar date established by the Bankruptcy Court.(The bar date did not apply to ZAI claims.) Such claims were reviewed in detailby Grace, categorized into claims with sufficient information to be evaluatedor claims that require additional information and, where sufficient informationexisted, the estimated cost of resolution was considered as part of Grace’srecorded asbestos-related liability. Approximately 200 claims did not containsufficient information to permit an evaluation. Grace objected to virtually all property damage claims on a number ofdifferent bases, including:  noauthorization to file a claim; the claim was previously settled or adjudicated;no or insufficient documentation; failure to identify a Grace product;expiration of the applicable statute of limitations and/or statute of repose,and/or laches; and a defense that the product in place is not hazardous. As of March 31,2008, following the reclassification, withdrawal or expungement of claims,approximately 460 property damage claims remain outstanding.  The Bankruptcy Court has approved settlementagreements covering approximately 275 property damage claims for an aggregateallowed amount of $82 million.

 

Eight of the ZAI caseswere filed as purported class action lawsuits in 2000 and 2001. In addition,ten lawsuits were filed as purported class actions in 2004 and 2005 withrespect to persons and homes in Canada. These cases seek damages and equitablerelief, including the removal, replacement and/or disposal of all suchinsulation. The plaintiffs assert that this product is in millions of homes andthat the cost of removal could be several thousand dollars per home. As aresult of the Filing, the eight U.S. cases have been stayed.

 

Based on Grace’sinvestigation of the claims described in these lawsuits, and testing andanalysis of this product by Grace and others, Grace believes that the product wasand continues to be safe for its intended purpose and poses little or no threatto human health. The plaintiffs in the ZAI lawsuits (and the U.S. government inthe Montana criminal proceeding described in Note 13) dispute Grace’s positionon the safety of ZAI. On October 18, 2004, the Bankruptcy Court held ahearing on motions filed by the parties to address a number of important legaland factual issues regarding the ZAI claims. On December 14, 2006, the Bankruptcy Court issued an opinion andorder holding that, although ZAI is contaminated with asbestos and can releaseasbestos fibers when disturbed, there is no unreasonable risk of harm fromZAI.  The ZAI claimants sought aninterlocutory appeal of the opinion and order with the District Court in Delawarebut that request was denied. The ZAI claimants have indicated they still intendto appeal such opinion and order when it becomes a final order.  The Debtors have asked the Bankruptcy Courtto establish a bar date for ZAI claims and approve a related notice programthat would require persons with a ZAI claim to submit individual proofs ofclaim.  At the same time, the ZAIClaimants have asked the Bankruptcy Court for various forms of relief: (1) totake such actions as would finalize the December 14 order and permit anappeal to be taken; (2) to allow the ZAI claims to return to the statecourt tort system; (3) to appoint an expert to estimate the number ofhomes containing ZAI; and (4) to certify a class claim on behalf ofWashington state residents. These motions are scheduled to be argued at ahearing on June 2, 2008.** **Grace’s recorded asbestos-related liability atMarch 31, 2008 assumes the risk of loss from ZAI litigation is notprobable.  If Grace’s view as to risk ofloss is not sustained, Grace believes the cost to resolve the matter would bematerial.

 

***Personal InjuryLitigation*******–****Asbestos personal injury claimants allege adverse healtheffects from exposure to asbestos-containing products formerly manufactured byGrace.  Historically, Grace’s cost toresolve such claims has been influenced by numerous variables, including thenature of the disease alleged, product identification, proof of exposure to aGrace product, negotiation factors, the solvency of other former producers ofasbestos containing products, cross-claims by co-defendants, the rate at whichnew claims are filed, the jurisdiction in which the claims are filed, and thedefense and disposition costs associated with these claims.

 

Cumulatively through theFiling Date, 16,354 asbestos personal injury lawsuits involving approximately35,720 claims were dismissed without payment of any damages or settlementamounts (primarily on the basis that Grace products were not involved) andapproximately 55,489 lawsuits involving approximately 163,698 claims weredisposed of (through settlements and judgments) for a total of $645.6million.  As of the 

 

I-19

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Filing Date, 129,191claims for personal injury were pending against Grace. Grace believes that asubstantial number of additional personal injury claims would have beenreceived between the Filing Date and March 31, 2008 had such claims notbeen stayed by the Bankruptcy Court.

 

TheBankruptcy Court has entered separate case management orders for estimatingliability for pending and future personal injury claims and adjudicatingpending property damage claims, excluding ZAI claims.  A trial for estimating liability for personal injury claims began in January 2008but was suspended in April 2008 as a result of the PI Settlement.

 

***Asbestos-RelatedLiability*******– The total recorded asbestos-related liabilityas of March 31, 2008 and December 31, 2007 was $1,700 million and isincluded in “liabilities subject to compromise” in the accompanyingConsolidated Balance Sheets.  Graceadjusted its asbestos-related liability in the fourth quarter of 2004 based onthe filing of the Debtors Plan as discussed in Note 2. The amount recorded at March 31,2008 and December 31, 2007 includes the $1,613 million maximum amountreflected as a condition precedent to the Debtors Plan and $87 million relatedto pre-Chapter 11 contractual settlements and judgments included in generalunsecured claims.

 

Pursuant to the DebtorsPlan, Grace requested that the Bankruptcy Court determine the aggregate dollaramount, on a net present value basis, that must be funded on the effective dateof the Debtors Plan into the Asbestos Trust (established under Section 524(g) ofthe Bankruptcy Code) to pay all asbestos-related personal injury and propertydamage claims (including ZAI) entitled to payment under the Debtors Plan andrelated trust administration costs and expenses on the later of the effectivedate of the Debtors Plan or when allowed (the “Funding Amount”). It is acondition to confirmation of the Debtors Plan that the Bankruptcy Court shallconclude that the Funding Amount is not greater than $1,613 million. Thisamount, which should be sufficient to fund over $2 billion in pending andfuture claims, was based in part on Grace’s 2004 evaluation of (1) existingbut unresolved personal injury and property damage claims, (2) actuarially-basedestimates of future personal injury claims, (3) the risk of loss from ZAIlitigation, (4) proposed claim payments reflected in the Debtors Plan, and(5) the cost of trust administration and litigation.  Based upon these and other factors, Grace isprepared to settle its asbestos-related claims at this amount as part of aconsensual plan of reorganization.  Aspart of the estimation and litigation process, if it continues, the amountsproposed to or adopted by the Bankruptcy Court may be materially different thanthis amount.

 

For personal injuryclaims, the Bankruptcy Court ordered that all claimants with claims pending asof the Filing Date (other than settled but unpaid claims) must completedetailed questionnaires providing information on, among other things, theirmedical condition, including diagnostic support, exposure to Grace andnon-Grace asbestos-containing products, employment history, and pendinglawsuits against other companies.  TheBankruptcy Court required questionnaires to be completed on or before July 12,2006 and supplemental questionnaires to be completed on or before January 12,2007.

 

The Bankruptcy Court also established proceduresand deadlines for filingproofs of claims for asbestos personal injury claims pending as of the FilingDate.  Claimants asserting claimssubject to enforceable written settlementagreements dated prior to the Filing Date, which have not been fully paid or satisfied, were required to file proofs of claim by October 16,2006.  Claimants asserting claims that are not subject tosuch settlement agreements were required to file proofs of claim by November 15, 2006.

 

Grace has catalogued and analyzed the information furnished with theproofs of claim and questionnaires. This information and other information,including Grace’s claims and settlement history, the experience of otherdefendants in asbestos-related litigation, and post-petition developments inasbestos-related litigation generally, have been analyzed and reviewed byexperts; and Grace, the PI Committee and the FCR have submitted expert reportsthat each party has relied upon to support its respective estimate of Grace’sasbestos personal injury liability. Copies of Grace’s and the PI Committee’s expert reports and portions ofthe FCR’s expert report are available through the Bankruptcy Court. Theseexpert reports (since supplemented, rebutted and made the subject of discovery)are based on data, methodologies and assumptions that may or may not beaccepted by the Bankruptcy Court.

 

For property damageclaims, the case management order provides that estimation will be preceded bylitigation on certain common threshold issues affecting a substantial majorityof claims. Such 

 

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litigation will consistof determining, among other things, (1) whether asbestos-containingproducts formerly manufactured by Grace are hazardous in place, and (2) compliancewith the applicable statute of limitations. Grace has asked****theBankruptcy Court to rule on Grace’s specific objections to individualclaims and groups of claims.

 

Under the Debtors Plan,the Funding Amount would primarily be a function of the number of propertydamage and personal injury claims entitled to be paid, and the amount payableper claim. Through the estimation process, Grace would seek to demonstrate thatmost claims have no value because they fail to establish any material propertydamage, health impairment or significant occupational exposure to asbestos fromGrace’s operations or products. If the Bankruptcy Court agreed with Grace’sposition on the number of, and the amounts to be paid in respect of, allowedpersonal injury and property damage claims, then Grace believes that theFunding Amount could be less than $1,613 million. However, this outcome wouldbe highly uncertain and would depend on a number of Bankruptcy Court rulingsfavorable to Grace’s position.

 

Conversely, the PI and PDCommittees and the FCR have asserted that Grace’s asbestos-related liabilitiesare substantially higher than $1,613 million, and in fact are in excess ofGrace’s business value.  If theBankruptcy Court accepted the position of the PI and PD Committees and the FCR,then any plan of reorganization likely would result in the loss of all orsubstantially all equity value by current shareholders. Therefore, due to thesignificant uncertainties of the estimation process and asbestos litigationgenerally, Grace is not able to estimate a probable Funding Amount that wouldbe accepted by the Bankruptcy Court.

 

However, as Grace iswilling to proceed with confirmation of the Debtors Plan with a Funding Amountof up to $1,613 million (assuming that other conditions precedent toconfirmation of the Debtors Plan are satisfied, including the availability ofthe payment from Cryovac directly to the Asbestos Trust under the Sealed AirSettlement described in Note 2), Grace’s recorded asbestos-related liabilityreflects the maximum amount allowed as a condition precedent under the DebtorsPlan. This amount, plus $87 million for pre-Chapter 11 contractual settlementsand judgments, brings the total recorded asbestos-related liability as of March 31,2008 and December 31, 2007 to $1,700 million. Any differences between theDebtors Plan as filed and the plan ultimately confirmed by the Bankruptcy Courtcould fundamentally change the accounting measurement of Grace’sasbestos-related liability and that change could be material.

 

On April 6, 2008, the Debtors reached an agreement in principle,the PI Settlement, with the PI Committee, the FCR, and the Equity Committeethat would settle all present and future asbestos-related personal injuryclaims.  As discussed in Note 2, the PISettlement contemplates that the Debtors, the PI Committee, the FCR and theEquity Committee would file a new joint plan of reorganization with theBankruptcy Court reflecting the terms and conditions of the PI Settlement.  The drafting and negotiation of the joint planand related documentation is in progress. The committee representing general unsecured creditors and the PDCommittee are not parties to the PI Settlement. Neither the PI Settlement nor a joint plan of reorganization reflectingits terms has been filed with the Bankruptcy Court.

 

As a result of the PI Settlement, a trial for estimating liability for asbestos personalinjury claims that began in January 2008 was suspended in April 2008.

 

Grace has not adjustedits accounting for asbestos-related liabilities and other liabilities subjectto compromise as at March 31, 2008 because:

 

·                  the Debtors Plan remains the only plan filed by the Debtors with theBankruptcy Court;

 

·                  while the PI Settlement broadly provides for a settlement ofsignificant economic issues, such issues and other issues remain subject toadditional negotiation among the parties thereto and significant documentationbefore a new joint plan of reorganization reflecting the PI Settlement may befiled with the Bankruptcy Court; and

 

·                  the estimated liability for certain property damage and generalunsecured claims could change materially prior to the time a new joint plan ofreorganization is filed or confirmed.

 

If a new joint plan of reorganization reflecting the PI Settlement isnot filed with the Bankruptcy Court, Debtors would expect to resume theestimation trial, that was suspended in April due to the PI Settlement, todetermine the amount of its asbestos-related liabilities.  Grace expects to adjust its recordedasbestos-related liability as necessary: 

 

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to reflect rulings made by the Bankruptcy Court; when a new joint planof reorganization is filed to reflect the terms of the PI Settlement; and whensignificant uncertainties have been resolved. Such adjustments may be material to Grace’s consolidated financialposition and results of operations.

 

***Insurance Rights*** –****Graceholds insurance policies that provide coverage for 1962 to 1984 with respect toasbestos-related lawsuits and claims. For the most part, coverage for years 1962 through 1972 has beenexhausted, leaving coverage for years 1973 through 1985 available for pendingand future asbestos claims.  Since 1985,insurance coverage for asbestos-related liabilities has not been commerciallyavailable to Grace.  As discussed in Note2, pursuant to the PI Settlement, insurance policies that provide coverage forasbestos personal injury claims and proceeds, including interest, receivedafter the date of the PI Settlement, would be assigned to the Asbestos Trust.

 

For each insurance year, Grace’s coverage consists of both primaryand excess coverage.  Primary coveragefor an insurance year generally reimburses Grace for the portion of paid claimsallocated to that year starting at the first dollar paid (after any deductible)through the coverage limit.  With oneexception, coverage disputes regarding Grace’s primary insurance policies havebeen settled, and the settlement amounts have been paid in full. Excessinsurance generally reimburses Grace for claims paid above a specified policythreshold through the coverage limit. For each insurance year, Grace’s insurance program includes multiplelayers of excess coverage.  A layer ofexcess coverage, which may include multiple insurers, is triggered once claimpayments that can be assigned to that insurance year are paid up to thethreshold of that layer.

 

Grace has entered into settlement agreements with various excessinsurance carriers. These settlements involve amounts paid and to be paid toGrace. The unpaid maximum aggregate amount available under these settlementagreements is approximately $487 million. With respect to asbestos-related personal injury claims, the settlementagreements generally require that the claims be spread over the claimant’sexposure period and that each insurer pay a pro rata portion of each claimbased on the amount of coverage provided during each year of the total exposureperiod.

 

Presently, Grace has no settlement agreements in place withinsurers with respect to approximately $430 million of excesscoverage.  Such policies are at layers ofcoverage that have not yet been triggered, but certain layers would betriggered if the Debtors Plan were approved at the recorded asbestos-relatedliability of $1,700 million. In estimating its ultimate insurance recovery,Grace has assumed that its unsettled excess coverage will be available on termsthat are substantially similar to the existing settlement agreements describedabove.  Grace believes that any allowed ZAIclaims (while not probable) also would be covered under the policies discussedabove to the extent they relate to installations of ZAI occurring after July 1,1973 but before June 30, 1985.

 

In addition, Grace hasapproximately $253 million of excess coverage with insolvent or non-payinginsurance carriers.  Non-paying carriersare those that, although technically solvent, are not currently meeting theirobligations to pay claims.  Grace hasfiled and continues to file claims in the insolvency proceedings of thesecarriers.  Grace periodically receivesdistributions from some of these insolvent carriers and expects to receivedistributions in the future.  Settlementamounts are recorded as income when received.

 

In November 2006,Grace entered into a settlement agreement with an underwriter of a portion ofits excess insurance coverage. The insurer paid a settlement amount of $90million directly to an escrow account for the benefit of the holders of claimsfor which Grace was provided coverage under the affected policies.  The escrow account balance at March 31,2008 approximated $95.7 million, including interest earned on the account.Funds will be distributed from this account directly to claimants at thedirection of the escrow agent pursuant to the terms of a confirmed plan ofreorganization or as otherwise ordered by the Bankruptcy Court.  The settlement agreement provides that unlessGrace confirms a plan of reorganization by December 31, 2008, at theoption of the insurer, exercisable at any time prior to April 30, 2009,the escrow amount with interest must be returned to the insurer.  Grace will record the amount in the escrowaccount as an asset and reduce its asbestos insurance receivable balance if andwhen all contingencies for the release of such amount are satisfied.

 

As of March 31, 2008, including the settlement discussedabove and after subtracting previous reimbursements by insurers and allowingfor 

 

I-22

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discounts pursuant to certain settlement agreements, there remainsapproximately $917 million of excess coverage from 54 presently solventinsurers.  Grace estimates that eligibleclaims would have to exceed $4 billion to access total coverage.  Grace further estimates that, assuming the resolutionvalue of asbestos-related claims is equal to the recorded liability of $1,700million (which should fund claim payments in excess of $2 billion), it shouldbe entitled to approximately $500 million of insurance recovery, including theescrow described above.  This amount wasdetermined by estimating the aggregate and per year payout for claims over timeand applying the expected insurance recovery factor to such claims. However,the ultimate amount of insurance recovered on such claims will depend on anumber of factors that will only be determined at the time claims are paidincluding: the nature of the claim (PI, PD or ZAI), the relevant exposureyears, the timing of payment, the solvency of insurers and the legal status ofpolicy rights. Accordingly, Grace’s recorded estimate of insurance recovery maydiffer materially from actual amounts received.

 

# **4.**              IncomeTaxes

# ** **

The amount ofunrecognized tax benefits at March 31, 2008 was $177.5 million, a decreaseof $0.3 million from December 31, 2007. If this amount were recognized, itwould reduce Grace’s effective tax rate, except for the amount of $15.8 millionrelated to alternative minimum tax credit (“AMTC”) carryforwards recorded asdeferred tax assets that will not be available if Grace is successful inresolving certain issues.

 

During the three monthsended March 31, 2008, Grace reduced its liability for uncertain taxpositions by $0.5 million due to lapses in the statute of limitations relatedto assessments in certain taxing jurisdictions, net of increases for interestand other tax contingencies in certain jurisdictions.

 

Grace accrues potential interest and any associated penalties relatedto uncertain tax positions in “benefit from (provision for) income taxes” inthe Consolidated Statements of Operations. The total amount of interest andpenalties (on a gross basis) accrued on uncertain tax positions as of December 31,2007 was $54.9 million out of the total amount of unrecognized tax benefits of$177.8 million. During the three months ended March 31, 2008, Graceaccrued additional net interest and penalties of $1.0 million (exclusive ofreductions of accrued interest resulting from lapses of statutes oflimitations).

 

Grace files U.S. federalincome tax returns as well as income tax returns in various states and foreignjurisdictions. In many cases, Grace’s uncertain tax positions are related totax years that remain subject to examination by the relevant taxingauthorities. The following table summarizes these open tax years by majorjurisdiction:

 
| **Tax Jurisdiction ****(1)** | ** ** | **Examination in  Progress** | ** ** | **Examination Not   Yet Initiated** | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|----------------------------------------------------|------------|
| United States (2)                      |       | 1994-2006                         |       | 2005-2007                                          |       |
| Germany                                |       | 1998-2001                         |       | 2002-2007                                          |       |
| United Kingdom                         |       | None                              |       | 2002-2007                                          |       |
| Singapore                              |       | None                              |       | 2002-2007                                          |       |
| France                                 |       | 2004-2006                         |       | 2007                                               |       |
| Italy                                  |       | None                              |       | 2003-2007                                          |       |

 

----

*(1)**   **Includes federal as well as state, provincial or localjurisdictions, as applicable.*

 

*(2)**   **In the U.S., the IRS has completed examining tax years2002-2004.  Tax years 1993-1996 and1997-2001 have been examined and partially resolved and there are still pendingissues in appeals or pending legal proceedings as described below.  The Federal examination of 2005-2007 has notyet been initiated.  Certain state taxexaminations remain in progress relative to the years 1994-2006.*

 

Based upon the outcome of these examinations, or as a result of theexpiration of statute of limitations for specific jurisdictions, it isreasonably possible that there may be a material change to Grace’s aggregaterecorded liabilities for uncertain tax positions in the next twelvemonths.  A decrease in recordedliabilities of $7 million to $8 million may arise as a result of settlement ofthe R&E credit issue described below. However, the outcomes of other ongoing tax examinations remainuncertain, and it is possible that new issues will be raised by taxauthorities, which may require an increase to the balance of unrecognizedbenefits.  An estimate of such increasescannot reasonably be made. The status of U.S. tax examinations is as follows:

 

·                  With respect to the 1993-1996 federal income tax audit,there is one issue outstanding related to $7.0 million of research andexperimentation (“R&E”) credits on which the Internal Revenue Service (“IRS”)and Grace have reached a tentative settlement, which will result in anadditional refund of approximately $4.5 million.  Grace anticipates filing a motion with theBankruptcy Court in the near future seeking approval of the settlement.  Upon receiving Bankruptcy Court approval, thesettlement will be submitted by the IRS to 

 

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the Joint Committee on Taxation for final review andapproval.

