**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549**

# **FORM 10-Q**

**(MarkOne)**
| **x**      | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d)**  |
|------------|------------|--------------------------------------------------------|
| ** ** | ** ** | **OF THE  SECURITIES EXCHANGE ACT OF 1934**            |
| ** ** | ** ** | ** **                                             |
| ** ** | ** ** | **FOR THE  QUARTERLY PERIOD ENDED MARCH 31, 2007**     |
| ** ** | ** ** | ** **                                             |
| ** ** | ** ** | **OR**                                                 |
| ** ** | ** ** | ** **                                             |
| **o**      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d)** |
| ** ** | ** ** | **OF THE  SECURITIES EXCHANGE ACT OF 1934**            |

 

**Commission File 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 phonenumber ofprincipal executive offices)

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

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

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer.  Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act.

| Large  accelerated filer o |   | Accelerated  filer x |   | Non-accelerated filer o |
|----------------------------|--------|----------------------|--------|-------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

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

 

70,082,385 sharesof Common Stock, $0.01 par value, were outstanding at April 30, 2007.

 

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

## Table of Contents

| **Part I.**  | ** ** | **Financial  Information**                                                                  |   | I-1    |
|--------------|------------|---------------------------------------------------------------------------------------------|--------|--------|
| ** **   | ** ** | ** **                                                                                  |   |   |
| 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-30   |
|         |       |                                                                                        |   |   |
| Item 3.      |       | Quantitative and Qualitative  Disclosures About Market Risk                                 |   | I-48   |
|         |       |                                                                                        |   |   |
| Item 4.      |       | Controls and  Procedures                                                                    |   | I-48   |
|         |       |                                                                                        |   |   |
|         |       |                                                                                        |   |   |
| **Part II.** | ** ** | **Other Information**                                                                       |   | II-1   |
| ** **   | ** ** | ** **                                                                                  |   |   |
| Item 1.      |       | Legal Proceedings                                                                           |   | II-1   |
|         |       |                                                                                        |   |   |
| Item 1A.     |       | Risk Factors                                                                                |   | II-2   |
|         |       |                                                                                        |   |   |
| Item 6.      |       | Exhibits                                                                                    |   | II-2   |

 

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

**Item1.  FINANCIAL STATEMENTS**

Reviewby Independent Registered Public Accounting Firm

With respect to theinterim consolidated financial statements included in this Quarterly Report onForm 10-Q for the three months ended March 31, 2007 and 2006,PricewaterhouseCoopers LLP, the company’s independent registered publicaccounting firm, has applied limited procedures in accordance with professionalstandards for a review of such information. Their report on the interim consolidated financial statements, whichfollows, states that they did not audit and they do not express an opinion onthe unaudited interim financial statements. Accordingly, the degree of reliance on their report on the unauditedinterim financial statements should be restricted in light of the limitednature of the review procedures applied. This report is not considered a “report” within the meaning of Sections7 and 11 of the Securities Act of 1933, and, therefore, the independentaccountants’ liability under Section 11 does not extend to it.

I-1

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### **Report of Independent RegisteredPublic Accounting Firm**

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

We have reviewed the accompanying consolidated balance sheet of W. R.Grace & Co. and its subsidiaries as of March 31, 2007, and the relatedconsolidated statements of operations, cash flows, shareholders’ equity(deficit) and comprehensive income (loss) for each of the three-month periodsended March 31, 2007 and March 31, 2006. These interim financial statements arethe responsibility of the Company’s management.

Weconducted our review in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). A review of interim financialinformation consists principally of applying analytical procedures and makinginquiries of persons responsible for financial and accounting matters. It issubstantially less in scope than an audit conducted in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theobjective of which is the expression of an opinion regarding the financialstatements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modificationsthat should be made to the accompanying interim consolidated financialstatements for them to be in conformity with accounting principles generallyaccepted in the United States of America.

The accompanying interim consolidated financial statements have beenprepared assuming 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.

We have previously audited, in accordance with the standards of thePublic Company Accounting Oversight Board (United States), the consolidatedbalance sheet as of December 31, 2006, and the related consolidated statementsof operations, cash flows, shareholders’ equity (deficit) and comprehensiveincome (loss) for the year then ended, management’s assessment of the effectivenessof the Company’s internal control over financial reporting as of December 31,2006 and the effectiveness of the Company’s internal control over financialreporting as of December 31, 2006; and in our report dated March 1, 2007, weexpressed (i) an unqualified opinion on those consolidated financial statementswith an explanatory paragraph relating to the Company’s ability to continue asa going concern and, (ii) unqualified opinions on management’s assessment ofthe effectiveness of the Company’s internal control over financial reportingand on the effectiveness of the Company’s internal control over financialreporting. The consolidated financial statements and management’s assessment ofthe effectiveness of internal control over financial reporting referred toabove are not presented herein. In our opinion, the information set forth inthe accompanying consolidated balance sheet as of December 31, 2006, is fairlystated in all material respects in relation to the consolidated balance sheetfrom which it has been derived.
| /s/ PricewaterhouseCoopers  LLP | ** ** |
|---------------------------------|------------|

McLean,Virginia

May 9, 2007

I-2

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

**Consolidated Statements of Operations (Unaudited)**
| ** **                                                                                                                                | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(In millions, except per share amounts)**                                                                      | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
|                                                                                                                                      |       |                                             |       |   |   |
| Net sales                                                                                                                                 | ** ** | **$**                                            | **715.6**  |   | $ | 658.6 |   |
|                                                                                                                                      |       |                                             |       |   |   |
| Cost of goods  sold, exclusive of depreciation and amortization shown separately below                                                    | ** ** | **478.7**                                        |       | 437.8 |   |
| Selling, general  and administrative expenses, exclusive of net pension expense and depreciation  and amortization shown separately below | ** ** | **127.5**                                        |       | 129.0 |   |
| Depreciation and  amortization                                                                                                            | ** ** | **27.6**                                         |       | 28.1 |   |
| Research and  development expenses                                                                                                        | ** ** | **17.8**                                         |       | 14.9 |   |
| Net pension  expense                                                                                                                      | ** ** | **12.7**                                         |       | 14.8 |   |
| Interest expense  and related financing costs                                                                                             | ** ** | **19.4**                                         |       | 15.8 |   |
| Chapter 11  expenses, net of interest income                                                                                              | ** ** | **17.8**                                         |       | 8.7 |   |
| Other (income)  expense, net                                                                                                              | ** ** | **(8.0**                                         | **)**      | (1.9 | ) |
|                                                                                                                                      | ** ** | **693.5**                                        |       | 647.2 |   |
|                                                                                                                                      |       |                                             |       |   |   |
| Income (loss)  before income taxes and minority interest                                                                                  | ** ** | **22.1**                                         |       | 11.4 |   |
| Benefit from  (provision for) income taxes                                                                                                | ** ** | **(14.9**                                        | **)**      | (4.5 | ) |
| Minority  interest in consolidated entities                                                                                               | ** ** | **(2.4**                                         | **)**      | (6.8 | ) |
|                                                                                                                                      |       |                                             |       |   |   |
| **Net income (loss)**                                                                                                                     | ** ** | **$**                                            | **4.8**    |   | $ | 0.1 |   |
|                                                                                                                                      |       |                                             |       |   |   |
| **Basic  earnings (loss) per share:**                                                                                                     | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Net income (loss)                                                                                                                         | ** ** | **$**                                            | **0.07**   |   | $ | 0.00 |   |
| Weighted average number of basic shares                                                                                                   | ** ** | **69.4**                                         |       | 67.0 |   |
|                                                                                                                                      |       |                                             |       |   |   |
| **Diluted  earnings (loss) per share:**                                                                                                   |       |                                             |       |   |   |
| Net income (loss)                                                                                                                         | ** ** | **$**                                            | **0.07**   |   | $ | 0.00 |   |
| Weighted average number of diluted shares                                                                                                 | ** ** | **70.5**                                         |       | 67.3 |   |

 