 

·                  With respect to the IRS examination of the 1997-2001tax years, Grace has received revised examination reports from the IRS, whichinclude the review of losses carried back to 1988-1989 (collectively, the “ExaminationReports”) asserting, in the aggregate, approximately $32.5 million of netadditional tax plus accrued interest. The most significant issue addressed in the Examination Reports concernsthe carryback of a specified liability loss from the 1998 tax period to the1989 taxable year.  On March 22,2007, Grace received a Notice of Deficiency with respect to the carryback ofthe specified liability loss and certain other issues.  On June 19, 2007, Grace filed a petitionin the United States Tax Court to resolve the issues relating to the Notice ofDeficiency.  On December 10, 2007,the Tax Court granted the parties’ motion to forward the case to the IRSAppeals Office for the purpose of conducting settlement negotiations.

 

·                  With respect to the years 2002-2004, the IRS completedits examination during the first quarter of 2008 and Grace has tentativelyagreed to proposed adjustments that result in net tax expense of $1.5 millionwhich has been provided for in Grace’s liability for uncertain tax positions.

 

OtherTax Matters

 

As of March 31,2008, Grace had tax credit carryforwards of $71.1 million, consisting of $51.6million of foreign tax credit carryforwards with expiration dates through 2017,$0.6 million of general business credit carryforwards with expiration datesthrough 2025 and $18.9 million of AMTC carryforwards with no expirationdates.  However, the $18.9 million ofAMTC carryforwards includes $15.8 million, which will not be available if Graceis successful in resolving certain issues reflected as uncertain tax positions.

 

Gracehas not yet recorded tax benefits of $14.4 million associated with stock optioncompensation that remained unrealized as of March 31, 2008.  When realized, the benefits will increasepaid-in capital in our Consolidated Balance Sheet.

 

Graceanticipates generating U.S. net operating loss (“NOL”) carryforwards uponemergence from bankruptcy.  Because Gracedid not pay a significant amount of U.S. taxes in prior years and/or hasalready received or applied for tax refunds from available NOL carryback years,it expects to carryforward most of its NOLs after emergence from bankruptcy.Under federal income tax law, a corporation is generally permitted tocarryforward NOLs for a 20-year period for deduction against future taxableincome. Grace’s ability to deduct NOL carryforwards could be significantlylimited if it were to undergo an ownership change during, or as a result of,the Chapter 11 proceeding.  During thecourse of the bankruptcy proceeding, the Bankruptcy Court entered an order thatplaces certain limitations on trading in Grace common stock or optionsconvertible into Grace common stock. Pursuant to these limitations, Grace intends to object to any purchaseof Grace common stock or options that would potentially contribute to anownership change.  However, Grace canprovide no assurance that these limitations will prevent an ownership change orthat its ability to utilize NOLs will not be significantly limited as a resultof Grace’s reorganization.

 

# **5.**              Other(Income) Expense, net

# ** **

Components of other(income) expense, net are as follows:

 
| ** **                                                       | ** ** | **Three Months  Ended  March 31,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------------|------------|
| **Other (Income) Expense, net**                                  | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| *(In  millions)*                                                 | ** ** | ** **                                   | ** ** | ** ** |   |   |   |
| COLI income, net                                                 | ** ** | **$**                                        | **(1.1**   | **)** | $ | (2.0 | ) |
| Interest income                                                  | ** ** | **(1.1**                                     | **)**      | (2.1 | ) |
| Net (gain) loss  on sales of investments and disposals of assets | ** ** | **(1.6**                                     | **)**      | (0.2 | ) |
| Currency  translation – intercompany loans                  | ** ** | **(38.6**                                    | **)**      | (2.8 | ) |
| Value of  currency contracts                                     | ** ** | **26.5**                                     | ** ** | 2.1 |   |
| Other currency  transaction effects                              | ** ** | **0.9**                                      | ** ** | 0.4 |   |
| Cash received on  previously written off receivable              | ** ** | **—**                                   | ** ** | (0.9 | ) |
| Other  miscellaneous income                                      | ** ** | **(2.3**                                     | **)**      | (2.5 | ) |
| Total other  (income) expense, net                               | ** ** | **$**                                        | **(17.3**  | **)** | $ | (8.0 | ) |

 

In November 2007, Grace executed an intercompany loan in theamount of €250 million between Grace’s principal U.S. operating subsidiary anda newly established German subsidiary as part of a legal restructuring.  In conjunction with the loan, Grace enteredinto a series of foreign currency forward contracts to attempt to minimizevolatility from foreign currency movements on the loan amount.  The forward contracts are aligned with thepayment schedule of the intercompany loan, which has annual principal 

 

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and interest payments in November 2009 through November 2013.  In the first quarter of 2008, the Eurocontinued to strengthen against the U.S. dollar, which resulted in significantforeign currency translation gains from the revaluation of the intercompanyloan.  The changes in fair values of theforeign currency forward contracts partially offset the translation gains.

 

# **6.**              FairValue Measurements

# ** **

SFAS No. 157defines fair value as the value that would be received at the measurement datein the principal or “most advantageous” market. Grace utilizes principal market data, whenever available, to valueassets and liabilities at fair value that are required to be reported at fairvalue.  SFAS No. 157 prescribesthree valuation techniques that shall be used to measure fair value as follows:

 

1.               Market approach – uses prices or other relevantinformation generated by market transactions involving identical or comparableassets or liabilities.

 

2.               Income approach – uses valuation techniques to convertfuture amounts to a single present amount (discounted).

 

3.               Cost approach – the amount that currently would berequired to replace the service capacity of an asset (i.e., current replacementcost).

 

One or acombination of the approaches above can be used to calculate fair value,whichever results in the most representative fair value.

 

In addition to thethree valuation techniques, SFAS No. 157 prescribes a fair value hierarchyin order to increase consistency and comparability in fair value measurementsand related disclosures.  The fair valuehierarchy prioritizes the inputs to valuation techniques used to measure fairvalue into three broad levels:

 

Level 1 Inputs - quoted prices in active markets for identicalassets or liabilities.  A quoted price inan active market provides the most reliable evidence of fair value.

 

Level 2 Inputs - inputs other than quoted prices that are observablefor the asset or liability, either directly or indirectly.

 

Level 3 Inputs - unobservable inputs for the asset orliability, which should reflect the reporting entity’s own assumptions aboutthe assumptions that market participants would use in pricing the asset orliability.

 

Grace has identified thefollowing financial assets and liabilities that are subject to the fair valueanalysis required by SFAS No. 157:

 

*InvestmentSecurities*

 

Investment securitiesconsist of direct or indirect investments in debt securities. Prior to thefourth quarter of 2007, Grace’s investment in the Columbia Strategic Cash Fundwas classified in cash and cash equivalents, as redemptions were available incash.  In December 2007, the fundbegan an orderly liquidation that is expected to continue through 2009 andrestricted redemptions to an in-kind distribution of securities held by thefund. In the first quarter of 2008, $33.1 million of the fund balance was distributedin cash.  Grace has elected to remain inthe fund and to value the fund based on the underlying securities as determinedby the fund principals.  The valuation ofthe fund was determined using a market approach, which consisted of matrixpricing techniques based on widely available market data and comparables.  The strategic cash investment fund was valuedat $64.0 million and $98.3 million at March 31, 2008 and December 31,2007, respectively.

 

Grace recorded a decreasein fair value of $1.2 million in the first quarter of 2008 due to continuedunfavorable conditions in the credit markets. The loss is recorded as an offset to interest income earned on the ColumbiaStrategic Cash Fund by the Debtors, which is netted against Chapter 11 expensesin the Consolidated Statements of Operations. This loss was deemed to be other than temporary, and as such, wasrecorded in earnings.

 

*Derivatives*

 

From time to time, Graceenters into commodity derivatives such as forward contracts or option contractsdirectly with natural gas suppliers, and fixed-rate swaps with financialinstitutions to mitigate the risk of volatility of natural gas prices.  Under fixed-rate swaps, Grace locks in afixed rate with a financial institution for future natural gas purchases,purchases its natural gas from a supplier at the prevailing market rate, andthen settles with the bank for any difference in the rates, thereby “swapping”a variable rate for a fixed rate.  

 

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In 2007 and 2008, Graceutilized fixed-rate swaps to mitigate the risk of natural gas pricevolatility.  The valuation of Grace’sfixed-rate natural gas swaps was determined using a market approach, based onnatural gas futures trading prices quoted on the New York Mercantile Exchange.

 

As part of its risk management program, Grace enters into foreigncurrency exchange rate forward and/or option contracts to mitigate the effectsof exchange rate fluctuations.  Gracealso utilizes foreign currency forward exchange rate and/or option contractsfrom time to time to hedge the value of its net investment in certain foreignentities.  The valuation of Grace’sforeign currency exchange rate forward contracts was determined using both amarket approach and an income approach. Inputs used to value foreign currency exchange rate forward contractsconsist of (1) spot rates, which are quoted by various financialinstitutions, (2) forward points, which are affected by changes ininterest rates on Euro and $U.S. deposits, and (3) discount rates used topresent value future cash flows, which are based on the London InterbankOffered Rate (LIBOR) curve.

 

The following tablepresents the fair value hierarchy for non-financial assets and liabilitiesmeasured at fair value on a recurring basis as of March 31, 2008:

 
| ** **                                             | ** ** | **Fair Value Measurements at  March 31, 2008 Using** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| **Items Measured at Fair Value on  a Recurring Basis** | ** ** | **Total**                                                                          | ** ** | **Quoted  Prices in  Active  Markets  for  Identical  Assets or  Liabilities  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs  (Level 2)** | ** ** | **Significant**

**Unobservable  Inputs  (Level 3)** | ** ** |
| *(In  millions)*                                       |       |                                                                               |       |   |   |   |   |   |   |
| **Assets**                                             |       |                                                                               |       |   |   |   |   |   |   |
| Available-for-sale  securities                         |       | $                                                                                  | 64.0       |   | $ | — |   | $ | 64.0 |   | $ | — |   |
| Commodity  derivatives                                 |       | 2.6                                                                                |       | — |   | 2.6 |   | — |   |
| **Total  Assets**                                      | ** ** | **$**                                                                              | **66.6**   | ** ** | **$** | **—** | ** ** | **$** | **66.6** | ** ** | **$** | **—** | ** ** |
| Liabilities                                            |       |                                                                               |       |   |   |   |   |   |   |
| Currency  derivatives                                  |       | $                                                                                  | 32.1       |   | $ | — |   | $ | 32.1 |   | $ | — |   |
| **Total  Liabilities**                                 | ** ** | **$**                                                                              | **32.1**   | ** ** | **$** | **—** | ** ** | **$** | **32.1** | ** ** | **$** | **—** | ** ** |

 

# **7.**              OtherBalance Sheet Accounts

 
|                                                          | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| *(In  millions)*                                              |       |                     |       |                        |       |
| **Inventories*******(1)***                                    |       |                     |       |                        |       |
| Raw materials                                                 | ** ** | **$**                    | **109.5**  |                        | $          | 76.3 |   |
| In process                                                    | ** ** | **51.1**                 |       | 44.7                        |       |
| Finished  products                                            | ** ** | **239.6**                |       | 207.1                       |       |
| General  merchandise                                          | ** ** | **42.0**                 |       | 38.2                        |       |
| Less: Adjustment  of certain inventories to a LIFO basis*(2)* | ** ** | **(70.3**                | **)**      | (62.8                       | )          |
|                                                          |       | **$**                    | **371.9**  |                        | $          | 303.5 |   |
| **Other  Assets**                                             |       |                     |       |                        |       |
| Deferred charges                                              | ** ** | **$**                    | **39.2**   |                        | $          | 40.9 |   |
| Long-term  receivables, less allowances of $0.0 (2007 - $0.0) | ** ** | **1.3**                  |       | 1.3                         |       |
| Patents,  licenses and other intangible assets, net           | ** ** | **82.8**                 |       | 82.2                        |       |
| Investments in  unconsolidated affiliates and other           | ** ** | **17.3**                 |       | 12.2                        |       |
|                                                          |       | **$**                    | **140.6**  |                        | $          | 136.6 |   |
| **Other  Current Liabilities**                                |       |                     |       |                        |       |
| Accrued  compensation                                         | ** ** | **$**                    | **72.3**   |                        | $          | 97.2 |   |
| Customer volume  rebates                                      | ** ** | **29.6**                 |       | 44.1                        |       |
| Accrued  commissions                                          | ** ** | **8.9**                  |       | 11.6                        |       |
| Accrued  reorganization fees                                  | ** ** | **31.9**                 |       | 27.5                        |       |
| Income tax  payable                                           | ** ** | **34.9**                 |       | 30.4                        |       |
| Deferred tax  liability                                       | ** ** | **9.6**                  |       | 8.8                         |       |
| Other accrued  liabilities                                    | ** ** | **103.3**                |       | 105.5                       |       |
|                                                          |       | **$**                    | **290.5**  |                        | $          | 325.1 |   |
| **Other  Liabilities**                                        |       |                     |       |                        |       |
| Long-term self  insurance reserve                             | ** ** | **$**                    | **8.0**    |                        | $          | 8.0 |   |
| Retained  obligations of divested businesses                  | ** ** | **5.3**                  |       | 5.3                         |       |
| Long-term  incentive compensation                             | ** ** | **7.0**                  |       | 13.8                        |       |
| Other accrued  liabilities                                    | ** ** | **35.5**                 |       | 19.1                        |       |
|                                                          |       | **$**                    | **55.8**   |                        | $          | 46.2 |   |

 

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*(1)**     **Inventories valued at LIFO costcomprised 47.5% of total inventories at March 31, 2008  and 47.0% at December 31, 2007.*

 

*(2)**     **During the three monthsended March 31, 2008, a reduction in U.S. LIFO inventory levels resultedin costs pertaining to prior periods being reflected in cost of sales for thefirst quarter of 2008.  This had theeffect of increasing pre-tax income by $0.7 million compared with current cost.*

 

Accrued compensation inthe table above includes salaries and wages as well as estimated currentamounts due under the annual and long-term incentive programs.

 

**8.****             ****Life Insurance**

 

Grace is the beneficiaryof corporate-owned life insurance (“COLI”) policies on certain current andformer employees with a net cash surrender value of $82.1 million and $81.0million at March 31, 2008 and December 31, 2007, respectively. Thepolicies were acquired to fund various employee benefit programs and otherlong-term liabilities and are structured to provide cash flow (primarilytax-free) over an extended number of years.

 

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The following tables summarize activity in these policies for the threemonths ended March 31, 2008 and 2007, and the components of net cash valueat March 31, 2008 and December 31, 2007:

 
| ** **                                                     | ** ** | **Three Months  Ended  March 31,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------------|------------|
| **Life Insurance – Activity Summary** | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| *(In  millions)*                                               |       |                                         |       |   |   |
| Earnings on  policy assets                                     | ** ** | **$**                                        | **1.2**    | ** ** | $ | 1.9 |   |
| Interest on  policy loans                                      | ** ** | **(0.1**                                     | **)**      | 0.1 |   |
| Policy loan  repayments                                        | ** ** | **—**                                   | ** ** | — |   |
| Proceeds from  termination of life insurance policies          | ** ** | **—**                                   | ** ** | — |   |
| Net investing  activity                                        | ** ** | **—**                                   | ** ** | (0.2 | ) |
| Change in net  cash value                                      | ** ** | **$**                                        | **1.1**    | ** ** | $ | 1.8 |   |
| Tax-free  proceeds received                                    | ** ** | **$**                                        | **—** | ** ** | $ | — |   |

 
| **Components of Net Cash Value** | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| *(In  millions)*                                     |       |                     | ** ** |                        |       |
| Gross cash value                                     | ** ** | **$**                    | **87.0**   | ** **                  | $          | 85.8 |   |
| Principal –  policy loans                       | ** ** | **(4.7**                 | **)**      | (4.7                        | )          |
| Accrued interest  – policy loans                | ** ** | **(0.2**                 | **)**      | (0.1                        | )          |
| Total net cash  value                                | ** ** | ** **               | **82.1**   | ** **                  |       | 81.0 |   |
| Less: current  portion                               | ** ** | **(78.2**                | **)**      | (77.1                       | )          |
| Net cash value –  long-term                     | ** ** | **$**                    | **3.9**    | ** **                  | $          | 3.9 |   |
| Insurance  benefits in force                         | ** ** | **$**                    | **142.1**  | ** **                  | $          | 141.1 |   |

 

Grace’s financial statements display income statement activity andbalance sheet amounts on a net basis, reflecting the contractualinterdependency of policy assets and liabilities.

 

**9.****             ****Debt**

 
| **Components of Debt**                         | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| *(In  millions)*                                         |       |                     |       |                        |       |
| **Debt  payable within one year**                        | ** ** | **$**                    | **3.2**    |                        | $          | 4.7 |   |
| **Debt  payable after one year**                         |       | ** **               |       |                        |       |
| DIP facility                                             | ** ** | **$**                    | **—** |                        | $          | — |   |
| Other long-term  borrowings                              | ** ** | **0.3**                  |       | 0.3                         |       |
|                                                     |       | **$**                    | **0.3**    |                        | $          | 0.3 |   |
| **Debt  subject to compromise**                          |       | ** **               |       |                        |       |
| Bank borrowings                                          | ** ** | **$**                    | **500.0**  |                        | $          | 500.0 |   |
| Accrued interest  on bank borrowings                     | ** ** | **295.1**                |       | 283.0                       |       |
| Drawn letters of  credit                                 | ** ** | **23.6**                 |       | 23.6                        |       |
| Accrued interest  on drawn letters of credit             | ** ** | **3.5**                  |       | 3.3                         |       |
|                                                     |       | **$**                    | **822.2**  |                        | $          | 809.9 |   |
| Full-year  weighted average interest rates on total debt | ** ** | **6.2**                  | **%**      | 8.1                         | %          |

 

The Debtors have entered into a debtor-in-possession post-petition loanand security agreement, or DIP facility, with a syndicate of lenders that, asamended effective April 1, 2008, provides for up to $165 million ofrevolving loans and face amount of letters of credit.  The DIP facility is secured by a prioritylien on substantially all assets of the Debtors with the exclusion of thecapital stock of non-U.S. subsidiaries, and bears interest based on LIBOR.  The term of the DIP facility ends on theearlier of April 1, 2010 or the Debtors’ emergence from Chapter 11.  The DIP facility permits the increase ofcommitments of existing lenders and/or commitments by new lenders up to anaggregate maximum of $250 million.

 

Asof March 31, 2008 and December 31, 2007, the Debtors had no revolvingloans and $61.4 million and $56.3 million, respectively, of standby letters ofcredit issued and outstanding under the DIP facility.  These letters of credit and other holdbackprovisions reduced the aggregate unused availability for revolving loans andletters of credit, as of the April 1, 2008 effective date of the amendedDIP facility, to $103.6 million.  Theletters of credit were issued mainly for trade-related matters such asperformance bonds, as well as certain insurance and environmental matters.

 

**10.****            ****Shareholders’ Equity (Deficit)**

 

Under its Certificate of Incorporation, the Company is authorized toissue 300,000,000 shares of common stock, $0.01 par value. Of the common stockunissued at March 31, 2008, 1,375,846 shares were reserved for issuancepursuant to stock options and other stock incentives. Since the Filing Date,Grace has not granted any stock options. During the three months ended March 31, 2008 and 2007, 462,517 and915,813 stock options were exercised for aggregate proceeds of $8.9 million and$14.2 million, respectively.