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

I-3

----

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

**Consolidated Statements of Cash Flows (Unaudited)**
| ** **                                                                                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(In millions)**                                                                               | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| ** **                                                                                           | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| **OPERATING  ACTIVITIES**                                                                            | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Net income  (loss)                                                                                   | ** ** | **$**                                            | **4.8**    |   | $ | 0.1 |   |
| Reconciliation  to net cash provided by (used for) operating activities:                             |       |                                             |       |   |   |
| Chapter 11 expenses, net of interest income                                                          | ** ** | **17.8**                                         |       | 8.7 |   |
| (Benefit from) provision for income taxes                                                            | ** ** | **14.9**                                         |       | 4.5 |   |
| Minority interest in consolidated entities                                                           | ** ** | **2.4**                                          |       | 6.8 |   |
| Depreciation and amortization                                                                        | ** ** | **27.6**                                         |       | 28.1 |   |
| Interest accrued on pre-petition liabilities subject  to compromise                                  | ** ** | **19.1**                                         |       | 15.4 |   |
| Net (gain) loss on sales of investments and  disposals of assets                                     | ** ** | **(0.2**                                         | **)**      | 1.8 |   |
| Net pension expense                                                                                  | ** ** | **12.7**                                         |       | 14.8 |   |
| Payments under defined benefit pension arrangements                                                  | ** ** | **(32.4**                                        | **)**      | (13.3 | ) |
| Payments under postretirement benefit plans                                                          | ** ** | **(0.2**                                         | **)**      | (2.2 | ) |
| Net income from life insurance policies                                                              | ** ** | **(2.0**                                         | **)**      | (1.2 | ) |
| Provision for uncollectible receivables                                                              | ** ** | **0.6**                                          |       | — |   |
| Expenditures for environmental remediation                                                           | ** ** | **(2.8**                                         | **)**      | (2.1 | ) |
| Expenditures for retained obligations of divested  businesses                                        | ** ** | **(0.4**                                         | **)**      | (0.7 | ) |
| Dividends paid to minority interests in consolidated  entities                                       | ** ** | **(11.8**                                        | **)**      | — |   |
| Changes in assets and liabilities, excluding effect  of foreign currency translation:                |       |                                             |       |   |   |
| Working capital items (trade accounts receivable,  inventories and accounts payable)                 | ** ** | **(7.1**                                         | **)**      | (49.8 | ) |
| Other accruals and non-cash items                                                                    | ** ** | **(61.0**                                        | **)**      | (32.8 | ) |
| Income taxes paid, net of refunds                                                                    | ** ** | **(2.5**                                         | **)**      | (2.8 | ) |
| **Net cash provided by (used for) operating  activities before Chapter 11 expenses and settlements** | ** ** | **(20.5**                                        | **)**      | (24.7 | ) |
| Cash paid to  resolve contingencies subject to Chapter 11                                            | ** ** | **(10.3**                                        | **)**      | — |   |
| Chapter 11  expenses paid                                                                            | ** ** | **(18.2**                                        | **)**      | (12.4 | ) |
| **Net cash provided by (used for) operating  activities**                                            | ** ** | **(49.0**                                        | **)**      | (37.1 | ) |
| ** **                                                                                           | ** ** | ** **                                       | ** ** |   |   |
| **INVESTING  ACTIVITIES**                                                                            | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Capital  expenditures                                                                                | ** ** | **(24.1**                                        | **)**      | (24.1 | ) |
| Net investment  in life insurance policies                                                           | ** ** | **0.2**                                          |       | (0.2 | ) |
| Proceeds from  sales of investments and disposals of assets                                          | ** ** | **0.7**                                          |       | 0.1 |   |
| **Net cash provided by (used for) investing  activities**                                            | ** ** | **(23.2**                                        | **)**      | (24.2 | ) |
| ** **                                                                                           | ** ** | ** **                                       | ** ** |   |   |
| **FINANCING  ACTIVITIES**                                                                            | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Net (repayments)  borrowings under credit arrangements                                               | ** ** | **(1.1**                                         | **)**      | (0.2 | ) |
| Fees under  debtor-in-possession credit facility                                                     | ** ** | **(0.7**                                         | **)**      | (0.5 | ) |
| Proceeds from  exercise of stock options                                                             | ** ** | **14.2**                                         |       | 2.0 |   |
| **Net cash provided by (used for) financing  activities**                                            | ** ** | **12.4**                                         |       | 1.3 |   |
| Effect of  currency exchange rate changes on cash and cash equivalents                               | ** ** | **2.8**                                          |       | 0.7 |   |
| **Increase (decrease) in cash and cash equivalents**                                                 | ** ** | **(57.0**                                        | **)**      | (59.3 | ) |
| Cash and cash  equivalents, beginning of period                                                      | ** ** | **536.3**                                        |       | 474.7 |   |
| Cash and cash  equivalents, end of period                                                            | ** ** | **$**                                            | **479.3**  |   | $ | 415.4 |   |

 

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

I-4

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

**Consolidated Balance Sheets**
| **(In millions, except par value and shares)**                                                         | ** ** | **March 31,  2007** | ** **   | **December 31,  2006** | ** **   |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|--------------|-----------------------------|--------------|
| ** **                                                                                                                           | ** ** | **(unaudited)**          | *** *** | *** ***                | *** *** |
| **ASSETS**                                                                                                                           |       |                     |         |                        |         |
| **Current  Assets**                                                                                                                  |       |                     |         |                        |         |
| Cash and cash  equivalents                                                                                                           | ** ** | **$**                    | **479.3**    |                        | $            | 536.3 |   |
| Trade accounts  receivable, less allowance of $7.1 (2006 - $6.6)                                                                     | ** ** | **446.7**                |         | 426.3                       |         |
| Inventories                                                                                                                          | ** ** | **306.8**                |         | 284.6                       |         |
| Deferred income  taxes                                                                                                               | ** ** | **32.7**                 |         | 37.8                        |         |
| Other current  assets                                                                                                                | ** ** | **82.9**                 |         | 83.8                        |         |
| **Total Current Assets**                                                                                                             | ** ** | **1,348.4**              |         | 1,368.8                     |         |
|                                                                                                                                 |       |                     |         |                        |         |
| Properties and  equipment, net of accumulated depreciation and amortization of $1,538.6   (2006 - $1,510.5)                          | ** ** | **665.8**                |         | 664.5                       |         |
| Goodwill                                                                                                                             | ** ** | **117.1**                |         | 116.5                       |         |
| Cash value of  life insurance policies, net of policy loans                                                                          | ** ** | **91.0**                 |         | 89.2                        |         |
| Deferred income  taxes                                                                                                               | ** ** | **724.2**                |         | 728.5                       |         |
| Asbestos-related  insurance                                                                                                          | ** ** | **500.0**                |         | 500.0                       |         |
| Overfunded  defined benefit pension plans                                                                                            | ** ** | **49.2**                 |         | 38.4                        |         |
| Other assets                                                                                                                         | ** ** | **132.0**                |         | 131.5                       |         |
| **Total Assets**                                                                                                                     | ** ** | **$**                    | **3,627.7**  |                        | $            | 3,637.4 |   |
|                                                                                                                                 |       |                     |         |                        |         |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY (DEFICIT)**                                                                             |       |                     |         |                        |         |
| **Liabilities  Not Subject to Compromise**                                                                                           | ** ** | ** **               | ** **   | ** **                  | ** **   |
| **Current  Liabilities**                                                                                                             |       |                     |         |                        |         |
| Debt payable  within one year                                                                                                        | ** ** | **$**                    | **2.1**      |                        | $            | 3.3 |   |
| Accounts payable                                                                                                                     | ** ** | **203.2**                |         | 172.7                       |         |
| Other current  liabilities                                                                                                           | ** ** | **231.5**                |         | 272.6                       |         |
| **Total Current Liabilities**                                                                                                        | ** ** | **436.8**                |         | 448.6                       |         |
|                                                                                                                                 |       |                     |         |                        |         |
| Debt payable  after one year                                                                                                         | ** ** | **0.2**                  |         | 0.2                         |         |
| Deferred income  taxes                                                                                                               | ** ** | **61.3**                 |         | 58.9                        |         |
| Minority  interest in consolidated entities                                                                                          | ** ** | **55.6**                 |         | 65.0                        |         |
| Underfunded  defined benefit pension plans                                                                                           | ** ** | **339.9**                |         | 349.6                       |         |
| Other  liabilities                                                                                                                   | ** ** | **41.0**                 |         | 43.3                        |         |
| **Total Liabilities Not Subject to Compromise**                                                                                      | ** ** | **934.8**                |         | 965.6                       |         |
| ** **                                                                                                                           | ** ** | ** **               | ** **   | ** **                  | ** **   |
| **Liabilities  Subject to Compromise – Note 2**                                                                                 | ** ** | **3,215.1**              |         | 3,221.6                     |         |
| **Total Liabilities**                                                                                                                | ** ** | **4,149.9**              |         | 4,187.2                     |         |
| ** **                                                                                                                           | ** ** | ** **               | ** **   | ** **                  | ** **   |
| **Commitments  and Contingencies**                                                                                                   | ** ** | ** **               | ** **   | ** **                  | ** **   |
| ** **                                                                                                                           | ** ** | ** **               | ** **   | ** **                  | ** **   |
| **Shareholders’  Equity (Deficit)**                                                                                             |       |                     |         |                        |         |
| Common stock  issued, par value $0.01; 300,000,000 shares authorized; outstanding:   2007 – 69,830,835 (2006 – 68,915,022) | ** ** | **0.8**                  |         | 0.8                         |         |
| Paid-in capital                                                                                                                      | ** ** | **427.1**                |         | 423.8                       |         |
| Accumulated  deficit                                                                                                                 | ** ** | **(480.6**               | **)**        | (487.6                      | )            |
| Treasury stock,  at cost: shares: 2007 – 7,148,925; (2006 – 8,064,738)                                                     | ** ** | **(85.1**                | **)**        | (96.0                       | )            |
| Accumulated  other comprehensive income (loss)                                                                                       | ** ** | **(384.4**               | **)**        | (390.8                      | )            |
| **Total Shareholders’ Equity (Deficit)**                                                                                        | ** ** | **(522.2**               | **)**        | (549.8                      | )            |
| **Total  Liabilities and Shareholders’ Equity (Deficit)**                                                                       | ** ** | **$**                    | **3,627.7**  |                        | $            | 3,637.4 |   |

 

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

I-5

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

**Consolidated Statements of 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, 2006**                                       |       | $                                                | 424.6      |                     | $          | (487.6              | )          | $                                                         | (96.0      | )                                                | $          | (390.8 | ) | $ | (549.8 | ) |
| Cumulative  effect of adoption of FASB Interpretation No. 48 (Note 4) |       | —                                           |       | 2.2                      |       | —              |       | —                                                    |       | 2.2                                              |       |
| **Balance,  January 1, 2007**                                         |       | $                                                | 424.6      |                     | $          | (485.4              | )          | $                                                         | (96.0      | )                                                | $          | (390.8 | ) | $ | (547.6 | ) |
| Net income  (loss)                                                    |       | —                                           |       | 4.8                      |       | —              |       | —                                                    |       | 4.8                                              |       |
| Stock plan  activity                                                  |       | 3.3                                              |       | —                   |       | 10.9                |       | —                                                    |       | 14.2                                             |       |
| Other  comprehensive income (loss)                                    |       | —                                           |       | —                   |       | —              |       | 6.4                                                       |       | 6.4                                              |       |
| **Balance, March 31, 2007**                                           | ** ** | **$**                                            | **427.9**  | ** **               | **$**      | **(480.6**          | **)**      | **$**                                                     | **(85.1**  | **)**                                            | **$**      | **(384.4** | **)** | **$** | **(522.2** | **)** |

 

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

**Consolidated Statements of Comprehensive Income(Loss) (Unaudited)**
| ** **                                                                                      | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(In millions)**                                                                          | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
|                                                                                            |       |                                             |       |   |   |
| **Net  income (loss)**                                                                          | ** ** | **$**                                            | **4.8**    |   | $ | 0.1 |   |
| ** **                                                                                      | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| **Other  comprehensive income (loss):**                                                         |       |                                             |       |   |   |
| Foreign currency translation adjustments                                                        | ** ** | **5.7**                                          |       | 1.0 |   |
| Gain (loss) from hedging activities, net of income  taxes                                       | ** ** | **1.1**                                          |       | (0.6 | ) |
| Defined benefit pension and other postretirement  plans, net of income taxes (see Note 11) | ** ** | **(0.4**                                         | **)**      | — |   |
| Total other comprehensive income (loss)                                                         | ** ** | **6.4**                                          |       | 0.4 |   |
| **Comprehensive income (loss)**                                                                 | ** ** | **$**                                            | **11.2**   |   | $ | 0.5 |   |

 

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

I-6

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

**Notes to ConsolidatedFinancial Statements (Unaudited)**

**1.****              Basis ofPresentation and Summary of Significant Accounting and Financial ReportingPolicies**

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 silica- and alumina-based catalysts and materials usedin a wide range of industrial applications; and “Grace Performance Chemicals,”which includes specialty chemicals and materials used in commercial andresidential construction and in rigid food and beverage packaging.