 

The Certificate of Incorporation also authorizes 53,000,000 shares ofpreferred stock, $0.01 par value, none of which has been issued.  Of the total, 3,000,000 shares have beendesignated as Series A Junior Participating Preferred Stock and arereserved for issuance in connection with the Company’s Preferred Stock PurchaseRights (“Rights”).  A Right tradestogether with each outstanding share of common stock and entitles the holder topurchase one one-hundredth of a share of Series A Junior ParticipatingPreferred Stock under certain circumstances and subject to certainconditions.  The Rights are not and willnot become exercisable unless and until certain events occur, and at no timewill the Rights have any voting power. The Rights agreement expires on March 30, 2018.

 

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**11.****            ****Earnings Per Share**

 

The following table showsa reconciliation of the numerators and denominators used in calculating basicand diluted earnings per share.

 
| ** **                                                 | ** ** | **Three Months  Ended  March 31,** | ** ** |
|------------------------------------------------------------|------------|----------------------------------------------|------------|
| **Earnings Per Share**                           | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| *(In  millions, except per share amounts)*                 |       |                                         |       |   |   |
| **Numerators**                                             |       |                                         |       |   |   |
| Net income                                                 | ** ** | **$**                                        | **13.6**   |   | $ | 4.8 |   |
| **Denominators**                                           |       |                                         |       |   |   |
| Weighted average  common shares – basic calculation   | ** ** | **72.5**                                     |       | 69.4 |   |
| Dilutive effect  of employee stock options                 | ** ** | **0.7**                                      |       | 1.1 |   |
| Weighted average  common shares – diluted calculation | ** ** | **73.2**                                     |       | 70.5 |   |
| **Basic  earnings per share**                              | ** ** | **$**                                        | **0.19**   |   | $ | 0.07 |   |
| **Diluted  earnings per share**                            | ** ** | **$**                                        | **0.19**   |   | $ | 0.07 |   |

 

There were noanti-dilutive options outstanding for the three months ended March 31,2008 and 2007.

 

**12.****            ****Comprehensive Income (Loss)**

 

The following tablespresent the pre-tax, tax and after-tax components of Grace’s othercomprehensive income (loss) for the three months ended March 31, 2008 and2007:

 
| **Three Months Ended March 31, 2008**                     | ** ** | **Pre-  Tax  Amount** | ** ** | **Tax  Benefit/  (Expense)** |   | **After-  Tax  Amount** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------------|--------|-------------------------|------------|
| *(In  millions)*                                                                   | ** ** | ** **            | ** ** | ** **                   |   | ** **              | ** ** |
| Defined benefit  pension and other postretirement plans:                           | ** ** | ** **            | ** ** | ** **                   |   | ** **              | ** ** |
| Amortization of  net prior service credit included in net periodic benefit cost    |       | $                     | (1.6       | )                            | $      | 0.6                     |       | **$** | **(1.0** | **)** |
| Amortization of  net deferred actuarial loss included in net periodic benefit cost |       | 6.8                   |       | (2.4                         | )      | **4.4**                 | ** ** |
| Other changes in  funded status                                                    |       | (2.4                  | )          | 2.3                          |   | **(0.1**                | **)**      |
| Benefit plans,  net                                                                |       | 2.8                   |       | 0.5                          |   | **3.3**                 | ** ** |
| Foreign currency  translation adjustments                                          |       | 1.9                   |       | —                       |   | **1.9**                 | ** ** |
| Gain (loss) from  hedging activities                                               |       | 3.5                   |       | (1.3                         | )      | **2.2**                 | ** ** |
| Other  comprehensive income (loss)                                                 |       | $                     | 8.2        |                         | $      | (0.8                    | )          | **$** | **7.4** | ** ** |

 
| **Three Months Ended March 31, 2007**                     | ** ** | **Pre-  Tax  Amount** | ** ** | **Tax  Benefit/  (Expense)** | ** ** | **After-  Tax  Amount** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------------|------------|-------------------------|------------|
| *(In  millions)*                                                                   |       |                  |       |                         |       |                    |       |
| Defined benefit  pension and other postretirement plans:                           |       |                  |       |                         |       |                    |       |
| Amortization of  net prior service credit included in net periodic benefit cost    |       | $                     | (1.7       | )                            | $          | 0.6                     |       | $ | (1.1 | ) |
| Amortization of  net deferred actuarial loss included in net periodic benefit cost |       | 6.7                   |       | (2.2                         | )          | 4.5                     |       |
| Other changes in  funded status                                                    |       | (5.5                  | )          | 1.7                          |       | (3.8                    | )          |
| Benefit plans,  net                                                                |       | (0.5                  | )          | 0.1                          |       | (0.4                    | )          |
| Foreign currency  translation adjustments                                          |       | 5.7                   |       | —                       |       | 5.7                     |       |
| Gain (loss) from  hedging activities                                               |       | 1.9                   |       | (0.8                         | )          | 1.1                     |       |
| Other  comprehensive income (loss)                                                 |       | $                     | 7.1        |                         | $          | (0.7                    | )          | $ | 6.4 |   |

 

The following table presents the components of Grace’s accumulatedother comprehensive income (loss) at March 31, 2008 and December 31,2007:

 
| **Components of Accumulated Other Comprehensive Income (Loss)** | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| *(In  millions)*                                                                              |       |                     |       |                        |       |
| Defined benefit  pension and other postretirement plans:                                      |       |                     |       |                        |       |
| Net prior  service credit (net of tax)                                                        | ** ** | **$**                    | **3.9**    |                        | $          | 4.9 |   |
| Net deferred  actuarial loss (net of tax)                                                     | ** ** | **(400.4**               | **)**      | (404.7                      | )          |
| Benefit plans,  net                                                                           | ** ** | **(396.5**               | **)**      | (399.8                      | )          |
| Foreign currency  translation                                                                 | ** ** | **52.1**                 | ** ** | 50.2                        |       |
| Hedging  activities, net of tax                                                               | ** ** | **1.7**                  | ** ** | (0.5                        | )          |
| Accumulated  other comprehensive income (loss)                                                | ** ** | **$**                    | **(342.7** | **)**                       | $          | (350.1 | ) |

 

Accumulated other comprehensive income (loss) related to the definedbenefit pension and other postretirement plans at March 31, 2008 and December 31,2007, respectively, represents the accumulation of net actuarial losses of$400.4 million and $404.7 million as well as net prior service credits of $3.9million and $4.9 million. These amounts are net of tax and are amortized as acomponent of net periodic benefit cost. For the three months ended March 31,2008 and 2007, the pre-tax benefit recognized related to prior service creditswas $1.6 million and $1.7 million, respectively, and the pre-tax expenserecognized for amortization of accumulated actuarial losses was $6.8 millionand $6.7 million, respectively.  Inaddition, $2.4 million and $5.5 million of pre-tax loss was recognized forchanges in funded status 

 

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during the three months ended March 31, 2008 and 2007,respectively.

 

Grace is a global enterprise operating in over 40 countries with localcurrency generally deemed to be the functional currency for accountingpurposes. The foreign currency translation amount represents the adjustmentsnecessary to translate the balance sheets valued in local currencies to theU.S. dollar as of the end of each period presented, and to translate revenuesand expenses at average exchange rates for each period presented.

 

See Note 6 for adiscussion of hedging activities.

 

**13.****            ****Commitments and ContingentLiabilities**

 

***Asbestos-Related Liability*******–**See Note 3**

 

***EnvironmentalRemediation*******–****Grace is subject to loss contingencies resulting fromextensive and evolving federal, state, local and foreign environmental laws andregulations relating to the generation, storage, handling, discharge anddisposition of hazardous wastes and other materials. Grace accrues foranticipated costs associated with investigative and remediation efforts wherean assessment has indicated that a probable liability has been incurred and thecost can be reasonably estimated. These accruals do not take into account anydiscounting for the time value of money.

 

Grace’s environmentalliabilities are reassessed whenever circumstances become better defined orremediation efforts and their costs can be better estimated. These liabilitiesare evaluated based on currently available information, including the progressof remedial investigation at each site, the current status of discussions withregulatory authorities regarding the method and extent of remediation at eachsite, existing technology, prior experience in contaminated site remediationand the apportionment of costs among potentially responsible parties. Graceexpects that the funding of environmental remediation activities will beaffected by the Chapter 11 proceedings.

 

At March 31, 2008,Grace’s estimated liability for environmental investigative and remediationcosts totaled $373.2 million, as compared with $368.6 million at December 31,2007. The amount is based on funding and/or remediation agreements in place andGrace’s best estimate of its cost for sites not subject to a formal remediationplan. During the fourth quarter of 2007, Grace filed a motion with theBankruptcy Court for approval of one of the largest of these remediationagreements, a multi-site settlement agreement that Grace has executed with theU.S. Government, on behalf of the Environmental Protection Agency (“EPA”) andother federal agencies.  This agreementaddresses 38 sites for which the EPA has filed a claim against Grace.  Under this agreement, Grace would payapproximately $44 million to the U.S. Government and other parties in settlementof 35 of these outstanding claims.  Inreturn, the U.S. Government would agree not to take action against Grace underthe Comprehensive Environmental Response, Compensation, and Liability Act withrespect to such sites.  Grace intends toseparately fund or carry out remediation at the three remaining sites,including remediation relating to Grace’s former vermiculite mining andprocessing site in Libby, Montana discussed below.

 

Grace’s estimatedenvironmental liabilities are included in “liabilities subject to compromise”in the accompanying Consolidated Balance Sheets.

 

Net cash expenditures charged against previously established reservesfor the three months ended March 31, 2008 and 2007 were $1.3 million and$2.8 million, respectively.

 

*Vermiculite Related Matters*

 

EPA Cost Recovery Claim - As a result of a 2003 U.S. DistrictCourt ruling, Grace is required to reimburse the U.S. Government for $54.5million (plus interest) in costs expended through December 2001, and forall appropriate future costs to complete asbestos-related remediation relatingto Grace’s former vermiculite mining and processing activities in the Libby,Montana area.  These costs includecleaning and/or demolition of contaminated buildings, excavation and removal ofcontaminated soil, health screening of Libby residents and former mine workers,and investigation and monitoring costs.

 

Grace and the U.S. Department of Justice have agreedto settle the EPA’s cost recovery claims with respect to Libby for a payment byGrace of $250 million (including the $54.5 million referenced above), suchpayment to be made within 30 days of the Bankruptcy Court’s approval of thesettlement agreement.  The settlementwould cover all past and future remediation costs in the Libby area, except forthose relating to the Grace-owned mine. In return, the EPA would agree to take no action against Grace withrespect to the Libby Asbestos 

 

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Superfund Site. The settlement agreement is subject to approval of the Bankruptcy Courtand a hearing on the matter is scheduled for June 2, 2008.

 

Grace’s total estimatedliability for asbestos remediation related to its former vermiculite operationsin Libby, including the cost of remediation at vermiculite processing sitesoutside of Libby, was $276.4 million and $270.8 million at March 31, 2008and December 31, 2007, respectively, excluding interest.  The estimated obligation as of each dateincludes $250 million for the settlement of Libby remediation costs and doesnot include the cost to remediate the Grace-owned mine site at Libby.

 

MontanaCriminal Proceeding****–****On February 7, 2005, the United States Department ofJustice announced the unsealing of a grand jury indictment against Grace andseven former senior level employees *(UnitedStates of America v. W. R. Grace & Co. et al)* relating toGrace’s former vermiculite mining and processing activities in Libby,Montana.  The indictment accuses thedefendants of (1) conspiracy to violate environmental laws and obstructfederal agency proceedings; (2) violations of the federal Clean Air Act;and (3) obstruction of justice.

 

Grace purchased the Libbymine in 1963 and operated it until 1990; vermiculite processing activitiescontinued until 1992. The grand jury charges that the conspiracy took placefrom 1976 to 2002.  According to the U.S.Department of Justice, Grace could be subject to fines in an amount equal totwice the after-tax profit earned from its Libby operations or twice thealleged loss suffered by victims, plus additional amounts for restitution tovictims. The indictment alleges that such after-tax profits were $140 million.Grace has categorically denied any criminal wrongdoing and intends tovigorously defend itself at trial.

 

In July 2006,the U.S. District Court for the District of Montana dismissed a portion of theconspiracy count of a superseding indictment alleging conspiracy to knowinglyendanger residents of the Libby area and others in violation of the Clean AirAct.  In August 2006, the DistrictCourt granted a motion by the defendants to exclude as evidence sample resultsthat included minerals that do not constitute asbestos under the Clean AirAct.  The Government appealed these andother rulings to the Ninth Circuit Court of Appeals.  In September 2007, the Ninth Circuitoverturned the July 2006 and August 2006 District Court rulings. In December 2007,Grace’s petition for rehearing concerning these rulings was denied.  Grace appealed the Ninth Circuit’s ruling tothe Supreme Court on April 14, 2008. A trial date has not yet been scheduled.

 

The U.S. Bankruptcy Courtpreviously granted Grace’s request to advance legal and defense costs to theemployees involved in this case, subject to a reimbursement obligation if it islater determined that the employees did not meet the standards forindemnification set forth under the appropriate state corporate law. For thethree months ended March 31, 2008 and 2007, total expense for Grace andthe employees was $3.0 million and $2.5 million, respectively, which amountsare included in selling, general and administrative expenses in theaccompanying Consolidated Statements of Operations.  Cumulative expenses to address this matterwere $94.6 million through March 31, 2008.

 

Grace is unable to assess whether the indictment, orany conviction resulting therefrom, will have a material adverse effect on theresults of operations or financial condition of Grace or affect Grace’sbankruptcy proceedings. While the appeal to the Supreme Court is pending, Graceexpects legal fees for this matter to be approximately $3 million perquarter.  Grace intends to expense suchcosts as they are incurred.

 

New Jersey Lawsuit – On June 1, 2005, the New JerseyDepartment of Environmental Protection (“DEP”) filed a lawsuit against Graceand two former employees in the Superior Court of New Jersey Law Division:Mercer County *(N.J. Dept. of EnvironmentalProtection v. W.R. Grace & Co. et al.)* seeking civilpenalties for alleged misrepresentations and false statements made in a PreliminaryAssessment/Site Investigation Report and Negative Declarations submitted byGrace to the DEP in 1995 pursuant to the New Jersey Industrial Site RecoveryAct. Grace submitted the report, which was prepared by an independentenvironmental consultant, in connection with the closing of Grace’s formerplant in Hamilton Township, New Jersey. The State of New Jersey and the U.S.Department of Justice also have conducted criminal investigations related toGrace’s former operations of the Hamilton plant, but Grace is not aware of anyrecent activity related to such investigations.

 

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Grace purchased theHamilton plant assets in 1963 and ceased operations in 1994. During theoperating period, Grace produced spray-on fire protection products and othervermiculite-based products at this plant. The current property owners areconducting remediation activities as directed by the EPA.  The property owners and the EPA have filedproofs of claim against Grace seeking approximately $4.2 million with respectto the Hamilton plant site, which is contemplated as part of the multi-sitesettlement agreement described above.

 

In August 2007, theBankruptcy Court denied the State of New Jersey’s motion for leave to file a lateproof of claim in the amount of $31 million. This ruling, which the State of New Jersey has appealed, does not affectthe claims against the former employees, for which Grace would have anindemnification obligation.  On April 1,2008, the Bankruptcy Court issued an opinion and order directing New Jersey todismiss its lawsuit against Grace with prejudice.  New Jersey has appealed this decision.

 

*Non-Vermiculite Related Matters*

 

At March 31, 2008and December 31, 2007, Grace’s estimated liability for remediation ofsites not related to its former vermiculite mining and processing activitieswas $96.8 million and $97.8 million, respectively. This liability relates toGrace’s current and former operations, including its share of liability foroff-site disposal at facilities where it has been identified as a potentiallyresponsible party.  Grace’s estimatedliability is based upon an evaluation of claims for which sufficientinformation was available and the liabilities settled pursuant to themulti-site settlement agreement described above. As Grace receives newinformation, its estimated liability may change materially.

 

***Purchase Commitments*******– Grace engages in purchase commitments to minimizethe volatility of major components of direct manufacturing costs includingnatural gas, certain metals, asphalt, amines and other materials.  Such commitments are for quantities thatGrace fully expects to use in its normal operations.

 

***Guarantees and Indemnification Obligations*******–****Graceis a party to many contracts containing guarantees and indemnificationobligations. These contracts primarily consist of:

 

·                  Contracts providing for the sale of a former business unit or productline in which Grace has agreed to indemnify the buyer against liabilitiesarising prior to the closing of the transaction, including environmentalliabilities. These liabilities are included in “liabilities subject tocompromise” in the accompanying Consolidated Balance Sheets.

 

·                  Guarantees of real property lease obligations of third parties, typicallyarising out of (a) leases entered into by former subsidiaries of Grace, or(b) the assignment or sublease of a lease by Grace to a third party. Theseobligations are included in “liabilities subject to compromise” in theaccompanying Consolidated Balance Sheets.

 

·                  Licenses of intellectual property by Grace to third parties in whichGrace has agreed to indemnify the licensee against third party infringementclaims.

 

·                  Contracts entered into with third party consultants, independentcontractors, and other service providers in which Grace has agreed to indemnifysuch parties against certain liabilities in connection with their performance.Based on historical experience and the likelihood that such parties will make aclaim against Grace, Grace believes that such indemnification obligations areimmaterial.

 

·                  Product warranties with respect to certain products sold to customersin the ordinary course of business. These warranties typically provide thatproduct will conform to specifications. Grace generally does not establish aliability for product warranty based on a percentage of sales or other formula.Grace accrues a warranty liability on a transaction-specific basis depending onthe individual facts and circumstances related to each sale. Both the liabilityand annual expense related to product warranties are immaterial to theConsolidated Financial Statements.

 

***FinancialAssurances*******–Financial assurances have been established for a variety of purposes, includinginsurance and environmental matters, asbestos settlements and appeals,trade-related commitments and other matters. At March 31 2008, Grace had gross financial assurances issued andoutstanding of $283.7 million, comprised of 

 

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$138.7 million of suretybonds issued by various insurance companies, and $145.0 million of standbyletters of credit and other financial assurances issued by various banks. Asdiscussed in Note 9, $61.4 million of these financial assurances have beenissued under the DIP facility.

 

In connection with a 1994 divestment, Grace obtained aletter of credit in the maximum amount of $25.0 million to secure scheduledpayments on bonds issued to fund the transaction.  Amounts drawn under this letter of creditaggregated $4.2 million through March 31, 2008.  The last of the bonds matures in November 2016.  Because the primary source of bond paymentfunds is revenue from contracts under which timing and amounts of sales arevariable, it is not possible to predict future draws.

 

No amounts have been accrued in the ConsolidatedFinancial Statements related to Grace’s financial assurances.

 

***Accounting forContingencies*******–****Although the outcome of each of the matters discussed abovecannot be predicted with certainty, Grace has assessed its risk and has madeaccounting estimates as required under U.S. generally accepted accountingprinciples. As a result of the Filing, claims related to certain of the itemsdiscussed above will be addressed as part of Grace’s Chapter 11 proceedings. Accrualsrecorded for such contingencies have been included in “liabilities subject tocompromise” in the accompanying Consolidated Balance Sheets. The amounts ofthese liabilities as ultimately determined through the Chapter 11 proceedingscould be materially different from amounts recorded at March 31, 2008.

 

**14.****            ****Pension Plans and OtherPostretirement Benefit Plans**

 

***Pension Plans***– Grace maintains defined benefit pension planscovering employees of certain units who meet age and service requirements.Benefits are generally based on final average salary and years of service.Grace funds its U.S. qualified pension plans (“U.S. qualified pension plans”)in accordance with U.S. federal laws and regulations. Non-U.S. pension plans (“non-U.S.pension plans”) are funded under a variety of methods, as required under locallaws and customs.

 

Grace also provides,through nonqualified plans, supplemental pension benefits in excess of U.S.qualified pension plan limits imposed by federal tax law. These plans coverofficers and higher-level employees and serve to increase the combined pensionamount to the level that they otherwise would have received under the U.S.qualified pension plans in the absence of such limits. The nonqualified plansare unfunded and Grace pays the costs of benefits as they are incurred.

 

At the December 31,2007 measurement date for Grace’s defined benefit pension plans, the projectedbenefit obligation (“PBO”) was approximately $1,449 million as measured underU.S. generally accepted accounting principles. The PBO basis reflects the present value (using a 6.25% discount ratefor U.S. plans and a 5.81% weighted average discount rate for non-U.S. plans asof December 31, 2007) of vested and non-vested benefits earned fromemployee service to date, based upon current services and estimated future payincreases for active employees.