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 thesenotes, the term “Company” refers to W. R. Grace & Co. The term “Grace”refers to the Company and/or one or more of its subsidiaries and, in certaincases, their respective predecessors.

***Voluntary Bankruptcy Filing***– During2000 and the first quarter of 2001, Grace experienced several adverse developmentsin its asbestos-related litigation, including: a significant increase inpersonal injury claims, higher than expected costs to resolve personal injuryand certain property damage claims, and class action lawsuits alleging damagesfrom Zonolite Attic Insulation (“ZAI”) a former Grace attic insulation product.

After a thoroughreview of these developments, the Board of Directors concluded that a federalcourt-supervised bankruptcy process provided the best forum available toachieve fairness in resolving these claims and on April 2, 2001 (the “Filing Date”), Graceand 61 of its United States subsidiaries and affiliates, including Grace-Conn.(collectively, the “Debtors”), filed voluntary petitions for reorganization(the “Filing”) under Chapter 11 of the United States Bankruptcy Code in theUnited States Bankruptcy Court for the District of Delaware (the “BankruptcyCourt”). The cases were consolidated and are being jointly administered undercase number 01-01139 (the “Chapter 11 Cases”). Grace’s non-U.S. subsidiariesand certain of its U.S. subsidiaries were not included in the Filing.

UnderChapter 11, the Debtors have continued to operate their businesses asdebtors-in-possession under court protection from creditors and claimants,while using the Chapter 11 process to develop and implement a plan foraddressing the asbestos-related claims. Since the Filing, all motions necessaryto conduct normal business activities have been approved by the BankruptcyCourt. (See Note 2 for Chapter 11-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 2006 Annual Reporton Form 10-K.  Such interim ConsolidatedFinancial Statements reflect all adjustments that, in the opinion ofmanagement, are necessary for a fair presentation of the results of the interimperiods presented; all such adjustments are of a normal recurring nature.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 ofoperations for the three-month interim period ended March 31, 2007 are notnecessarily indicative of the results of operations for the year endingDecember 31, 2007.

***Reclassifications***–****Certain amounts in prior years’ Consolidated FinancialStatements have been reclassified to conform to the 2007 presentation.  Such reclassifications have not materiallyaffected previously reported amounts in the Consolidated Financial Statements.

***Use of Estimates***–****The preparation of financial statements inconformity with U.S. generally accepted accounting principles requires thatmanagement make estimates and assumptions affecting the assets and liabilitiesreported at the date of the Consolidated Financial Statements, and the revenuesand expenses reported for the periods presented. Actual amounts could differfrom those estimates, and the differences could be 

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material.  Changes in estimates are recorded in theperiod identified.  Grace’s accountingmeasurements that are most affected by management’s estimates of future eventsare:

·                  Contingentliabilities which depend on an assessment of the probability of loss and anestimate of ultimate resolution cost, such as asbestos-related matters (seeNotes 2 and 3), environmental remediation (see Note 12), income taxes (see Note4), and litigation (see Note 12);

·                  Pensionand postretirement liabilities that depend on assumptions regarding participantlife spans, future inflation, discount rates and total returns on investedfunds (see Note 13); and

·                  Realizationvalues of net deferred tax assets and insurance receivables, which depend onprojections of future income and cash flows and assessments of insurancecoverage 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 June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertaintyin Income Taxes” (“FIN 48”), which prescribes a recognition threshold andmeasurement attribute for tax positions taken or expected to be taken in taxreturns.  FIN 48 also provides guidanceon derecognition, classification, interest and penalties, accounting in interimperiods, disclosure, and transition. Grace adopted FIN 48 effective in the first quarter of 2007.  See Note 4 for a discussion of the impact ofthe adoption of FIN 48.

In February 2007, theFASB issued SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities.”  SFAS No. 159permits entities to measure many financial instruments and certain other itemsat fair value that are not currently required to be measured at fairvalue.  SFAS No. 159 is effective for thefirst quarter of 2008, and Grace is currently evaluating the impact on itsfinancial statements of adopting SFAS No. 159.

In September 2006, theFASB Emerging Issues Task Force (“EITF”) promulgated Issue No. 06-4, “Accountingfor Deferred Compensation and Postretirement Benefit Aspects of EndorsementSplit-Dollar Life Insurance Arrangements.” This Issue specifies that if a company provides a benefit to an employeeunder an endorsement split-dollar life insurance arrangement that extends topostretirement periods, it would have to recognize a liability and relatedcompensation costs.  In November 2006,the EITF promulgated Issue No. 06-10, “Accounting for Deferred Compensation andPostretirement Benefit Aspects of Collateral Assignment Split-Dollar LifeInsurance Arrangement.”  EITF 06-10,among other things, extends the guidance in EITF 06-4 to collateral assignmentsplit-dollar life insurance arrangements. Grace will adopt EITF 06-4 and EITF 06-10 effective in the first quarterof 2008, and has not yet assessed the estimated impact of these Issues on itsConsolidated Financial Statements.