 

Beginning in 2007, on a quarterlybasis, Grace analyzes pension assets and pension liabilities along with theresulting funded status, and updates its estimate of these measures.  Funded status is adjusted for contributions,benefit payments, actual return on assets, current discount rates and otheridentifiable and material actuarial changes.

 

The assumed discount rate for pension plans reflects the market ratesfor high quality corporate bonds currently available and is subject to changebased on changes in the overall market interest rates. For the U.S. qualifiedpension plans, the assumed discount rate of 6.25% as of December 31, 2007was selected by Grace, in consultation with its independent actuaries, based ona yield curve constructed from a portfolio of high quality bonds for which thetiming and amount of cash outflows approximate the estimated payouts of theplan. Based on review of an updated yield curve analysis as of March 31,2008, Grace increased the discount rate for the U.S. qualified pension plans to6.50% based on market rates at that time. Grace also evaluated the currentdiscount rates for the pension plans in the United Kingdom, Germany and Canada,which combined represented approximately 90% of the benefit obligation of thenon-U.S. pension plans as of December 31, 2007. Based on review of theyield curve analyses for these plans as of March 31, 2008, Grace increasedthe discount rate for the United Kingdom from 5.75% at December 31, 2007to 6.75% at March 

 

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31, 2008, for Germany from 5.50% at December 31, 2007 to 6.00% at March 31,2008, and for Canada from 5.50% at December 31, 2007 to 6.00% at March 31,2008. The aggregate adjustment to the funded status resulting from the changein discount rates as of March 31, 2008 (including the postretirement plan)was an increase to total assets of approximately $32 million, and a decrease tototal liabilities of approximately $38 million. After tax effects, total assets increased by approximately $10 million,total liabilities decreased by approximately $38 million and shareholders’equity increased by approximately $48 million.

 

AtMarch 31, 2008, Grace’srecorded pension liability for underfunded and unfunded plans was $441.3million ($192.9 million included in “underfunded defined benefit pension plans”,$140.8 million included in “unfunded pay-as-you-go defined benefit pensionplans”, $13.0 million included in “other current liabilities”, and $94.6million related to noncurrent supplemental pension benefits, included in “liabilitiessubject to compromise”). The recorded liability reflects 1) the shortfallbetween dedicated assets and the PBO of underfunded plans ($192.9 million); and2) the PBO of unfunded pay-as-you-go plans ($248.4 million).

 

***Postretirement Benefits Other Than Pensions*** –****Graceprovides postretirement health care and life insurance benefits for retiredemployees of certain U.S. business units and certain divested units.  The postretirement medical plan providesvarious levels of benefits to employees hired before 1991 who retire from Graceafter age 55 with at least 10 years of service. These plans are unfunded and Grace pays a portion of the costs ofbenefits under these plans as they are incurred. Grace applies SFAS No. 106,“Employers’ Accounting for Postretirement Benefits Other Than Pensions,” whichrequires that the future costs of postretirement health care and life insurancebenefits be accrued over the employees’ years of service.

 

Retirees andbeneficiaries covered by the postretirement medical plan are required tocontribute a minimum of 40% of the calculated premium for that coverage. During2002, per capita costs under the retiree medical plans exceeded caps on theamount Grace was required to contribute under a 1993 amendment to the plan. Asa result, for 2003 and future years, retirees will bear 100% of any increase inpremium costs.

 

For 2008 measurementpurposes, per capita costs, before retiree contributions, were assumed toinitially increase at a rate of 8.5%. The rate is assumed to decrease gradually to 5% through 2012 and remainat that level thereafter.  A onepercentage point increase or decrease in assumed health care medical cost trendrates would not materially change Grace’s postretirement benefit obligations(impact of less than $1.0 million) and would have a negligible impact on theaggregate of the service and interest cost components of net periodic benefitcost.

 

The components of netperiodic benefit cost (income) for Grace’s pension and postretirement plans forthe three months ended March 31, 2008 and 2007 are as follows:

 
| ** **                                                                         | ** ** | **Three Months  Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| ** **                                                                         | ** ** | **Pension**                                  | ** ** | ** ** | ** ** | **Pension** | ** ** | ** ** | ** ** |
| **Components of Net Periodic Benefit Cost (Income)** | ** ** | **U.S.**                                     | ** ** | **Non-  U.S.** | ** ** | **Post-  retirement** | ** ** | **U.S.** | ** ** | **Non-  U.S.** | ** ** | **Post-  retirement** | ** ** |
| *(In  millions)*                                                                   |       |                                         |       |   |   |   | ** ** |   |   |   |   |   |   |
| Service cost                                                                       | ** ** | **$**                                        | **4.2**    | ** ** | **$** | **2.2** | ** ** | **$** | **0.1** | ** ** | $ | 4.2 |   | $ | 2.0 |   | $ | 0.1 |   |
| Interest cost                                                                      | ** ** | **15.6**                                     | ** ** | **5.9** | ** ** | **1.3** | ** ** | 14.4 |   | 5.0 |   | 1.1 |   |
| Expected return  on plan assets                                                    | ** ** | **(15.5**                                    | **)**      | **(5.0** | **)** | **—** | ** ** | (14.8 | ) | (5.2 | ) | — |   |
| Amortization of  prior service cost (credit)                                       | ** ** | **0.4**                                      | ** ** | **0.2** | ** ** | **(2.2** | **)** | 0.6 |   | 0.2 |   | (2.5 | ) |
| Amortization of  net deferred actuarial loss                                       | ** ** | **5.0**                                      | ** ** | **1.3** | ** ** | **0.5** | ** ** | 4.9 |   | 1.4 |   | 0.4 |   |
| **Net  periodic benefit cost (income)**                                            | ** ** | **$**                                        | **9.7**    | ** ** | **$** | **4.6** | ** ** | **$** | **(0.3** | **)** | $ | 9.3 |   | $ | 3.4 |   | $ | (0.9 | ) |

 

***Plan Contributions and Funding*** – Subject to any required approval ofthe Bankruptcy Court, Grace intends to satisfy its funding obligations underthe U.S. qualified pension plans and to comply with all of the requirements ofthe Employee Retirement Income Security Act of 1974 (“ERISA”).  For ERISA purposes, funded status iscalculated on a different basis than under U.S. generally accepted accountingprinciples.  Grace has obtained BankruptcyCourt approval to fund all minimum required payments under the U.S. qualifiedpension plans through April 2008. In that regard, Grace contributed approximately $76 million in 2007,approximately $15 million in January 2008, and approximately $18 millionin April 2008 to the trusts that hold assets of the U.S. qualified pensionplans.  While Grace intends to continueto fund all minimum required payments under the U.S. qualified pension plans,there can be no assurance that 

 

I-33

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the Bankruptcy Court willcontinue to approve these payments.

 

Contributions to non-U.S.pension plans are not subject to Bankruptcy Court approval and Grace intends tofund such plans based on applicable legal requirements, and actuarial andtrustee recommendations.

 

Grace plans to paybenefits as they become due under virtually all pay-as-you-go plans and tomaintain compliance with federal funding laws for its U.S. qualified pensionplans.

 

**15.****            ****Operating Segment Information**

 

Grace is a globalproducer of specialty chemicals and materials. It generates revenues from twooperating segments: Grace Davison and Grace Construction Products.  Intersegment sales, eliminated inconsolidation, are not material.

 

Grace’s reportable operating segments reflectthe transfer of the packaging technologies product line to the Grace Davisonoperating segment, which was completed in the fourth quarter of 2007. Theprevious Grace Performance Chemicals operating segment has been renamed “GraceConstruction Products” as a result of the transfer. Previously reported segmentinformation contained herein has been retrospectively restated to reflect thisrealignment.

 

The following table presents information related to Grace’s operatingsegments for the three month periods ended March 31, 2008 and 2007,respectively. Only those corporate expenses directly related to the operatingsegments are allocated for reporting purposes. All remaining corporate itemsare reported separately and labeled as such.

 
| ** **                           | ** ** | **Three Months  Ended  March 31,** | ** ** |
|--------------------------------------|------------|----------------------------------------------|------------|
| **Operating Segment Data** | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| *(In  millions)*                     |       |                                         |       |   |   |
| **Net  Sales**                       |       |                                         |       |   |   |
| Grace Davison                        | ** ** | **$**                                        | **497.1**  |   | $ | 467.6 |   |
| Grace  Construction Products         | ** ** | **262.1**                                    |       | 248.0 |   |
| **Total**                            | ** ** | **$**                                        | **759.2**  |   | $ | 715.6 |   |
| **Pre-tax  Operating Income**        |       |                                         | ** ** |   |   |
| Grace Davison                        | ** ** | **$**                                        | **62.3**   | ** ** | $ | 54.4 |   |
| Grace  Construction Products         | ** ** | **24.7**                                     | ** ** | 26.8 |   |
| Corporate costs                      | ** ** | **(24.8**                                    | **)**      | (20.6 | ) |
| **Total**                            | ** ** | **$**                                        | **62.2**   |   | $ | 60.6 |   |

 

Corporate costs includeexpenses of corporate headquarters functions incurred in support of coreoperations, such as corporate financial and legal services, human resourcesmanagement, communications and regulatory affairs. Corporate costs also includecertain pension and postretirement benefits, including the amortization ofdeferred costs that are considered a core operating expense but not allocatedto operating segments.

 

The following table presents information related to the geographicareas in which Grace operated for the three months ended March 31, 2008and 2007, respectively. Sales are attributed to geographic areas based oncustomer location.

 
| ** **                         | ** ** | **Three Months  Ended  March 31,** | ** ** |
|------------------------------------|------------|----------------------------------------------|------------|
| **Geographic Area Data** | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| *(In  millions)*                   |       |                                         |       |   |   |
| **Net  Sales**                     |       |                                         |       |   |   |
| United States                      | ** ** | **$**                                        | **250.3**  |   | $ | 245.8 |   |
| Canada and  Puerto Rico            | ** ** | **23.3**                                     |       | 20.9 |   |
| Total North  America               | ** ** | **273.6**                                    |       | 266.7 |   |
| Europe Africa                      | ** ** | **324.0**                                    |       | 295.0 |   |
| Asia Pacific                       | ** ** | **112.2**                                    |       | 110.6 |   |
| Latin America                      | ** ** | **49.4**                                     |       | 43.3 |   |
| **Total**                          | ** ** | **$**                                        | **759.2**  |   | $ | 715.6 |   |

 

The pre-tax operating income for Grace’s operating segments for thethree months ended March 31, 2008 and 2007, respectively, is reconciled belowto income before income taxes and minority interest presented in theaccompanying Consolidated Statements of Operations.

 
| ** **                                                                                              | ** ** | **Three Months  Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| **Reconciliation of Operating Segment Data to Financial Statements** | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| *(In  millions)*                                                                                        |       |                                         |       |   |   |
| Pre-tax  operating income – core operations                                                        | ** ** | **$**                                        | **62.2**   | ** ** | $ | 60.6 |   |
| Minority  interest in consolidated entities                                                             | ** ** | **1.9**                                      | ** ** | 2.4 |   |
| Chapter 11  expenses, net of interest income                                                            | ** ** | **(18.4**                                    | **)**      | (17.8 | ) |
| Net gain (loss)  on sales of investments and disposals of assets                                        | ** ** | **1.6**                                      | ** ** | 0.2 |   |
| Provision for  environmental remediation                                                                | ** ** | **(5.9**                                     | **)**      | — |   |
| Interest expense  and related financing costs                                                           | ** ** | **(15.1**                                    | **)**      | (19.4 | ) |
| Other, net                                                                                              | ** ** | **4.8**                                      | ** ** | (3.9 | ) |
| Income before  income taxes and minority interest                                                       | ** ** | **$**                                        | **31.1**   | ** ** | $ | 22.1 |   |

 

Minority interest pertains to several joint ventures that Graceconsolidates, the largest of which is Advanced Refining Technologies LLC (“ART”),a joint venture between Grace and Chevron Products 

 

I-34

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Company, in which Grace has a 55% economic interest.

 

**16.****            ****Minority Interest in ConsolidatedEntities**

 

Within both Grace Davisonand Grace Construction Products, Grace conducts certain business activities invarious countries through joint ventures with unaffiliated third parties, thefinancial results of which are included in Grace’s consolidated financialstatements.  The following table presentssummary financial statistics for Grace’s combined businesses subject to profitsharing:

 
| ** **                            | ** ** | **Three Months  Ended  March 31,** | ** ** |
|---------------------------------------|------------|----------------------------------------------|------------|
| ** **                            | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| *(In millions)*                  | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Sales                                 | ** ** | **$**                                        | **89.0**   |   | $ | 95.3 |   |
| Income before  taxes                  | ** ** | **5.0**                                      |       | 5.8 |   |
| Net income                            | ** ** | **4.3**                                      |       | 5.6 |   |
| Minority  interests in net income     | ** ** | **1.9**                                      |       | 2.4 |   |
| Dividends paid  to minority interests | ** ** | **$**                                        | **—** |   | $ | 11.8 |   |

 
| ** **                                       | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| *(In  millions)*                                 |       |                     |       |                        |       |
| Cash                                             | ** ** | **$**                    | **68.6**   |                        | $          | 57.0 |   |
| Other current  assets                            | ** ** | **159.1**                |       | 157.0                       |       |
| Total assets                                     | ** ** | **248.3**                |       | 233.1                       |       |
| Total  liabilities                               | ** ** | **82.9**                 |       | 74.5                        |       |
| Shareholders’  equity                       | ** ** | **165.4**                |       | 158.6                       |       |
| Minority  interests in shareholders’ equity | ** ** | **$**                    | **71.8**   |                        | $          | 70.8 |   |

 

I-35

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**Item 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

**Financial Summary for March 31,2008**

 

Following is a summary ofkey financial measures of our performance for the three months ended March 31,2008 compared with the prior year period. Our reportable operatingsegments reflect the transfer of the packaging technologies product line to theGrace Davison operating segment, which was completed in the fourth quarter of2007. The previous Grace Performance Chemicals operating segment has beenrenamed “Grace Construction Products” as a result of the transfer. All segmentinformation contained herein has been retrospectively restated to reflect thisrealignment.

 

·                  Sales increased 6.1% from the prior year period, which included anincrease of 6.3% for the Grace Davison operating segment and an increase of5.7% for the Grace Construction Products operating segment.  Overall, sales were up 2.6% in North America,9.8% in Europe Africa, 1.4% in Asia Pacific and 14.1% in Latin America.

 

·                  Net results for each period have been primarily affected by: theperformance of our businesses – which is categorized as “core operations;” andthe impact of legal contingencies and other nonoperating liabilities – which iscategorized as “noncore activities.”

 

·                  Net income for the three months ended March 31, 2008 and 2007 was$13.6 million and $4.8 million, respectively. The current year and prior year periods were negatively affected byChapter 11 expenses, litigation, and other matters not related to coreoperations.

 

·                  Pre-tax income from core operations was $62.2 million compared with$60.6 million in the prior year quarter, a 2.6% increase.  Pre-tax operating income of the Grace Davisonoperating segment was $62.3 million compared with $54.4 million in the prioryear quarter, up 14.5%.  Pre-taxoperating income of Grace Construction Products was $24.7 million compared with$26.8 million for the prior year quarter, a 7.8% decrease. Corporate costsrelated to core operations were $24.8 million in the first quarter of 2008compared with $20.6 million in the prior year quarter.

 

·                  The pre-tax loss from noncore activities was $0.6 million compared witha loss of $5.8 million in the prior year period.

 

·                  Operating cash outflows were $(47.7) million compared with $(49.0)million for the prior year period.

 

See the Analysis of Continuing Operations table, “Results of Operations”and “Operating Segment Overview” sections below for analyses of our operatingresults on a consolidated basis, as well as by operating segment.  See “Analysis of Cash Flows” below forfurther discussion of cash flows.

 

We are attempting toresolve noncore liabilities and contingencies through our Chapter 11proceeding. Our noncore liabilities include asbestos-related litigation,environmental remediation, tax disputes and business litigation. Our operatingstatements include periodic adjustments to account for changes in estimates ofsuch liabilities and developments in our Chapter 11 case. These liabilities andcontingencies may result in continued volatility in net income in the future.

 

**Description of Core Business**

 

We are engaged inspecialty chemicals and specialty materials businesses on a worldwide basisthrough two operating segments:

 

***Grace Davison***includes:

 

·                  Refining Technologies products, including:

 

·                  Fluid catalytic cracking, or FCC,catalysts, that help to “crack” the hydrocarbon chain in distilled crude oil toproduce transportation fuels, such as gasoline and diesel fuels, and otherpetroleum-based products; and FCC additives used to reduce sulfur in gasoline,maximize propylene production from refinery FCC units, and reduce emissions ofsulfur oxides, nitrogen oxides and carbon monoxide from refinery FCC units, and

 

·                  Hydroprocessing catalysts that are usedin process reactors to upgrade heavy oils into lighter, more useful products byremoving impurities such as nitrogen,

 

I-36

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sulfur and heavy metals,allowing less expensive feedstocks to be used in the petroleum refiningprocess;

 

·                  Materials Technologies products,including:

 

·                  Silica-based and silica-alumina-based engineeredmaterials used in:

 

·                  Industrial applications, such as rubber and tires,plastics, precision investment casting, refractory, insulating glass windows,drying applications, fulfilling various functions such as reinforcement, hightemperature binding and moisture scavenging,

 

·                  Consumer applications, as a free-flow, carrier orprocessing aid in food and personal care products; as a toothpaste abrasive;and for the processing and stabilization of edible oils and beverages, and

 

·                  Coatings and print media applications consisting offunctional additives that:  providematting effects and corrosion protection for industrial coatings; enableenhanced media and paper quality in ink jet coatings; and act as a functionalfiller and retention aid in paper, and

 

·                  Sealants and coatings used in rigid food and beveragepackaging, including can and closure sealants used to seal and enhance theshelf life of can and bottle contents, and coatings for cans and closures thatprevent metal corrosion, protect package contents from the influence of metaland ensure proper adhesion of sealing compounds and technologies designed toreduce off-taste effects and extend the shelf-life of packaged products;

 

·                  Specialty Technologies products, including:

 

·                  Polyolefin catalysts and catalyst supports that areessential components in the manufacture of polyethylene and polypropyleneresins, and other chemical catalysts used in a variety of industrial,environmental and consumer applications, and

 

·                  Silica-based materials and chromatography columns,instruments, consumables and accessories used in analytical chemistryapplications and life sciences.

 

Hydroprocessing catalystsare sold through Advanced Refining Technologies, LLC, ART, our joint venturewith Chevron Products Company (“Chevron”). We report 100% of the revenues ofthe ART joint venture, but only receive 55% of the income after minorityinterest is allocated to Chevron.

 

Key external factorsaffecting our Refining Technologies product group are the economics of thepetroleum refining industry, specifically the impacts of demand fortransportation fuels and petrochemical products, and crude oil supply. FCCcatalysts and some hydroprocessing catalysts are consumed at a relativelysteady rate and replaced regularly, while other hydroprocessing catalysts areconsumed over a period of years and replaced in an irregular pattern.

 

Sales of our MaterialsTechnologies and Specialty Technologies product groups are affected by globaleconomic conditions, including the underlying growth rate of targeted end-useapplications.

 

***Grace Construction Products***includes specialty chemicals and buildingmaterials, including concrete admixtures and fibers used to improve thedurability and working properties of concrete, additives used in cementprocessing to improve energy efficiency, enhance the characteristics offinished cement and improve ease of use, building materials used in commercial,infrastructure and residential construction and renovation to protect buildingsfrom water, vapor and air penetration, and fire protection materials used toprotect buildings in the event of fire.

 

Construction Productssales are primarily impacted by global non-residential construction activityand U.S. residential construction activity.

 

We manage theConstruction Products operating segment by geographic region as follows:

 

·                  **Americas**— includes North, Central and SouthAmerica.

 

·                  **Europe**— includes Eastern and Western Europe,the Middle East, Africa, and India.