In September 2006, theEITF promulgated Issue No. 06-5, “Accounting for Purchases of LifeInsurance—Determining the Amount That Could Be Realized in Accordance with FASBTechnical Bulletin No. 85-4, *Accounting forPurchases of Life Insurance.*”  Companies can choose to purchase life insurance policies to fund thecost of employee benefits or to protect against the loss of key persons, andreceive tax-free death benefits.  Thesepolicies are commonly referred to as corporate-owned life insurance(COLI).  This Issue clarifies whether thepolicyholder should consider additional amounts from the policy other than thecash surrender value in determining the amount that could be realized under the insurance contract, orwhether a policyholder should consider the contractual ability to surrender allindividual life policies at the same time in determining the amount that couldbe realized under the insurance contract. Grace adopted EITF 06-5 effective in the first quarter of 2007, and ithad no impact on the Consolidated Financial Statements.

In September 2006, theFASB issued SFAS No. 157, “Fair Value Measurements.”  SFAS No. 157 defines fair value, establishesa framework for measuring fair value, and expands disclosures about fair valuemeasurements.  Grace will adopt SFAS No.157 effective in the first quarter of 2008, and has not yet assessed theestimated impact on its Consolidated Financial Statements.

**2.****              Chapter 11-RelatedInformation**

***Official Parties to Grace’s Chapter 11 Proceedings*****– Three creditors’ committees, tworepresenting asbestos claimants and the third 

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representing otherunsecured creditors, and a committee representing shareholders, have beenappointed in the Chapter 11 Cases. These committees, and a legal representativeof future asbestos claimants, have the right to be heard on all matters thatcome before the Bankruptcy Court and have important roles in the Chapter 11Cases. The Debtors are required to bear certain costs and expenses of thecommittees and of the representative of future asbestos claimants, includingthose of their counsel and financial advisors.

***Plan of Reorganization***–**On November 13, 2004 Grace filed a planof reorganization, as well as several associated documents, including adisclosure statement, with the Bankruptcy Court.  On January 13, 2005, Grace filed an amendedplan of reorganization (the “Plan”) and related documents to address certainobjections of creditors and other interested parties. The Plan is supported bycommittees representing general unsecured creditors and equity holders, but isnot supported by committees representing asbestos personal injury claimants andasbestos property damage claimants or the representative of future asbestosclaimants.

Under the terms ofthe Plan, a trust would be established under Section 524(g) of the BankruptcyCode to which all pending and future asbestos-related claims would be channeledfor resolution.  The Plan contemplates thatthe Bankruptcy Court will conduct hearings to determine, among other things,the amount that would need to be paid into the trust on the effective date ofthe Plan to satisfy Grace’s asbestos-related liabilities and trustadministration costs and expenses over time. The Plan provides that Grace’sasbestos-related liabilities would be satisfied using cash and securities fromGrace and third parties.

The Plan willbecome effective only after a vote of eligible creditors and with the approvalof the Bankruptcy Court and the U.S. District Court for the District ofDelaware. Votes on the Plan may not be solicited until the Bankruptcy Courtapproves the disclosure statement. The Bankruptcy Court has currently deferredconsideration of the disclosure statement and Plan until after completion ofhearings on the amount of Grace’s asbestos-related liability. The Debtors havereceived extensions of their exclusive right to propose a plan ofreorganization and solicit acceptances of that plan through July 23, 2007.  The committees representing asbestosclaimants and the future claimants’ representative have appealed the extensionof exclusivity to the Third Circuit Court of Appeals.

Under the terms ofthe Plan, claims would be satisfied under the Chapter 11 Cases as follows:

Asbestos-RelatedClaims and Costs

Under the Plan, atrust would be established under Section 524(g) of the Bankruptcy Code to whichall pending and future asbestos-related claims would be channeled forresolution.  The trust would utilizespecified trust distribution procedures to satisfy the following allowedasbestos-related claims and costs:

*Personalinjury claims that meet specified exposure and medical criteria (PersonalInjury-Symptomatic Eligible or “PI-SE” Claims)**–*In order to qualify for this class,claimants would have to prove that their health is impaired from meaningfulexposure to asbestos-containing products formerly manufactured by Grace.

*Personalinjury claims that do not meet the exposure and medical criteria necessary toqualify as PI-SE Claims (Personal Injury-Asymptomatic and Other or “PI-AO”Claims)**–*Thisclass would contain all asbestos-related personal injury claims against Gracethat do not meet the specific requirements to be PI-SE Claims, but do meetcertain other specified exposure and medical criteria.

*Propertydamage claims, including claims related to ZAI (“PD Claims”)* –In order to qualify for this class, claimants would have to prove Graceliability for loss of property value or remediation costs related to productsformerly manufactured by Grace that claimants allege contained asbestos.

*Trustadministration costs and legal expenses*

The pendingasbestos-related legal proceedings are described in “Asbestos-RelatedLitigation” (see Note 3). The claims arising from such proceedings would be subjectto this classification process as part of the Plan.

The BankruptcyCourt has entered separate case management orders for estimating liability forpending and future personal injury claims and adjudicating pending propertydamage claims, excluding ZAI claims. Trial dates for estimating liability for personal injuryclaims are currently scheduled to begin in the fall of 2007.  Hearings for 

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the adjudication of various issues regarding propertydamage claims are scheduled for the second quarter of 2007.  The Debtors expect that the estimatedliability for all asbestos-related claims may provide the basis for determiningthe amount to be paid into a trust on the effective date of a plan ofreorganization.

Under the Plan,asbestos personal injury claimants, including both PI-SE and PI-AO claims,would have the option either to litigate their claims against the trust infederal court in Delaware or, if they meet specified eligibility criteria,accept a settlement amount based on the severity of their condition. Under thePlan, asbestos property damage claimants would be required to litigate theirclaims against the trust in federal court in Delaware. The Plan provides that,as a condition precedent to confirmation, the maximum estimated aggregatefunding amount for all asbestos-related liabilities (PI-SE, PI-AO and PDincluding ZAI) 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.

The PI-SE Claims,the PD Claims and the related trust administration costs and expenses would befunded with (1) a payment of $512.5 million in cash (plus interest at 5.5%compounded annually from December 21, 2002) and 18 million shares (reflecting arecent two-for-one stock split) of common stock of Sealed Air Corporation (“SealedAir”) to be made directly by Cryovac, Inc., a wholly owned subsidiary of SealedAir (“Cryovac”), to the asbestos trust pursuant to the terms of a settlementagreement resolving asbestos-related, successor liability and fraudulenttransfer claims against Sealed Air and Cryovac and (2) Grace common stock. Thenumber of shares of Grace common stock required to satisfy these claims willdepend on the price of Grace common stock on the effective date of the Plan,liability measures approved by the Bankruptcy Court, and the value of theSealed Air settlement, which changes daily with the accrual of interest and thetrading value of Sealed Air common stock. The Sealed Air settlement agreementhas been approved by the Bankruptcy Court, but remains subject to thefulfillment of specified conditions.

The PI-AO Claimswould be funded with warrants exercisable for that number of shares of Gracecommon stock which, when added to the shares issued directly to the trust onthe effective date of the Plan, would represent 50.1% of Grace’s votingsecurities. If the common stock issuable upon exercise of the warrants isinsufficient to pay all PI-AO Claims (the liability for which is uncapped underthe Plan), then Grace would pay any additional liabilities in cash.

Under the Plan,the amounts to fund PI-SE Claims, PD Claims and the expense of trustadministration would be capped at the amount determined by the BankruptcyCourt. Amounts required to fund PI-AO Claims would not be capped, so if theamount funded in respect thereof later proved to be inadequate, Grace would beresponsible for contributing additional funds into the asbestos trust tosatisfy PI-AO Claims.  Because of thenumber and nature of the uncertainties involved, Grace is unable to determinethe extent to which, if any, the liability under the Plan for PI-AO claims mayexceed the amount funded into the trust in respect thereof.

Other Claims

The Plan provides that all allowed administrative or priority claimswould be paid 100% in cash and all general unsecured claims, other than thosecovered by the asbestos trust, would be paid 85% in cash and 15% in Gracecommon stock. Grace estimates that claims with a recorded value ofapproximately $1,257 million, including interest accrued through March 31,2007, would be satisfied in this manner at the effective date of the Plan.Grace would finance these payments with cash on hand, cash from FreseniusMedical Care Holdings, Inc. (“Fresenius”) paid in settlement of asbestos andother Grace-related claims, new Grace debt, and Grace common stock.  Grace would satisfy other non-asbestosrelated liabilities and claims (primarily certain environmental, tax, pensionand retirement medical obligations) as they become due and payable over time usingcash flow from operations, insurance proceeds from policies and settlementagreements covering asbestos-related liabilities, and new credit facilities. Proceeds from available product liabilityinsurance applicable to asbestos-related claims would supplement operating cashflow to service new debt and liabilities not paid on the effective date of thePlan.

Effect on GraceCommon Stock

The Plan providesthat Grace common stock will remain outstanding at the effective date of thePlan, but that the interests of existing shareholders would be subject todilution by additional shares of common stock issued under the Plan. Inaddition, in order to preserve significant tax benefits from net operating losscarryforwards (“NOLs”) and certain 

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future deductions,which are subject to elimination or limitation in the event of a change incontrol (as defined by the Internal Revenue Code) of Grace, the Plan placesrestrictions on the purchase of Grace common stock. The restrictions wouldprohibit (without the consent of Grace), for a period of three years after theeffective date of the Plan, a person or entity from acquiring more than 4.75%of the outstanding Grace common stock or, for those persons already holdingmore than 4.75%, prohibit them from increasing or decreasing their holdings.The Bankruptcy Court has approved the trading restrictions described above,excluding the restriction on sales, until the effective date of the Plan.