 

I-37

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·                  **Asia**— includes Asia (excluding India), the Pacific RimCountries, Australia and New Zealand.

 

***Global scope*** – We operate our business on a global scale withapproximately 67% of our revenue (see following table) and over 50% of ouroperating properties outside the United States. We conduct business in 41countries and in more than 20 currencies. We manage our operating segments on aglobal basis, to serve global markets. Currency fluctuations in relation to theU.S. dollar affect our reported earnings, net assets and cash flows.

 

The table below shows thesales in each of our operating segments, and domestic and international sales,as a percentage of our total sales.

 
| ** **                                         | ** ** | **Three Months  Ended  March 31,** | ** ** |
|----------------------------------------------------|------------|----------------------------------------------|------------|
| **Percentage of Total Grace Sales** | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| Grace Davison                                      | ** ** | **65.5**                                     | **%**      | 65.4 | % |
| Grace  Construction Products                       | ** ** | **34.5**                                     | **%**      | 34.6 | % |
| **Total**                                          | ** ** | **100.0**                                    | **%**      | 100.0 | % |
| Grace U.S.                                         | ** ** | **33.0**                                     | **%**      | 34.3 | % |
| Grace non-U.S.                                     | ** ** | **67.0**                                     | **%**      | 65.7 | % |
| **Total**                                          | ** ** | **100.0**                                    | **%**      | 100.0 | % |

 

**Voluntary Bankruptcy Filing**

 

Inresponse to a sharply increasing number of asbestos-related personal injuryclaims, on April 2, 2001, Grace and 61 of our United States subsidiariesand affiliates, including W. R. Grace & Co. – Conn., filed voluntarypetitions for reorganization under Chapter 11 of the United States BankruptcyCode in the United States Bankruptcy Court for the District of Delaware. Ournon-U.S. subsidiaries and certain of our U.S. subsidiaries were not included inthe Chapter 11 filing.

 

UnderChapter 11, we have continued to operate as debtors-in-possession under courtprotection from creditors and claimants, while using the Chapter 11 process todevelop and implement a plan for addressing the asbestos-related claims. Sincethe Chapter 11 filing, the bankruptcy court has approved all motions necessaryto conduct normal business activities.

 

OnJanuary 13, 2005, we filed an amended plan of reorganization and relateddocuments with the bankruptcy court. On July 26, 2007, the bankruptcycourt terminated our exclusive rights to propose a plan of reorganization andsolicit votes thereon. As a result of the termination of these rights, anyparty-in-interest can propose a competing plan of reorganization.

 

OnNovember 5, 2007, the committee representing asbestos personal injuryclaimants and the representative of future asbestos claimants filed a proposedplan of reorganization with the bankruptcy court. The filing did not include adisclosure statement, trust distribution procedures, exhibits, or othersupporting documents.

 

On April 6, 2008, wereached an agreement in principle, the PI Settlement, with the committeerepresenting asbestos personal injury claimants, the representative of futureasbestos claimants, and the committee representing equity security holders thatwould settle all present and future asbestos-related personal injury claims. Thecommittees representing general unsecured creditors and property damageclaimants are not parties to the PI Settlement.

 

See Note 2 to theConsolidated Financial Statements for discussion of the plans of reorganization.See Note 2 to the Consolidated Financial Statements and “Chapter 11 RecentDevelopments” below for discussion of the PI settlement.

 

Any plan ofreorganization will become effective only after a vote of eligible creditorsand with the approval of the bankruptcy court and the U.S. District Court forthe District of Delaware. Votes on a plan of reorganization may not besolicited until the bankruptcy court approves the related disclosure statement.

 

**Critical Accounting Estimates**

 

See the “CriticalAccounting Estimates” heading in Item 7 of our Form 10-K for the yearended December 31, 2007 for a discussion of our critical accountingestimates.

 

**Recent Accounting Pronouncements**

 

See Note 1 to theConsolidated Financial Statements for a discussion of recent accountingpronouncements and their effect on us.

 

**Summary Financial Information andMetrics**

 

Set forth below is achart that lists our key operating statistics, and dollar and percentage 

 

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changes for the threemonth periods ended March 31, 2008 and 2007. Please refer to this Analysisof Continuing Operations chart when reading Management’s Discussion andAnalysis of Financial Condition and Results of Operations.

 

In the Analysis of ContinuingOperations chart, as well as in the financial information presented throughoutManagement’s Discussion and Analysis of Financial Condition and Results ofOperations, we present our financial results in the same manner as results arereviewed internally. We break out our results of operations by operatingsegment and between “core operations” and “noncore activities.” Core operationscomprise the financial results of Grace Davison, Grace Construction Products,and the costs of corporate activities that directly or indirectly support ourbusiness operations. In contrast, noncore activities comprise all other eventsand transactions not directly related to the generation of operating revenue orthe support of our core operations and generally relate to our formeroperations and products. See “Pre-tax Income (Loss) from Noncore Activities”for more information about noncore activities. We use pre-tax income from coreoperations as the performance factor in determining certain incentivecompensation and as the profitability factor in all significant businessdecisions.

 

Pre-tax income from coreoperations, pre-tax income (loss) from noncore activities, pre-tax income fromcore operations as a percentage of sales, and pre-tax income from coreoperations before depreciation and amortization do not purport to representincome or cash flow measures as defined under U.S. generally acceptedaccounting principles, and you should not consider them an alternative to suchmeasures as an indicator of our performance. We provide these measures so youcan distinguish the operating results of our current business base from theincome and expenses of our past businesses, discontinued products, andcorporate legacies, and the effect of our Chapter 11 proceedings, and to ensurethat you understand the key data that management uses to evaluate our resultsof operations.

 

Pre-tax income from core operations has material limitations as anoperating performance measure because it excludes income and expenses thatcomprise our noncore activities, which include, among other things, provisionsfor asbestos-related litigation and environmental remediation, income frominsurance settlements, and legal defense costs, all of which have been materialcomponents of our net income (loss). Pre-tax income from core operations beforedepreciation and amortization also has material limitations as an operatingperformance measure since it excludes the impact of depreciation andamortization expense. Our business is substantially dependent on the successfuldeployment of our capital assets; therefore, depreciation and amortizationexpense is a necessary element of our costs and ability to generate revenue. Wecompensate for the limitations of these measurements by using these indicatorstogether with net income (loss) as measured under U.S. generally acceptedaccounting principles to present a complete analysis of our results ofoperations. You should evaluate pre-tax income from core operations and pre-taxincome from core operations before depreciation and amortization in conjunctionwith net income (loss) for a more complete analysis of our financial results.

 

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| ** **                                                                                   | ** ** | **Three Months  Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| **Analysis of Continuing Operations**                                         | ** ** | **2008**                                     | ** ** | **2007** | ** ** | **$ Change  Fav  (Unfav)** | ** ** | **% Change  Fav  (Unfav)** | ** ** |
| *(In millions)*                                                                         |       |                                         |       |   |   |   |   |   |   |
| **Net sales:**                                                                          |       |                                         |       |   |   |   |   |   |   |
| **Grace  Davison**                                                                           | ** ** | **$**                                        | **497.1**  |   | $ | 467.6 |   | $ | 29.5 |   | 6.3 | % |
| Refining  Technologies                                                                       | ** ** | **236.9**                                    |       | 219.9 |   | 17.0 |   | 7.7 | % |
| Materials  Technologies                                                                      | ** ** | **170.3**                                    |       | 159.6 |   | 10.7 |   | 6.7 | % |
| Specialty  Technologies                                                                      | ** ** | **89.9**                                     | ** ** | 88.1 |   | 1.8 |   | 2.0 | % |
| **Grace  Construction Products**                                                             | ** ** | **262.1**                                    | ** ** | 248.0 |   | 14.1 |   | 5.7 | % |
| Americas                                                                                     | ** ** | **132.5**                                    | ** ** | 135.3 |   | (2.8 | ) | (2.1 | %) |
| Europe                                                                                       | ** ** | **97.6**                                     | ** ** | 83.1 |   | 14.5 |   | 17.4 | % |
| Asia                                                                                         | ** ** | **32.0**                                     | ** ** | 29.6 |   | 2.4 |   | 8.1 | % |
| **Total  Grace net sales**                                                                   | ** ** | **$**                                        | **759.2**  | ** ** | $ | 715.6 |   | $ | 43.6 |   | 6.1 | % |
| ** **                                                                                   |       |                                         | ** ** |   |   |   |   |   |   |
| **Pre-tax  operating income:**                                                               |       |                                         | ** ** |   |   |   |   |   |   |
| Grace Davison*(1)*                                                                           | ** ** | **$**                                        | **62.3**   | ** ** | $ | 54.4 |   | $ | 7.9 |   | 14.5 | % |
| Grace  Construction Products*(2)*                                                            | ** ** | **24.7**                                     | ** ** | 26.8 |   | (2.1 | ) | (7.8 | %) |
| Corporate costs:                                                                             |       |                                         | ** ** |   |   |   |   |   |   |
| Support  functions                                                                           | ** ** | **(12.2**                                    | **)**      | (11.1 | ) | (1.1 | ) | (9.9 | %) |
| Pension,  performance-related compensation, and other                                        | ** ** | **(12.6**                                    | **)**      | (9.5 | ) | (3.1 | ) | (32.6 | %) |
| Total Corporate  costs                                                                       | ** ** | **(24.8**                                    | **)**      | (20.6 | ) | (4.2 | ) | (20.4 | %) |
| **Pre-tax  income from core operations**                                                     | ** ** | **62.2**                                     | ** ** | 60.6 |   | 1.6 |   | 2.6 | % |
| **Pre-tax  income (loss) from noncore activities**                                           | ** ** | **(0.6**                                     | **)**      | (5.8 | ) | 5.2 |   | 89.7 | % |
| Interest expense                                                                             | ** ** | **(15.1**                                    | **)**      | (19.4 | ) | 4.3 |   | 22.2 | % |
| Interest income                                                                              | ** ** | **1.1**                                      | ** ** | 2.1 |   | (1.0 | ) | (47.6 | %) |
| **Income  before Chapter 11 expenses and income taxes**                                      | ** ** | **47.6**                                     | ** ** | 37.5 |   | 10.1 |   | 26.9 | % |
| Chapter 11  expenses, net of interest income                                                 | ** ** | **(18.4**                                    | **)**      | (17.8 | ) | (0.6 | ) | (3.4 | %) |
| Provision for  income taxes                                                                  | ** ** | **(15.6**                                    | **)**      | (14.9 | ) | (0.7 | ) | (4.7 | %) |
| **Net  income**                                                                              | ** ** | **$**                                        | **13.6**   | ** ** | $ | 4.8 |   | $ | 8.8 |   | 183.3 | % |
| ** **                                                                                   |       |                                         | ** ** |   |   |   |   |   |   |
| **Key  Financial Measures:**                                                                 |       |                                         | ** ** |   |   |   |   |   |   |
| **Pre-tax  income from core operations as a percentage of sales:**                           |       |                                         | ** ** |   |   |   |   |   |   |
| Grace Davison                                                                                | ** ** | **12.5**                                     | **%**      | 11.6 | % | NM |   | 0.9 |  pts |
| Grace  Construction Products                                                                 | ** ** | **9.4**                                      | **%**      | 10.8 | % | NM |   | (1.4 | ) pts |
| Total Core  Operations                                                                       | ** ** | **8.2**                                      | **%**      | 8.5 | % | NM |   | (0.3 | ) pts |
| Total Core  Operations adjusted for profit sharing of joint  ventures*(3)*                   | ** ** | **8.4**                                      | **%**      | 8.8 | % | NM |   | (0.4 | ) pts |
| ** **                                                                                   | ** ** | ** **                                   | ** ** |   |   |   |   |   |   |
| **Pre-tax  income from core operations before depreciation and amortization**                | ** ** | **$**                                        | **92.4**   | ** ** | $ | 88.2 |   | $ | 4.2 |   | 4.8 | % |
| **As a  percentage of sales**                                                                | ** ** | **12.2**                                     | **%**      | 12.3 | % | NM |   | (0.1 | ) pts |
| **Depreciation  and amortization**                                                           | ** ** | **$**                                        | **30.2**   | ** ** | $ | 27.6 |   | $ | (2.6 | ) | (9.4 | %) |
| **Gross  profit percentage (sales less cost of goods sold as a percent of sales)***(4)***:** |       |                                         | ** ** |   |   |   |   |   |   |
| Grace Davison                                                                                | ** ** | **29.2**                                     | **%**      | 28.1 | % | NM |   | 1.1 |  pts |
| Grace  Construction Products                                                                 | ** ** | **33.7**                                     | **%**      | 35.3 | % | NM |   | (1.6 | ) pts |
| Total Grace                                                                                  | ** ** | **30.6**                                     | **%**      | 30.4 | % | NM |   | 0.2 |  pts |
| ** **                                                                                   |       |                                         | ** ** |   |   |   |   |   |   |
| **Net  Consolidated Sales by Region:**                                                       |       |                                         | ** ** |   |   |   |   |   |   |
| North America                                                                                | ** ** | **$**                                        | **273.6**  | ** ** | $ | 266.7 |   | $ | 6.9 |   | 2.6 | % |
| Europe Africa                                                                                | ** ** | **324.0**                                    | ** ** | 295.0 |   | 29.0 |   | 9.8 | % |
| Asia Pacific                                                                                 | ** ** | **112.2**                                    | ** ** | 110.6 |   | 1.6 |   | 1.4 | % |
| Latin America                                                                                | ** ** | **49.4**                                     | ** ** | 43.3 |   | 6.1 |   | 14.1 | % |
| **Total**                                                                                    | ** ** | **$**                                        | **759.2**  | ** ** | $ | 715.6 |   | $ | 43.6 |   | 6.1 | % |

 

----

NM = Not meaningful

 
| *(1)* | * * | *Grace  Davison pre-tax operating income includes minority interest expense related  to the Advanced Refining Technologies joint venture.* |
|-------|----------|--------------------------------------------------------------------------------------------------------------------------------------------|
| *(2)* | * * | *Grace  Construction Products pre-tax operating income includes minority interest expense  related to consolidated joint ventures.*        |
| *(3)* | * * | *Reflects  the add-back of minority interest expense.*                                                                                     |
| *(4)* | * * | *Includes  depreciation and amortization related to manufacturing of products.*                                                            |

 

I-40

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**Results of Operations**

 

The following is an overview of our financialperformance for the three months ended March 31, 2008 compared with theprior year period.

 

***Net Sales*****–**The following table identifies thequarter-over-quarter increase or decrease in sales attributable to changes inproduct volume, product price and/or mix, and the impact of foreign currencytranslation:

 
| ** **                           | ** ** | **Three Months Ended March 31, 2008 as a  Percentage Increase (Decrease) from  Three Months Ended March 31, 2007** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Net Sales Variance Analysis** | ** ** | **Volume**                                                                                                                                                                                    | ** ** | **Price/Mix** | ** ** | **Currency  Translation** | ** ** | **Total** | ** ** |
| Grace Davison                        |       | (4.9                                                                                                                                                                                          | %)         | 5.9 | % | 5.3 | % | 6.3 | % |
| Grace  Construction Products         |       | (1.3                                                                                                                                                                                          | %)         | 2.0 | % | 5.0 | % | 5.7 | % |
| Net sales                            |       | (3.7                                                                                                                                                                                          | %)         | 4.6 | % | 5.2 | % | 6.1 | % |
| **By  Region:**                      | ** ** | ** **                                                                                                                                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| North America                        |       | (3.3                                                                                                                                                                                          | %)         | 5.4 | % | 0.5 | % | 2.6 | % |
| Europe Africa                        |       | (4.5                                                                                                                                                                                          | %)         | 4.5 | % | 9.8 | % | 9.8 | % |
| Asia Pacific                         |       | (6.1                                                                                                                                                                                          | %)         | 3.7 | % | 3.8 | % | 1.4 | % |
| Latin America                        |       | 6.6                                                                                                                                                                                           | %          | 1.7 | % | 5.8 | % | 14.1 | % |

 

Sales for the three months ended March 31, 2008 were favorablyimpacted by improved pricing in both operating segments in response to higherraw material cost inflation and by favorable currency translation from salesdenominated in foreign currencies, partially offset by overall reduced volumes(including acquisitions and divestitures). We experienced lower volumes in U.S.construction markets, and lower volumes due to order patterns in ourhydroprocessing catalysts product line. Acquisitions contributed $3.0 millionor 0.4 percentage points of the sales growth.

 

***Pre-tax Income fromCore Operations –*** Operating profit increased mainly due to selling price increases inresponse to raw material cost inflation and due to productivity gains.

 

Corporate costs include corporate functional costs (such as financialand legal services, human resources, communications and informationtechnology), the cost of corporate governance (including directors and officersliability insurance) and pension costs related to both corporate employees andto the effects of changes in assets and liabilities for all of our pensionplans. Corporate costs increased due to higher expenses for pensions and otheremployment-related costs.

 

We value our U.S.inventories under the last-in/first- out method, or LIFO, and our non-U.S.inventories under the first-in/first-out, or FIFO, method. LIFO was selected in1974 for U.S. financial reporting and tax purposes because it generally resultsin a better matching of current revenue with current costs during periods ofinflation. We have not elected LIFO for our non-U.S. inventories due tostatutory restrictions. However, if we valued our U.S. inventories using theFIFO method, consistent with our non-U.S. subsidiaries, our pre-tax income fromcore operations would have been approximately 10.2% higher and 11.9% higher forthe three months ended March 31, 2008 and 2007, respectively. Thesignificant change in inventory valuations between FIFO and LIFO relatesprimarily to price increases of commodity metals and energy used in GraceDavison products and production processes. We attempt to mitigate pricevolatility through hedging techniques such as layering our required supplyunder fixed delivery contracts, entering into commodity option and swapcontracts with suppliers and financial institutions, and by negotiating salescontracts that permit the partial pass-through of market price increases forthese volatile commodity items.

 

We normally attempt tolock in raw material costs through long-term supply contracts and targetedhedging programs. Arrangements and programs can span a few months to severalyears. Major raw materials include natural gas, certain metals, petroleum-basedmaterials and certain industrial chemicals. The actual cost of these rawmaterials can differ significantly from spot prices at any point in time. Ourreported gross profit for the periods presented has been favorably impacted bycertain raw material supply arrangements and unfavorably affected by others,relative to the then-current market price. We expect that new supply agreementsand hedging arrangements will result in raw material costs that can be significantlyfavorable or unfavorable compared with prior periods. We attempt to mitigateperiod-over-period commodity-driven cost changes through utilization andcustomer pricing strategies; however, gross profit margins are still likely tobe affected when compared over time.

 

Within both Grace Davisonand Grace Construction Products, we conduct certain business activities invarious countries through joint ventures with unaffiliated third parties. Minorityinterest in consolidated entities decreased due to lower earnings of our jointventures, particularly ART, our largest joint venture. ART’s year-over-yearpre-tax 

 

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net income can changematerially based on refill order patterns of customers and changes in commodity-basedraw materials.

 

***Pre-Tax Income(Loss) from Noncore Activities*****–**Pre-tax income (loss) from noncore activitiesreflects financial matters unrelated to our core operations. This category ofcosts and income is expected to be volatile as potentially material items areaddressed through our Chapter 11 proceedings and/or as the financialimplications of our legal contingencies become apparent. Some noncoreactivities are shown as separate items on the Consolidated Statement ofOperations. Those not separately listed are primarily included in selling,general and administrative expenses and in other (income) expense. The tablebelow shows the components of noncore activities, and the captions in whicheach component is presented in the Consolidated Statements of Operations:

 
| ** **                                                   | ** ** | **Three Months  Ended  March 31,** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                   | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| *(In millions)*                                         | ** ** | ** **                                   | ** ** | ** ** |   |   |   |
| Provision for  environmental remediation - vermiculite       | ** ** | **$**                                        | **(5.0**   | **)** | $ | — |   |
| Provision for  environmental remediation – other sites  | ** ** | **(0.9**                                     | **)**      | — |   |
| **Total  provision for environmental remediation**           | ** ** | **$**                                        | **(5.9**   | **)** | $ | — |   |
|                                                         |       |                                         | ** ** |   |   |
| COLI income, net                                             | ** ** | **$**                                        | **1.1**    | ** ** | $ | 2.0 |   |
| Translation  effects – intercompany loans               | ** ** | **38.6**                                     | ** ** | 2.8 |   |
| Value of  currency contracts                                 | ** ** | **(26.5**                                    | **)**      | (2.1 | ) |
| Gain on sale of  real estate                                 | ** ** | **1.5**                                      | ** ** | 0.6 |   |
| Other                                                        | ** ** | **(0.5**                                     | **)**      | (0.4 | ) |
| **Total  other income (expense), net**                       | ** ** | **$**                                        | **14.2**   | ** ** | $ | 2.9 |   |
| D&O  insurance cost – portion related to Chapter 11 | ** ** | **$**                                        | **(1.0**   | **)** | $ | (1.5 | ) |
| Asbestos  administration                                     | ** ** | **(1.8**                                     | **)**      | (2.7 | ) |
| Postretirement  benefit income – divested businesses    | ** ** | **—**                                   | ** ** | 0.6 |   |
| Legal defense  costs                                         | ** ** | **(3.0**                                     | **)**      | (2.6 | ) |
| Other                                                        | ** ** | **(0.4**                                     | **)**      | (0.5 | ) |
| **Total  selling, general and administrative expenses**      | ** ** | **$**                                        | **(6.2**   | **)** | $ | (6.7 | ) |
| Net pension  costs – divested businesses                | ** ** | **(2.7**                                     | **)**      | (2.0 | ) |
| **Total  defined benefit pension expense**                   | ** ** | **$**                                        | **(2.7**   | **)** | $ | (2.0 | ) |
| **Total  pre-tax income (loss) from noncore activities**     | ** ** | **$**                                        | **(0.6**   | **)** | $ | (5.8 | ) |

 

The change in the pre-taxloss from noncore activities from 2007 to 2008 is attributable primarily to:

 

·                  Environmental remediation expenses of $5.9 million in 2008 to adjustour estimate of costs to resolve environmental remediation claims; and

 

·                  A net gain of $10.4 million from foreign currency translation on aEuro-denominated intercompany loan (see discussion of €250 million intercompanynote below).

 

In March 2004, we began accounting for currency fluctuations on a€293 million intercompany loan between our subsidiaries in the United Statesand Germany as a component of operating results instead of as a component ofother comprehensive income. This change was prompted by an analysis of new taxlaws in Germany and our cash flow planning in connection with our Chapter 11reorganization, which together indicated that we should no longer consider thisloan as part of our permanent capital structure in Germany. In May 2004,we entered into a series of foreign currency forward contracts with a U.S. bankto mitigate future currency fluctuations on the remaining loan balance.Contract amounts of €200.7 million were extended in June 2005 at varyingrates and have terms that coincide with loan repayments due periodicallythrough December 2008. As part of the contract extension, we were requiredto pay a settlement premium of $9.3 million to the bank. We are recovering thissettlement premium over time as the contracts settle at rates greater than theinitial rates in the May 2004 foreign currency forward contracts, andexpect to recover the full amount by the end of 2008. For the three monthsended March 31, 2008 and 2007, respectively, €18.3 million and €18.2million of loan principal was repaid. For the three months ended March 31,2008 and 2007, we recognized a $7.0 million and a $2.1 million contract loss,respectively, offset by an $8.0 million and a $2.8 million foreign currency gain,respectively.

 

In November 2007, we executed an intercompany loan in the amountof €250 million between our principal U.S. operating subsidiary and a newlyestablished German subsidiary as part of a legal restructuring. In conjunctionwith the loan, our U.S. subsidiary entered into a series of foreign currencyforward contracts to attempt to minimize volatility from foreign currencymovements on the loan amount. The forward contracts are aligned with thepayment schedule of the intercompany loan, which has annual principal andinterest payments in November 2009 through November 2013. While theintercompany loan is valued each period at the current exchange rate, the fairvalue of the hedge contract is determined by the net present value of 

 

I-42

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the notional contract amounts at the current exchange rate plus orminus forward points to the date of maturity of each contract. In the firstquarter of 2008, the difference in the value of the loan and the fair value ofthe hedge contract has resulted in a net gain of $10.4 million, of whichapproximately $8 million represents the change in forward points as interestrate differentials widened between the U.S. dollar and the Euro. The change invalue of the intercompany loan and the hedge contract is recorded as acomponent of other (income) expense in the Consolidated Statements ofOperations.

 

***Chapter 11Expenses*******–****Although we are unable to precisely measure the impact ofthe Chapter 11 proceedings on our overall financial performance, we incursignificant added costs that are directly attributable to operating in Chapter11. Net Chapter 11 expenses consist primarily of legal, financial andconsulting fees that we, the three creditors’ committees, the equity committeeand the legal representative of future asbestos claimants, incur, reduced byinterest income earned on cash and cash equivalents held by our entitiessubject to Chapter 11. We pay for the costs of all committees, and thecommittees’ advisors. These costs fluctuate with the activity in our Chapter 11proceedings.

 

An analysis of Chapter 11costs follows:

 
| ** **                                      | ** ** | **Three Months  Ended  March 31,** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------|------------|
| **Chapter 11 Expenses, net**     | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| *(In millions)*                            |       |                                         |       |   |   |
| **Costs  related to:**                          |       |                                         |       |   |   |
| Grace as  debtor-in-possession                  | ** ** | **$**                                        | **10.5**   |   | $ | 15.0 |   |
| General  Unsecured Committee                    | ** ** | **0.7**                                      |       | 1.0 |   |
| Asbestos  Property Damage Committee             | ** ** | **0.1**                                      |       | 0.8 |   |
| Asbestos  Personal Injury Committee             | ** ** | **3.3**                                      |       | 1.8 |   |
| Future Asbestos  Claims Representative          | ** ** | **2.8**                                      |       | 1.1 |   |
| Equity Committee                                | ** ** | **1.3**                                      |       | 0.4 |   |
| Total expenses                                  | ** ** | **18.7**                                     |       | 20.1 |   |
| Interest earned  on filing entity cash balances | ** ** | **(0.3**                                     | **)**      | (2.3 | ) |
| **Chapter  11 expenses, net**                   | ** ** | **$**                                        | **18.4**   |   | $ | 17.8 |   |

 

The decrease ininterest income earned on filing entity cash balances is primarily due to a$1.2 million loss related to a decrease in value of investment securities. See “CashResources and Available Credit Facilities” below for further discussion ofGrace’s investment securities.

 

We incur numerous otherindirect costs to manage the Chapter 11 proceedings such as: management time devotedto Chapter 11 matters; added cost of debt capital; added costs of generalbusiness insurance, including D&O liability insurance premiums; and lostbusiness and acquisition opportunities due to the complexities and restrictionsof operating under Chapter 11.

 

***Interest******Expense***– Net interest expense for the three months ended March 31, 2008 decreasedcompared with the prior year period due to reductions in the prime rate andreduced interest accruals for certain pre-petition obligations, partially offsetby the effects of compounding interest on certain liabilities subject tocompromise over the course of the Chapter 11 proceeding. Our existing plan ofreorganization states that each holder of an allowed general unsecured claimshall be paid in full, pluspost-petition interest. Post-petitioninterest shall accrue through the date of payment as follows:

 

·                  For the holders of pre-petition bank credit facilities, beginning January 1,2006, we agreed to pay interest on pre-petition bank debt at the prime rate,adjusted for periodic changes, and compounded quarterly. The effective rates onpre-petition bank debt for the three months ended March 31, 2008 and 2007were 6.22% and 8.25%, respectively. The holders of pre-petition bank creditfacilities have requested post-petition interest greater than that reflected inthe rates specified above that, if paid, could be material.

 

·                  For the holders of claims who, but for the Chapter 11 filing, would beentitled under a contract or otherwise to accrue or be paid interest on suchclaim in a non-default (or non-overdue payment) situation under applicablenon-bankruptcy law, the rate provided in the contract between the Grace entityand the claimant or such rate as may otherwise apply under applicablenon-bankruptcy law.

 

·                  For all other holders of allowed general unsecured claims, at a rate of4.19% per annum, compounded annually, unless otherwise negotiated during theclaim settlement process.

 

The average effectiveinterest rates on pre-petition obligations for the three months ended March 31,2008 and 2007 were 4.78% and 7.00%, respectively. Such interest, which underthe 

 

I-43

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existing plan ofreorganization is payable 85% in cash and 15% in Grace common stock, will notbe paid until the plan of reorganization is confirmed and funded.

 

***Income Taxes*****–**Income tax provision at the federal corporate rateof 35% for the three months ended March 31, 2008 and 2007 would have been$10.2 million and $6.9 million, respectively.  The primary differences in each period betweenthese amounts and the recorded provision for income taxes, $15.6 million and$14.9 million, respectively, are due to provisions for tax contingencies, thenon-deductibility of certain Chapter 11 expenses and, in the three months endedMarch 31, 2007, an increase in the reserve for repatriation of foreignearnings.

 

**Operating Segment Overview**

 

The following is an overview of financialmeasures of the performance of our operating segments for the three months endedMarch 31, 2008 compared with the prior year period.

 

***Grace Davison***

 

*Sales*

 

·                  Refining Technologies –sales increased by 7.7%, driven by selling price increases, the pass-through tocustomers of higher prices for certain metals, and foreign currency translation.Volumes were lower due to shifting order patterns in our hydroprocessingproduct line.

 

·                  MaterialsTechnologies – sales increased 6.7% due to foreign currency translation,selling price increases, and the benefit of a third quarter 2007 acquisition,partially offset by lower volumes.

 

·                  Specialty Technologies – sales increased 2.0%from selling price increases and product mix, higher volumes and foreigncurrency translation. Sales growth was negatively impacted by a product linedivestiture that occurred in the third quarter of 2007.

 
| ** **                        | ** ** | **Three Months  Ended  March 31,** | ** ** |
|-----------------------------------|------------|----------------------------------------------|------------|
| **Net Sales by Region** | ** ** | **2008**                                     | ** ** | **2007** | ** ** | **$ Change  Fav  (Unfav)** | ** ** | **% Change  Fav  (Unfav)** | ** ** |
| *(In millions)*              | ** ** | ** **                                   | ** ** |   |   |   |   |   |   |   |   |   |
| North America                     | ** ** | **$**                                        | **153.5**  |   | $ | 142.3 |   | $ | 11.2 |   | 7.9 | % |
| Europe Africa                     | ** ** | **226.7**                                    |       | 212.3 |   | 14.4 |   | 6.8 | % |
| Asia Pacific                      | ** ** | **79.7**                                     |       | 80.5 |   | (0.8 | ) | (1.0 | %) |
| Latin America                     | ** ** | **37.2**                                     |       | 32.5 |   | 4.7 |   | 14.5 | % |
| **Total  Grace Davison**          | ** ** | **$**                                        | **497.1**  |   | $ | 467.6 |   | $ | 29.5 |   | 6.3 | % |

 

North America sales increased, driven by Refining Technologies’ highervolumes and selling price increases. Europe Africa sales increased from thebenefit of foreign currency translation and selling price increases; overallvolume declined from the shifting order patterns in our hydroprocessingcatalysts product line. Asia Pacific sales decreased due to shifting orderpatterns in hydroprocessing catalysts, which offset selling price increases andthe benefits of foreign currency translation. Latin America sales increased,driven by volume growth in our Materials Technologies product group and from favorablecurrency translation.

 

###### *Operating Income and Margin*

###### * *

Grace Davison operating income increased 14.5% due to strongproductivity gains, the benefit of foreign currency translation, product mix,and selling price increases, which offset raw material cost inflation. Operatingmargins grew 0.9 percentage points compared to the first quarter of 2007.

 

***GraceConstruction Products***

 

*Sales*

* *
| · | Americas – sales decreased 2.1%. Sales in the U.S. decreased by 4.2%  largely due to the continuing decline in residential construction. The  decrease in sales to the U.S. residential construction segment was partially  offset by sales to the U.S. commercial construction segment and growth in the  commercial and infrastructure construction segment in Latin America. |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                 |
| · | Europe – sales increased 17.4%, reflecting higher volumes of products  sold for commercial and infrastructure applications in Central Europe and the  Middle East and favorable currency translation effects.                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                                 |
| · | Asia – sales increased 8.1%, reflecting higher volumes of products  sold for commercial and infrastructure applications.                                                                                                                                                                                                                                                        |

 

 

I-44

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Sales in allregions were positively affected by price increases in both product groupsdesigned to offset rising raw material costs.

 

We do not expectthe level of U.S. construction activity to recover during 2008.  As a result, we are implementing costcontainment actions within our Grace Construction Products operating segmentand its supporting functions, which actions include a reduction in force.  Based on actions that are currently inprogress or planned, we expect to record a charge in the second quarter of 2008that we currently estimate will be approximately $6 million.

 
| ** **                               | ** ** | **Three Months  Ended  March 31,** | ** ** |
|------------------------------------------|------------|----------------------------------------------|------------|
| **Net Sales by Product Group** | ** ** | **2008**                                     | ** ** | **2007** | ** ** | **$ Change  Fav  (Unfav)** | ** ** | **% Change  Fav  (Unfav)** | ** ** |
| *(In millions)*                     | ** ** | ** **                                   | ** ** |   |   |   |   |   |   |   |   |   |
| Construction  Chemicals                  | ** ** | **$**                                        | **168.7**  |   | $ | 163.8 |   | $ | 4.9 |   | 3.0 | % |
| Building  Materials                      | ** ** | **93.4**                                     |       | 84.2 |   | 9.2 |   | 10.9 | % |
| **Total  Grace Construction Products**   | ** ** | **$**                                        | **262.1**  |   | $ | 248.0 |   | $ | 14.1 |   | 5.7 | % |

 

ConstructionChemicals product group sales include sales of specialty chemicals used in themanufacture of concrete and cement products. Sales of these products increased 3.0% due to overall higher volumes andselling price increases, most notably in Europe, partially offset by decreasedsales of concrete products in the Americas.

 

Building Materialsproduct group sales include sales of waterproofing and fire protectionproducts.  Sales of these productsincreased 10.9% due to increased volumes and higher selling prices.

 

*Operating Income and Margin*

 

Grace ConstructionProducts operating income decreased 7.8% compared to the prior year periodprimarily due to lower U.S. volumes and higher raw material costs, partiallyoffset by price increases and productivity gains.  Operating margins decreased by 1.4 percentagepoints compared to the first quarter of 2007.

 

***Operating Returns on Assets Employed*****–**The following tables set forth the GraceDavison and Grace Construction Products total asset position and pre-tax returnon average total assets as of March 31, 2008 and December 31, 2007. Weuse the measure pre-tax return on average total assets as an indicator of ourefficiency in using our assets and allocating our resources to generateearnings. We devote significantly higher capital to the manufacture of GraceDavison products than to the manufacture of Grace Construction Productsproducts. Conversely, non-manufacturing costs, particularly selling expenses,are significantly higher for Grace Construction Products than for GraceDavison.

 
| **Grace Davison**                                       | ** ** | **March 31,  2008** | ** **  | **December 31,  2007** | ** ** |
|--------------------------------------------------------------|------------|--------------------------|-------------|-----------------------------|------------|
| *(In millions)*                                         | ** ** | ** **               | ** **  |                        |       |   |   |
| Trade  receivables                                           | ** ** | **$**                    | **274.1**   |                        | $          | 295.9 |   |
| Inventory                                                    | ** ** | **306.8**                |        | 239.7                       |       |
| Other current  assets                                        | ** ** | **31.6**                 |        | 31.5                        |       |
| Total current  assets                                        | ** ** | **612.5**                |        | 567.1                       |       |
| Properties and  equipment, net                               | ** ** | **498.2**                |        | 484.7                       |       |
| Goodwill and  other intangible assets                        | ** ** | **118.0**                |        | 116.4                       |       |
| Other assets                                                 | ** ** | **17.5**                 |        | 17.4                        |       |
| Total assets                                                 | ** ** | **$**                    | **1,246.2** |                        | $          | 1,185.6 |   |
| Pre-tax return  on average total assets (trailing 12 months) | ** ** | **21.2**                 | **%**       | 21.1                        | %          |

 

Grace Davison’s total assets increased by $60.6 million in the quarterended March 31, 2008. The increase was primarily due to higher inventoryfor raw materials and finished goods to support 2008 planned sales, coupledwith $43.9 million in higher foreign currency translation effects reflecting aweaker U.S. dollar.

 
| **Grace**** Construction Products**                     | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| *(In millions)*                                         | ** ** | ** **               | ** ** |                        |       |   |   |
| Trade  receivables                                           | ** ** | **$**                    | **212.7**  |                        | $          | 201.2 |   |
| Inventory                                                    | ** ** | **65.2**                 |       | 63.9                        |       |
| Other current  assets                                        | ** ** | **10.8**                 |       | 9.5                         |       |
| Total current  assets                                        | ** ** | **288.7**                |       | 274.6                       |       |
| Properties and  equipment, net                               | ** ** | **199.0**                |       | 194.6                       |       |
| Goodwill and  other intangible assets                        | ** ** | **93.0**                 |       | 88.2                        |       |
| Other assets                                                 | ** ** | **7.2**                  |       | 4.2                         |       |
| Total assets                                                 | ** ** | **$**                    | **587.9**  |                        | $          | 561.6 |   |
| Pre-tax return  on average total assets (trailing 12 months) | ** ** | **25.2**                 | **%**      | 26.1                        | %          |

 

Grace ConstructionProducts’ total assets increased by $26.3 million in the quarter ended March 31,2008. The increase was primarily due to higher trade receivables, coupled with$16.6 million in higher foreign currency translation due to a weaker U.S.dollar.

 

I-45

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**Noncore Liabilities**

 

We have a number offinancial exposures originating from past businesses, products and events.These obligations arose from transactions and/or business practices that dateto when Grace was a much larger company, when we produced products or operatedbusinesses that are no longer part of our revenue base, when governmentregulation was less stringent and when scientific knowledge with respect tosuch businesses and products was much less advanced than today.

 

The following tablesummarizes our net noncore liabilities at March 31, 2008 and December 31,2007:

 
| **Net**** Noncore Liabilities** | ** ** | **March 31,  2008** | ** **   | **December 31,  2007** | ** ** |
|-------------------------------------------|------------|--------------------------|--------------|-----------------------------|------------|
| *(In millions)*                      | ** ** | ** **               | ** **   | ** **                  |       |   |   |
| Asbestos-related  liabilities             | ** ** | **$**                    | **(1,700.0** | **)**                       | $          | (1,700.0 | ) |
| Asbestos-related  insurance receivable    | ** ** | **500.0**                | ** **   | 500.0                       |       |
| Asbestos-related  liability, net          | ** ** | **(1,200.0**             | **)**        | (1,200.0                    | )          |
| Environmental  remediation                | ** ** | **(373.2**               | **)**        | (368.6                      | )          |
| Postretirement  benefits                  | ** ** | **(82.7**                | **)**        | (84.0                       | )          |
| Income taxes                              | ** ** | **(86.3**                | **)**        | (89.3                       | )          |
| Retained  obligations and other           | ** ** | **(36.3**                | **)**        | (36.2                       | )          |
| **Net  noncore liability**                | ** ** | **$**                    | **(1,778.5** | **)**                       | $          | (1,778.1 | ) |

 

We expect to resolve most of these noncore recorded and contingentliabilities through our Chapter 11 proceedings. The amounts of these liabilitiesas ultimately determined through the Chapter 11 proceedings could be materiallydifferent from amounts we recorded at March 31, 2008.

 

**Chapter 11 Recent Developments**

 

As described under “VoluntaryBankruptcy Filing” in Notes 1 and 2 to the Consolidated Financial Statements,Grace and our principal U.S. operating subsidiary are debtors-in-possessionunder Chapter 11 of the bankruptcy code. Our non-U.S. subsidiaries, althoughnot part of the Chapter 11 filing, are owned directly or indirectly by our principaloperating subsidiary or other filing entities. Consequently, we expect that anyChapter 11 plan of reorganization will utilize the combined value of our globalbusinesses and other assets to fund (with cash and/or securities) ourobligations as adjudicated through the bankruptcy process. We have analyzed ourcash flow and capital needs to continue to fund our businesses and believethat, while in Chapter 11, sufficient cash flow and credit facilities areavailable to support our business strategy.

 

On January 13, 2005,we filed a plan of reorganization and related documents, the Debtors Plan, thatamended our original plan of reorganization and disclosure statement filed on November 13,2004 to address certain objections of creditors and other interested parties.

 

OnJuly 26, 2007, the bankruptcy court terminated our exclusive rights topropose a plan of reorganization and solicit votes thereon. As a result of thetermination of these rights, any party-in-interest may propose a competing planof reorganization.

 

On November 5, 2007,the committee representing asbestos personal injury claimants, the PICommittee, and the representative of future asbestos claimants, the FCR, fileda competing plan of reorganization with the bankruptcy court, the PI Plan. Thisfiling did not include a disclosure statement, trust distribution procedures,exhibits, or other supporting documents.

 

On April 6, 2008, wereached an agreement in principle, the PI Settlement, with the PI Committee,the FCR, and the committee representing equity security holders, the EquityCommittee, that would settle all present and future asbestos-related personalinjury claims. The PI Settlement contemplates that along with the PI Committee,the FCR and the Equity Committee, we would file a new joint plan ofreorganization with the bankruptcy court reflecting the terms and conditions ofthe PI Settlement. The drafting and negotiation of the joint plan and relateddocumentation are in progress. The committees representinggeneral unsecured creditors and property damage claimants are not parties tothe PI Settlement. We, along with the Equity Committee, PI Committee and FCRcontemplate that a joint plan of reorganization reflecting the terms of the PISettlement would be filed with the Bankruptcy Court and would supersede theexisting plans on file.

 

See Note 2 to theConsolidated Financial Statements for more information on these plans ofreorganization and the PI Settlement.

 

As a result of the PI Settlement, a trial for estimating liability for asbestos personalinjury claims that began in January 2008 was suspended in April 2008.

 

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Each of the plans ofreorganization that have been filed with the bankruptcy court and the PISettlement contemplate that an asbestos trust would be established under Section 524(g) ofthe Bankruptcy Code to which certain asbestos-related claims would be channeledfor resolution.

 

Under the terms of the PISettlement, the asbestos trust would be funded with:

 

·                  $250 million in cash;

 

·                  a warrant to acquire 10 million shares of Grace common stock at anexercise price of $17.00 per share, expiring one year from the effective dateof a plan of reorganization;

 

·                  all of our insurance policies and proceeds, including interest,received after the date of the PI Settlement, that are available for payment ofpending and future asbestos-related personal injury claims and demands asdescribed in Note 2 to the Consolidated Financial Statements;

 

·                  cash and shares of common stock of Sealed Air Corporation to be paid byCryovac, Inc. to the asbestos trust pursuant to the settlement agreementwith Sealed Air Corporation and Cryovac, Inc. as described in Note 2 tothe Consolidated Financial Statements;

 

·                  the proceeds of the payment to be received pursuant to the settlementagreement with Fresenius Medical CareHoldings, Inc. as described in Note 2 to the Consolidated FinancialStatements; and

 

·                  deferred payments by W. R. Grace & Co.— Conn., ourwholly-owned subsidiary, of $110 million per year for five years beginning in2019, and $100 million per year for 10 years beginning in 2024, that would besubordinate to any bank debt or bonds outstanding, subject to our guaranty andsecured by our obligation to issue 50.1% of the outstanding Grace common stockto the asbestos trust in the event of default.

 

See Notes 2 and 3 to theConsolidated Financial Statements for further discussion of the PI Settlement.

 

We anticipate that wewill require up to approximately $1.5 billion in new financing to fund a planof reorganization under the terms of the PI Settlement.  The actual amount of new financing willgenerally depend on market factors, resolution costs of our outstanding claimsand contingent liabilities, and our operating capital requirements.

 

We expect to measure thevarious forms of consideration that we would fund the asbestos trust with undera plan of reorganization that reflects the terms of the PI Settlement asfollows:

 

1.               Warrants – The warrants would be recordedin our Consolidated Financial Statements at fair value as an increase inpaid-in capital and a decrease in our asbestos-related liability.  The value of the warrants would be calculatedusing inputs such as risk-free borrowing rates, the market price of Gracecommon stock underlying the warrants and the expected volatility of Gracecommon stock prices.

 

2.               Insurance proceeds – The insurancereceivable asset reflected in our Consolidated Balance Sheet would be assignedto the asbestos trust and removed as an asset from our Consolidated BalanceSheet.

 

3.               Deferred payments – We would record aliability for the present value of the future cash payments to be made from2019 to 2033, and a decrease in our asbestos-related liability.  We would estimate this value using a discountrate that is impacted by many factors including (i) interest rates at thetime of issuance; (ii) our credit standing, (iii) restrictive covenantsand terms of our other credit facilities; (iv) assessment of the risk of adefault, which would require us to issue shares of Grace common stock; and (v) underlyingeconomic factors affecting the value of the U.S. dollar.

 

Each of theaforementioned items would impact our accounting for our asbestos personalinjury liabilities, assuming they are ultimately resolved pursuant to aconfirmed plan of reorganization that reflects the terms of the PI Settlement.

 

The U.S. tax treatment applying to each item transferred to theasbestos trust under the PI Settlement is described below.  The fair value of the warrants on the date ofissuance to the asbestos trust would be treated as a deductible expense in theyear of transfer.  The deferred paymentliability 

 

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(as determined under U.S. tax rules) would be recorded at its netpresent value.  As the discount isaccreted on the liability, a portion of the discount would be treated asdeductible interest expense. The remaining amount would be deductible in fullat the time of payment to the asbestos trust.

 

Due to the payment ofthese and other deductible bankruptcy claims, we anticipate generatingsignificant net operating losses, NOLs, in the year of emergence.  Although, we intend to implement tax planningstrategies to preserve the NOLs, there is a risk that substantial NOLs will beutilized in structuring emergence financing. The NOLs can also be lost or substantially reduced upon a change in theownership of Grace common stock as defined under U.S. tax rules.  In order to preserve NOLs, we intend to seeka right to restrict stock transfers under certain conditions as part of anyplan of reorganization.

 

We have not adjusted ouraccounting for asbestos-related liabilities and other liabilities subject tocompromise as at March 31, 2008 because:

 

·                  the Debtors Plan remains the only planthat we have filed with the bankruptcy court;

 

·                  while the PI Settlement broadly providesfor a settlement of significant economic issues, such issues and other issuesremain subject to additional negotiation among the parties thereto andsignificant documentation before a new joint plan of reorganization reflectingthe PI Settlement may be filed with the bankruptcy court; and

 

·                  the estimated liability for certainproperty damage and general unsecured claims could change materially prior tothe time a new joint plan of reorganization is filed or confirmed.

 

If a new joint plan ofreorganization reflecting the PI Settlement is not filed with the bankruptcycourt, we would expect to resume the estimation trial, that was suspended in April dueto the PI Settlement, to determine the amount of our asbestos-relatedliabilities.  We expect to adjust ourrecorded asbestos-related liability as necessary: to reflect rulings made bythe bankruptcy court; when a new joint plan of reorganization is filed toreflect the terms of the PI Settlement; and when significant uncertainties havebeen resolved.  Such adjustments may bematerial to our consolidated financial position and results of operations.

 

Since our amended plan ofreorganization was filed with the bankruptcy court in 2005, we have providedproforma financial statements in our quarterly and annual filings to describethe proforma effects of the terms of our plan of reorganization.  We presented proforma financial statementsfor our plan of reorganization in our Annual Report on Form 10-K for theyear ended December 31, 2007 in order to portray the financial effects ofour plan of reorganization for a completed fiscal year. We expect to againprovide proforma financial information when we adjust our accounting forasbestos-related liabilities for a new joint plan of reorganization thatreflects the PI Settlement.

 

Although the existing plansremain on file with the bankruptcy court and we contemplate filing a new jointplan reflecting the terms of the PI Settlement, it is possible that none ofsuch plans will be approved by the bankruptcy court.  Instead, a materially different plan of reorganizationmay ultimately be approved and, under the ultimate plan of reorganization, theinterests of our shareholders could be substantially diluted or cancelled.  The value of Grace common stock following aplan of reorganization and the extent of any recovery by non-asbestos-relatedcreditors will depend principally on the amount of our asbestos-relatedliability under a confirmed plan of reorganization.

 

Any resolution of ourasbestos-related liabilities, other than as reflected in the Debtors Plan, couldresult in adjustments to such liabilities in our financial statements and suchadjustments could be material.

 

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# ** **

# **Financial Condition, Liquidity and Capital Resources**

# ** **

***Financial Condition –***Our balance sheet as of March 31,2008, as compared to our balance sheet as of December 31, 2007, wasimpacted by the following:

 

·                  an increase in inventories of $68.4 million, primarily driven byinventory build in hydroprocessing catalysts to meet expected sales demand inthe second half of 2008, strategic advance purchases of certain raw materialsused in Grace Davison manufacturing processes, foreign currency translation andraw material cost inflation;

 

·                  a decrease in investment securities of $34.3 million due todistributions in cash from, and changes in fair value of, our investmentsecurities, as discussed below;

 

·                  a decrease in accounts receivable of $12.5 million primarily from thecollection of amounts due from customers related to fourth quarter 2007 sales;

 

·                  a decrease in other current accrued liabilities of $34.6 millionprimarily due to first quarter payments related to annual incentivecompensation and customer volume rebates; and

 

·                  an increase in pension assets of $21.5million representing the change in funded status of overfunded defined benefitpension plans, and an increase in pension obligations of $26.3 millionrepresenting the change in funded status of unfunded and underfunded definedbenefit pension plans, as discussed below.

 

***Chapter 11-Related Information –*** See Note 2 tothe Consolidated Financial Statements.

 

***Asbestos-Related Litigation –*****See Note 3 to the Consolidated Financial Statements.

 

***Environmental Matters*****–**See Note 13 tothe Consolidated Financial Statements.

 

***Defined Contribution Retirement Plans*****–**We sponsor a defined contributionretirement plan for our employees in the United States. This plan qualifiesunder section 401(k) of the U.S. tax code. At the present time, wecontribute an amount equal to 100% of employee contributions, up to 6% of anindividual employee’s salary or wages. Our costs related to this benefit planwere $3.5 million and $3.0 million for the three month periods ended March 31,2008 and 2007, respectively.

 

***Defined BenefitPension Plans –*******We sponsor defined benefit pension plans for ouremployees in the United States, Canada, the United Kingdom, Australia, Germany,Italy, France, Spain, Netherlands, Japan, Philippines, South Korea, Taiwan,South Africa, Brazil and Mexico and fund government sponsored programs in othercountries where we operate.  Certain ofour sponsored plans are advance-funded and others are pay-as-you-go. Theadvance-funded plans are administered by trustees who direct the management ofplan assets and arrange to have obligations paid when due out of a trust. Themost significant advance-funded plans cover our salaried employees in the U.S.and U.K. and employees covered by collective bargaining agreements at certainof our U.S. facilities.

 

The following table presents the components of definedbenefit pension expense and cash contributions for the advance-funded andpay-as-you-go plans:

 
| ** **                                                                 | ** ** | **Three Months  Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| **Components of Defined Benefit Pension Expense** | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| ***(In millions)***                                                   | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Annual pension  benefits earned                                            | ** ** | **$**                                        | **6.4**    | ** ** | $ | 6.2 |   |
| Interest on  opening liability – advance-funded plans                 | ** ** | **18.0**                                     | ** ** | 16.5 |   |
| Expected return  on plan assets                                            | ** ** | **(20.5**                                    | **)**      | (20.0 | ) |
| Net financing  cost (benefit) of advance-funded plans                      | ** ** | **(2.5**                                     | **)**      | (3.5 | ) |
| Interest on  opening liability – pay-as-you-go plans                  | ** ** | **3.5**                                      | ** ** | 2.9 |   |
| Net pension  financing cost (benefit)                                      | ** ** | **1.0**                                      | ** ** | (0.6 | ) |
| Amortization of:                                                           |       |                                         | ** ** |   |   |
| Plan changes  related to prior service                                     | ** ** | **0.6**                                      | ** ** | 0.8 |   |
| Accumulated  differences between actual and assumed performance (1)        | ** ** | **6.3**                                      | ** ** | 6.3 |   |
| Net pension  catch-up expense                                              | ** ** | **6.9**                                      | ** ** | 7.1 |   |
| **Total  Defined Benefit Pension Expense**                                 | ** ** | **$**                                        | **14.3**   | ** ** | $ | 12.7 |   |
| **Cash  Contributions to Defined Benefit Pension Plans:**                  |       |                                         | ** ** |   |   |
| U.S.  advance-funded plans                                                 | ** ** | **$**                                        | **14.8**   | ** ** | $ | 16.2 |   |
| U.S.  pay-as-you-go plans                                                  | ** ** | **1.3**                                      | ** ** | 1.3 |   |
| Foreign  advance-funded plans                                              | ** ** | **1.6**                                      | ** ** | 13.3 |   |
| Foreign  pay-as-you-go plans                                               | ** ** | **1.8**                                      | ** ** | 1.6 |   |
| **Total  Cash Contributions**                                              | ** ** | **$**                                        | **19.5**   | ** ** | $ | 32.4 |   |

 

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*(1)**             **Primarily related toreturn on assets, termination, and mortality*

 

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The following table presents the funded status of fully-funded,underfunded and unfunded pension plans as determined under U.S. generallyaccepted accounting principles:

 
| ** **                                             | ** ** | **Fully-Funded ****(1)********Pension Plans** | ** ** | **Underfunded ****(1)********Pension Plans** | ** ** | **Unfunded ****(2)********Pension Plans** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------------------|------------|--------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **Funded Status of Pension Plans** | ** ** | **March 31,  2008**                                | ** ** | **December 31,  2007**                            | ** ** | **March 31,  2008**                            | ** ** | **December 31,  2007** | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
| *(In millions)*                                   | ** ** | ** **                                              |       |                                                   | ** ** | ** **                                          |       |   | ** ** | ** ** |   |   |   |
| Projected  benefit obligation                          | ** ** | **$**                                                   | **226.8**  |                                                   | $          | 254.8                                               | ** ** | **$** | **927.8** |   | $ | 948.3 | ** ** | **$** | **248.4** |   | $ | 245.9 |   |
| Fair value of  plan assets                             | ** ** | **302.4**                                               |       | 308.9                                                  | ** ** | **734.9**                                           |       | 779.2 | ** ** | **—** |   | — |   |
| Funded status  (PBO basis)                             | ** ** | **$**                                                   | **75.6**   |                                                   | $          | 54.1                                                | ** ** | **$** | **(192.9** | **)** | $ | (169.1 | ) | **$** | **(248.4** | **)** | $ | (245.9 | ) |

 

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*(1)**             **Plans intended to be advance-funded*

*(2)**             **Plans intended to bepay-as-you-go*

 

Fully-funded plansinclude several defined benefit pension plans where the fair value of the planassets exceeds the projected benefit obligation, or PBO.  This group of plans was overfunded by $75.6million as of March 31, 2008, and the overfunded status is reflected as “overfundeddefined benefit pension plans” in the Consolidated Balance Sheet. Underfundedplans include a group of defined benefit pension plans that are underfunded ona PBO basis by a total of $192.9 million as of March 31, 2008.Additionally, we have several plans that are funded on a pay-as-you-go basis,and therefore, the entire PBO of $248.4 million at March 31, 2008 isunfunded.  The combined balance of theunderfunded and unfunded plans was $441.3 million as of March 31, 2008 andis presented as a liability on the Consolidated Balance Sheet as follows -$13.0 million in “other current liabilities,” $192.9 million included in “underfundeddefined benefit pension plans”, $140.8 million included in “unfundedpay-as-you-go defined benefit pension plans”, and $94.6 million in “liabilitiessubject to compromise.”

 

Beginningin 2007, on a quarterly basis, we analyze pension assets and pensionliabilities along with the resulting funded status and update our estimate ofthese measures.  Funded status isadjusted for contributions, benefit payments, actual return on assets, currentdiscount rates and other identifiable and material actuarial changes.

 

The assumed discount rate for pension plans reflects the market ratesfor high quality corporate bonds currently available and is subject to changebased on changes in the overall market interest rates. For the U.S. qualifiedpension plans, the assumed discount rate of 6.25% as of December 31, 2007was selected in consultation with our independent actuaries, based on a yieldcurve constructed from a portfolio of high quality bonds for which the timingand amount of cash outflows approximate the estimated payouts of the plan.Based on review of an updated yield curve analysis as of March 31, 2008,we increased the discount rate for the U.S. qualified pension plans to 6.50%based on market rates at that time. In addition, we evaluated the currentdiscount rates for the pension plans in the United Kingdom, Germany and Canada,which combined represented approximately 90% of the benefit obligation of the non-U.S.pension plans as of December 31, 2007. Based on review of the yield curveanalyses for these plans as of March 31, 2008, we increased the discountrate for the United Kingdom from 5.75% at December 31, 2007 to 6.75% at March 31,2008, for Germany from 5.50% at December 31, 2007 to 6.00% at March 31,2008, and for Canada from 5.50% at December 31, 2007 to 6.00% at March 31,2008. The aggregate adjustment to the funded status resulting from the changein discount rates as of March 31, 2008 (including the postretirement plan)was an increase to total assets of approximately $32 million, and a decrease tototal liabilities of approximately $38 million. After tax effects, total assets increased by approximately $10 million,total liabilities decreased by approximately $38 million and shareholders’equity increased by approximately $48 million.

 

At the December 31,2007 measurement date for the U.S. advance-funded defined benefit pensionplans, the PBO was approximately $932 million as measured under U.S. generallyaccepted accounting principles. The PBO is measured as the present value (usinga 6.25% discount rate as of December 31, 2007) of vested and non-vestedbenefits earned from employee service to date, based upon current services andestimated future pay increases for active employees.  Of the participants in the pension plans,approximately 82% are current retirees or employees of our former businesses,which skews the payout pattern to the nearer term. Assets available to fund thePBO at December 31, 2007 were approximately $774 million, or approximately$158 million less than the measured obligation.

 

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Assets available at March 31, 2008 to fund the PBO of the U.S.advance-funded defined benefit pension plans totaled approximately $729million, down $45 million from December 31, 2007, primarily as a result ofnegative equity market returns.  It isour intention to satisfy obligations under the pension plans and to comply withthe requirements of the Employee Retirement Income Security Act of 1974.  We have obtained bankruptcy court approval tofund all minimum required payments under the plans through April 2008.  In that regard, we contributed approximately$76 million in 2007, approximately $15 million in January 2008, andapproximately $18 million in April 2008 to the trusts that hold assets ofthe U.S. defined benefit pension plans. While we intend to continue to fund all minimum required payments underthe U.S. defined benefit pension plans, there can be no assurance that thebankruptcy court will continue to approve the funding needs of such plans.  Contributions to non-U.S. plans are notsubject to bankruptcy court approval and we intend to fund such plans based onapplicable legal requirements, and actuarial and trustee recommendations; $3.4million was funded during the three months ended March 31, 2008.

 

We expect total pensionexpense for 2008 to be approximately $57 million, and benefit payments toretirees to aggregate approximately $86 million for all pension programs in2008.

 

***PostretirementBenefits Other Than Pensions*****–**We provide certain health care and life insurancebenefits for retired employees, a large majority of whom are retirees ofdivested businesses. These plans are unfunded, and we pay the costs of benefitsunder these plans as they are incurred. Our share of benefits under thisprogram was $1.5 million during the three months ended March 31, 2008,compared with $2.9 million in the prior year period.  We received Medicare subsidy payments of $0.4million and $2.7 million during the three months ended March 31, 2008 and2007, respectively.  Our recordedliability for postretirement benefits of $82.7 million at March 31, 2008is stated at net present value discounted at 6.50% (as discussed under DefinedBenefit Pension Plans). Our proposed plan of reorganization provides for thecontinuation of these benefits.

 

***Tax Matters –*** See Note 4 to the Consolidated Financial Statementsand “Income Taxes” above for further discussion of our tax accounting and taxcontingencies.

 

***Other Contingencies –*** See Note 13 to the Consolidated Financial Statementsfor a discussion of our other contingent matters.

 

***Cash Resourcesand Available Credit Facilities*****–**At March 31, 2008, we had cash and cash equivalentsof $460.8 million, short-term investment securities of $64.0 million, and netcash value of life insurance of $82.1 million.

 

Investment securities of$64.0 million and $98.3 million at March 31, 2008 and December 31,2007, respectively, consist of direct or indirect investments in debtsecurities. Prior to the fourth quarter of 2007, our investment in the ColumbiaStrategic Cash Fund was classified in cash and cash equivalents as redemptionswere available in cash. In December 2007, the fund began an orderlyliquidation that is expected to continue through 2009 and restrictedredemptions to an in-kind distribution of securities held by the fund. We haveelected to remain in the fund and to value the fund based on the underlyingsecurities as determined by the fund principals.  The strategic cash investment fund was valuedat $64.0 million at March 31, 2008, which includes a decrease in fairvalue of $1.2 million recorded in the quarter ended March 31, 2008 due tocontinued unfavorable conditions of the credit markets.  The loss is recorded as an offset to interestincome earned on the Columbia Strategic Cash Fund, which is net against Chapter11 expenses in the Consolidated Statements of Operations.  This loss was deemed to be other thantemporary, and as such, was recorded in earnings.

 

Net cash value of lifeinsurance represents the cash value of premiums paid by us for life insurancepolicies in the names of current and former executive officers.  We have presented $78.2 million and $77.1million of the total value at March 31, 2008 and December 31, 2007,respectively, as current assets, as it is our expectation that this amount maybe accessed in 2008 as part of our reorganization financing.

 

Our existing $250 million debtor-in-possession post-petition loan andsecurity agreement, or DIP facility, expired on March 31, 2008.  On April 1, 2008, we entered into anamended DIP facility with a syndicate of lenders that provides for up to $165million of revolving loans and face amount of letters of credit.  The amended DIP facility is secured by apriority lien on substantially all assets of our filing entities with theexclusion of the capital stock of 

 

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non-U.S. subsidiaries, and bears interest based on the London InterbankOffered Rate (LIBOR).  The amended DIPfacility permits the increase of commitments of existing lenders and/orcommitments by new lenders up to an aggregate maximum of $250 million.

 

The following table summarizes our U.S. and non-U.S. credit facilitiesas of March 31, 2008, giving effect to the April 1, 2008 amendment tothe DIP facility:

 
| **Credit Facilities** | ** ** | **Maximum  Borrowing  Amount** | ** ** | **Amount  Available** | ** ** | **Expiration  Date** | ** **   |
|----------------------------|------------|--------------------------------|------------|-----------------------|------------|----------------------|--------------|
| *(In millions)*       | ** ** | ** **                     | ** ** | ** **            | ** ** | ** **           | ** **   |
| **Country**                |       |                           |       |                  |       |                 |         |
| U.S.                       |       | $                              | 165.0      |                  | $          | 103.6                | *** *** | 04/01/10 | *(1)* |
| Germany                    |       | 78.9                           |       | 44.3                  |       | 12/31/09             |         |
| Germany                    |       | 18.9                           |       | 10.1                  |       | 09/30/08             |         |
| France                     |       | 5.7                            |       | 5.7                   |       | 06/30/08             |         |
| Brazil                     |       | 1.2                            |       | 1.2                   |       | 06/30/08             |         |
| Singapore                  |       | 5.4                            |       | 2.8                   |       | 06/30/08             |         |
| Venezuela                  |       | 0.9                            |       | 0.9                   |       | 06/30/08             |         |
| Colombia                   |       | 0.1                            |       | 0.1                   |       | 06/30/08             |         |
| **Total**                  |       | $                              | 276.1      |                  | $          | 169.0                |         |   |   |

 

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*(1)**             **Expiration date is theearlier of April 1, 2010 or our emergence from Chapter 11*

 

We believe that these funds and credit facilities will be sufficient tofinance our business strategy while in Chapter 11.

 

***Debt and OtherContractual Obligations –***Total debt outstanding at March 31, 2008 was$825.7 million including $298.6 million of accrued interest on pre-petitiondebt.  As a result of the Chapter 11filing, we are now in default, under the terms of the relevant agreements, on$523.6 million of pre-petition debt, which, together with accrued interestthereon, has been included in “liabilities subject to compromise” as of March 31,2008.  The amount of accrued interestcould be adjusted upward or downward consistent with the plan of reorganizationultimately approved by the bankruptcy court. The automatic stay provided under the bankruptcy code prevents ourlenders from taking any action to collect the principal amounts as well asrelated accrued interest. However, we will continue to accrue and reportinterest on such debt during the Chapter 11 proceedings unless furtherdevelopments lead management to conclude that it is probable that such interestwill be compromised.

 

See Note 13 to theConsolidated Financial Statements for a discussion of financial assurances.

 

**Analysis of Cash Flows**

 

Our net cash used foroperating activities for the three months ended March 31, 2008 and 2007was $47.7 million and $49.0 million, respectively.  In the 2008 quarter, we experienced lowercash contributions to defined benefit pension plans and did not pay dividendsto minority partners in joint ventures as in the prior year quarter.  These reductions in cash outflows were offsetby increased levels of inventories to meet 2008 sales demand and by higher cashtaxes paid.  Net cash provided byinvesting activities for the three months ended March 31, 2008 was $6.7million, primarily relating to proceeds from sales of investment securities,partially offset by capital investments. Net cash inflow from financing activities was $6.7 million, primarilyfrom cash received from stock option exercises.

 

***Cash Flow FromCore Operations –*******Thefollowing table presents the components of net cash flow from core operations for the three months ended March 31,2008 and 2007.  The decrease in core netcash outflows is primarily due to lower contributions to defined benefitpension plans, partially offset by higher working capital.

** **
| ** **                                                 | ** ** | **Three Months  Ended  March 31,** | ** ** |
|------------------------------------------------------------|------------|----------------------------------------------|------------|
| **Core Operations **                             | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| *(In millions)*                                       |       |                                         |       |   |   |
| **Cash  flows:**                                           |       |                                         |       |   |   |
| Pre-tax  operating income                                  | ** ** | **$**                                        | **62.2**   | ** ** | $ | 60.6 |   |
| Depreciation and  amortization                             | ** ** | **30.2**                                     | ** ** | 27.6 |   |
| **Pre-tax  earnings before depreciation and amortization** | ** ** | **92.4**                                     | ** ** | 88.2 |   |
| Working capital  and other changes                         | ** ** | **(99.4**                                    | **)**      | (102.3 | ) |
| **Cash  flow before investing**                            | ** ** | **(7.0**                                     | **)**      | (14.1 | ) |
| Capital  expenditures                                      | ** ** | **(25.9**                                    | **)**      | (24.1 | ) |
| Purchase of  equity investment                             | ** ** | **(3.0**                                     | **)**      | — |   |
| **Net  cash flow from core operations**                    | ** ** | **$**                                        | **(35.9**  | **)** | $ | (38.2 | ) |

 

We expect to continue toinvest excess cash flow and/or other available capital resources in our corebusiness base. These investments are likely to be in the form of additionalplant capacity, product line extensions and geographic market expansions,and/or acquisitions in existing product lines. Investments that are outside the ordinary course of business may besubject to bankruptcy court approval and review by the Chapter 11 creditorcommittees.

 

***Cash Flow FromNoncore Activities –*** The cash flow from our noncore activities can be volatile.******

 

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Expenditures are generally governed by bankruptcy court rulings andreceipts are generally nonrecurring. Historically, much of our noncore spendinghas been under Chapter 11 first-day motions that allow us to fundpostretirement benefits and required environmental remediation on Grace-ownedsites. Cash inflows have been from asbestos-related insurance recovery onpre-Chapter 11 liability payments, and unusual events.  The following table presents the componentsof net cash flow from noncore activitiesfor the three months ended March 31, 2008 and 2007.

 
| ** **                                     | ** ** | **Three Months  Ended  March 31,** | ** ** |
|------------------------------------------------|------------|----------------------------------------------|------------|
| **Noncore Activities **              | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| *(In millions)*                           |       |                                         |       |   |   |
| **Cash  flows:**                               |       |                                         | ** ** |   |   |
| Pre-tax income  (loss) from noncore activities | ** ** | **$**                                        | **(0.6**   | **)** | $ | (5.8 | ) |
| Other non-cash  charges                        | ** ** | **(8.5**                                     | **)**      | 0.5 |   |
| Cash received  (disbursed) for:                |       |                                         | ** ** |   |   |
| Proceeds from  sale of investment securities   | ** ** | **33.1**                                     | ** ** | — |   |
| Tax settlement                                 | ** ** | **—**                                   | ** ** | (10.3 | ) |
| Environmental  remediation                     | ** ** | **(1.3**                                     | **)**      | (2.8 | ) |
| Postretirement  benefits                       | ** ** | **(1.1**                                     | **)**      | (0.2 | ) |
| Retained  obligations and other                | ** ** | **—**                                   | ** ** | (0.4 | ) |
| **Net  cash flow from noncore activities**     | ** ** | **$**                                        | **21.6**   | ** ** | $ | (19.0 | ) |

 

Net cash flow from core operations and net cash flowfrom noncore activities do not represent income or cash flow as defined undergenerally accepted accounting principles, and you should not consider them tobe an alternative to such measures as an indicator of our performance. Weprovide these measures to permit you to distinguish operating results of ourcurrent business base from results and related assets and liabilities of past businesses,discontinued products, and corporate legacies and the effect of our Chapter 11proceedings.

 

**Forward-Looking Statements**

 

This document contains, and our other public communications maycontain, forward-looking information, that is, information related to future,not past, events. Such information generally includes the words ‘‘believes,’’ ‘‘plans,’’‘‘intends,’’ ‘‘targets,’’ ‘‘will,’’ ‘‘expects,’’ ‘‘anticipates,’’ or similarexpressions.  Forward-looking informationincludes all statements regarding our Chapter 11 case; expected financialposition; results of operations; cash flows; financing plans; businessstrategy; budgets; capital and other expenditures; competitive positions;growth opportunities for existing products; benefits from new technology andcost reduction initiatives, plans and objectives;  and markets for securities. For thesestatements, we claim the protection of the safe harbor for forward-lookingstatements contained in the Private Securities Litigation Reform Act of 1995.Factors that could cause actual results to materially differ from thosecontained in the forward-looking statements include:  our bankruptcy and proposed plan ofreorganization, our recent settlement with certain creditors, our legalproceedings, especially the Montana criminal proceeding and the environmentalproceedings, the cost and availability of raw materials and energy, ourunfunded pension obligations, risks related to foreign operations, especially,security, regulation and currency risks, costs of compliance with environmentalregulation and those factors set forth in our most recent Annual Report on Form 10-K,this quarterly report on Form 10-Q and current reports on Form 8-K,which have been filed with the Securities and Exchange Commission.  Like other businesses, we are subject torisks and uncertainties that could cause our actual results to differmaterially from our projections or that could cause other forward-lookinginformation to prove incorrect. Further, our reported results should not be consideredas an indication of our future performance. Readers are cautioned not to placeundue reliance on our projections and forward-looking information, which speakonly as of the date thereof. We undertake no obligation to publicly release anyrevisions to the projections and forward-looking information contained in thisdocument, or to update them to reflect events or circumstances occurring afterthe date of this document.

 

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**Item 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

See the “Market Risk”heading in Item 7 of our Form 10-K for the year ended December 31,2007 for disclosures required by this item.

 

**Item 4. CONTROLS AND PROCEDURES**

 

*EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES*

 

As of March 31,2008, Grace carried out an evaluation of the effectiveness of the design andoperation of its disclosure controls and procedures pursuant to Rule 13a-15under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).Based upon that evaluation, Grace’s Chief Executive Officer and Chief FinancialOfficer concluded that Grace’s disclosure controls and procedures are effectiveto ensure that information required to be disclosed in Grace’s Exchange Actreports is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms, and that material informationrelating to Grace is made known to management, including Grace’s ChiefExecutive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosure.

 

*CHANGESIN INTERNAL CONTROL OVER FINANCIAL REPORTING*

 

There were no changes inGrace’s internal control over financial reporting during the quarter ended March 31,2008 that have materially affected, or are reasonably likely to materiallyaffect, Grace’s internal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

**Item1.  LEGAL PROCEEDINGS**

 

Notes 2, 3 and 13 to the interim consolidated financial statements in Part 1of this Report are incorporated herein by reference.

 

**Item 1A.RISK FACTORS**

 

With respect to certain riskfactors disclosed in the “Risk Factors” section of our Annual Report on Form 10-Kfor the year ended December 31, 2007, more recent numerical measures andother information are available in the “Financial Statements” and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”sections of this Report and as set forth below. These more recent measures and information are incorporated herein byreference.

 

****Ourproposed plan of reorganization as filed with the bankruptcy court, and anyplan that we file to reflect our recent agreement in principle with parties ininterest in our Chapter 11 case, if confirmed, will substantially impact thevalue of currently outstanding shares of Grace common stock.  An alternative plan that has been filed withthe bankruptcy court provides for the cancellation of currently outstandingshares of Grace common stock.****

 

Our proposed plan ofreorganization as filed with the bankruptcy court will, and any joint plan ofreorganization that is filed with the bankruptcy court to reflect our recentagreement in principle with the committees representing asbestos personalinjury claimants and equity security holders and the legal representative offuture asbestos claimants*,***will substantiallyimpact the value of** the **ownership interests of holders of currentlyoutstanding Grace common stock**.  The committee representing asbestos personalinjury claimants and the legal representative of future asbestos claimants havefiled an alternative plan of reorganization with the bankruptcy court thatprovides for the cancellation of **the ownership interests of holders of currently outstandingGrace common stock**. Each of the filed plans is subject to the fulfillment of numerousconditions that may not ultimately be fulfilled.  The agreement in principle constitutes abroad overview of settled issues that are subject to substantial additionalnegotiation among the parties thereto before a joint plan reflecting its termsmay be filed with the bankruptcy court and although it is supported by theparties thereto, other parties-in-interest in our Chapter 11 case are notparties thereto and may have objections to all or part thereof.  As a result, it is possible that neither ofthe filed plans, nor any plan reflecting the agreement in principle, will beapproved by the bankruptcy court.  Noparty currently has exclusive rights to propose a plan of reorganization andsolicit votes thereon, so any party-in-interest can propose a competing plan ofreorganization at any time.  Therefore,until an ultimate plan of reorganization is confirmed, the interests of theholders of Grace common stock remain subject to substantial dilution orcancellation.  Accordingly, the value ofGrace common stock is highly speculative and any investment in Grace commonstock poses a high degree of risk.

 

****Ourfinancial statements have not been updated to reflect the terms of our recentagreement in principle with the committees representing asbestos personalinjury claimants and equity security holders and the legal representative offuture asbestos claimants.****

 

Our financial statements reflect accounting for asbestos-relatedliabilities that is based on our proposed plan of reorganization as filed withthe bankruptcy court.  Since the filingof our plan, the bankruptcy court has terminated Grace’s exclusive rights topropose a plan of reorganization and solicit votes thereon, the committeerepresenting asbestos personal injury claimants and the legal representative offuture asbestos claimants have filed a competing plan and we have entered intoa agreement in principle with the committees representing asbestos personalinjury claimants and equity security holders and the legal representative offuture asbestos claimants.  Our plan, thecompeting plan and a plan based on the agreement in principle would result insubstantially different treatment of our asbestos-related liabilities in ourfinancial statements.  We expect toadjust our asbestos-related liability as necessary: to reflect rulings made bythe bankruptcy court; when a new plan of reorganization is filed to reflect theterms of the agreement in principle; and when significant uncertainties havebeen resolved.  When we adjust 

 

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our accounting based on a revised plan of reorganization or anotherplan that is filed and/or confirmed, such adjustments could be materialto our consolidated financial position and results of operations.

 

**Item6.  EXHIBITS**

 

The following is a list of Exhibits filed as part ofthis Quarterly Report on Form 10-Q:

 
| **Exhibit No.** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                          |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                    |
| 4.1                  |       | Amended and Restated  Rights Agreement dated as of March 25, 2008 by and between W. R.  Grace & Co. and Mellon Investor Services, LLC, as rights agent  (incorporated by reference from Amendment No. 1 to the Grace  Registration Statement on Form 10 as filed with the Securities and  Exchange Commission on March 25, 2008) |
|                 |       |                                                                                                                                                                                                                                                                                                                                                          |
| 4.2                  |       | Amendment No. 5 to  Post-Petition Loan and Security Agreement (incorporated by reference from  Exhibit 4.1 to Current Report on Form 8-K as filed with the  Securities and Exchange Commission on April 1, 2008)                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                                          |
| 4.3                  |       | Amendment No. 6 to  Post-Petition Loan and Security Agreement (incorporated by reference from  Exhibit 4.2 to Current Report on Form 8-K as filed with the  Securities and Exchange Commission on April 1, 2008)                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                                          |
| 10.1                 |       | Letter Agreement dated  March 3, 2008 between Fred Festa, on behalf of Grace, and Hudson La  Force III (incorporated by reference from Exhibit 10.01 to Current  Report on Form 8-K as filed with the Securities and Exchange Commission  on March 7, 2008)                                                                               |
|                 |       |                                                                                                                                                                                                                                                                                                                                                          |
| 10.2                 |       | Letter Agreement dated  March 31, 2008 between Fred Festa, on behalf of Grace, and Robert M.  Tarola                                                                                                                                                                                                                                                     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                          |
| 10.3                 |       | Settlement Agreement  dated March 11, 2008 between W. R. Grace & Co. and the U.S.  government (incorporated by reference from Exhibit 10.01 to Current  Report on Form 8-K as filed with the Securities and Exchange Commission  on March 11, 2008)                                                                              |
|                 |       |                                                                                                                                                                                                                                                                                                                                                          |
| 15                   |       | Accountants’ Awareness  Letter                                                                                                                                                                                                                                                                                                                           |
|                 |       |                                                                                                                                                                                                                                                                                                                                                          |
| 31.(i).1             |       | Certification of  Periodic Report by Chief Executive Officer under Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                        |
|                 |       |                                                                                                                                                                                                                                                                                                                                                          |
| 31.(i).2             |       | Certification of Periodic  Report by Chief Financial Officer under Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                        |
|                 |       |                                                                                                                                                                                                                                                                                                                                                          |
| 32                   |       | Certification of  Periodic Report by Chief Executive Officer and Chief Financial Officer under  Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                            |

 

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**SIGNATURE**

 

In accordance with therequirements of the Securities Exchange Act of 1934, the Registrant caused thisReport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

 
|                   | W. R. GRACE &  CO. |
|------------------------|-----------------------------|
|                   | (Registrant)                |
|                   |                        |
| Date: May 9, 2008 | By                          | /s/ A. E. Festa |
|                   |                        | A. E. Festa  President and  Chief Executive Officer |
|                   |                        |   |
| Date: May 9, 2008 | By                          | /s/ Hudson La Force III |
|                   |                        | Hudson La Force III  Senior Vice President and  Chief Financial Officer  (Principal Accounting  Officer) |

 

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**EXHIBITINDEX**

 
| **Exhibit No.** | ** ** | **Description of Exhibit**                                                                                                               |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                                                                         |
| 10.2                 |       | Letter Agreement dated  March 31, 2008 between Fred Festa, on behalf of Grace, and Robert M.  Tarola                                          |
|                 |       |                                                                                                                                               |
| 15                   |       | Accountants’ Awareness  Letter                                                                                                                |
|                 |       |                                                                                                                                               |
| 31.(i).1             |       | Certification of  Periodic Report by Chief Executive Officer under Section 302 of the  Sarbanes-Oxley Act of 2002                             |
|                 |       |                                                                                                                                               |
| 31.(i).2             |       | Certification of  Periodic Report by Chief Financial Officer under Section 302 of the  Sarbanes-Oxley Act of 2002                             |
|                 |       |                                                                                                                                               |
| 32                   |       | Certification of  Periodic Report by Chief Executive Officer and Chief Financial Officer under  Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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