Grace intends toaddress all pending and future asbestos-related claims and all otherpre-petition claims as outlined in the Plan. However, the Plan may not beultimately approved by the Bankruptcy Court and other interested parties. Forexample, the asbestos creditors committees and representative of futureasbestos claimants have challenged the confirmability of the Plan, arguing thatthe Plan impairs the rights of asbestos creditors and impermissibly denies themvoting rights, and have asserted that Grace’s asbestos-related liabilitiesexceed the fair value of Grace’s assets. As a result of these challenges and other Bankruptcy Court rulings, amaterially different plan of reorganization may ultimately be approved and,under the ultimate plan of reorganization, the interests of the Company’sshareholders could be substantially diluted or cancelled. The value of Gracecommon stock following a plan of reorganization, and the extent of any recoveryby non-asbestos-related creditors, will depend principally on the amount of Grace’sasbestos-related liability under a confirmed plan of reorganization.

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

Approximately14,900 proofs 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 filedafter the bar date.

Approximately7,000 of the non-asbestos related claims involve claims by employees or formeremployees for future retirement benefits such as pension and retiree medicalcoverage. Grace views most of these claims as contingent and has proposed aplan of reorganization that would retain such benefits. These claims includeclaims for payment of goods and services, taxes, product warranties, principaland interest under pre-petition credit facilities, amounts due under leases andother contracts, leases and other executory contracts rejected in theBankruptcy Court, environmental remediation, pending non-asbestos-relatedlitigation, and non-asbestos-related personal injury.  Claims for indemnification or contribution toactual or potential codefendants in asbestos-related and other litigation werealso filed.

The Debtors haveanalyzed the claims filed pursuant to the March 31, 2003 bar date and havefound that many are duplicates, represent the same claim filed against morethan one of the Debtors, lack any supporting documentation, or provide insufficientsupporting documentation. As of March 31, 2007, of the approximately 4,000 asbestosproperty damage claims filed, approximately 3,375 claims have been expunged orwithdrawn by claimants, leaving approximately 625 claims to be addressedthrough the property damage case management order approved by the BankruptcyCourt.  As of March 31, 2007, of theapproximately 3,250 non-asbestos claims filed, approximately 1,450 claims havebeen expunged or withdrawn by claimants, approximately 1,100 claims have beenresolved, and an additional approximately 700 claims are to be addressedthrough the claims objection process and the dispute resolution proceduresapproved by the Bankruptcy Court.

Grace believesthat its recorded 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 

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conditionsprecedent under the Plan, as described in “Accounting Impact” below. Grace willadjust its recorded asbestos-related liability, as necessary, to reflectrulings by the Bankruptcy Court.  Any such adjustments could be material to itsconsolidated financial position and results of operations.

***Litigation Proceedings in Bankruptcy Court*****– In September 2000, Grace was named in apurported 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 Official Committee of Asbestos PersonalInjury Claimants and the Official Committee of Asbestos Property DamageClaimants to proceed with claims against Fresenius and Sealed Air and Cryovacon 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 such Committees to settle asbestos,successor liability and fraudulent transfer claims related to such transactions(the “litigation settlement agreements”). Under the terms of the Freseniussettlement, subject to the fulfillment of certain conditions, Fresenius wouldpay $115.0 million to the Debtors’ estate as directed by the Bankruptcy Courtupon confirmation of the Debtors’ plan of reorganization. In July 2003, theFresenius settlement was approved by the Bankruptcy Court. Under the terms ofthe Sealed Air settlement, subject to the fulfillment of certain conditions,Cryovac would make a payment of $512.5 million (plus interest at 5.5%compounded annually, commencing on December 21, 2002) and nine million shares(now 18 million shares to reflect a recent two-for-one stock split) of SealedAir common stock (collectively valued at $1,213.2 million as of March 31,2007), as directed by the Bankruptcy Court upon confirmation of the Debtors’plan of reorganization. In June 2005, the Sealed Air settlement was approved bythe Bankruptcy Court.

***Debt Capital*** – All of the Debtors’pre-petition debt is in default due to the Filing. The accompanyingConsolidated Balance Sheets reflect the classification of the Debtors’pre-petition debt within “liabilities subject to compromise.”

The Debtors haveentered into a debtor-in-possession post-petition loan and security agreementwith Bank of America, N.A. (the “DIP facility”) in the aggregate amount of $250million.  The term of the DIP facilityexpires on April 1, 2008.

***Accounting Impact*** – The accompanyingConsolidated Financial Statements have been prepared in accordance withStatement of Position 90-7 (“SOP 90-7”), “Financial Reporting by Entities inReorganization Under the Bankruptcy Code,” promulgated by the AmericanInstitute of Certified Public Accountants. SOP 90-7 requires that financialstatements of debtors-in-possession be prepared on a going concern basis, whichcontemplates continuity of operations, realization of assets and liquidation ofliabilities in the ordinary course of business. However, as a result of the Filing, the realization of certain of theDebtors’ assets and the liquidation of certain of the Debtors’ liabilities aresubject to significant uncertainty. While operating as debtors-in-possession,the Debtors may sell or otherwise dispose of assets and liquidate or settleliabilities for amounts other than those reflected in the ConsolidatedFinancial Statements. Further, the ultimate plan of reorganization couldmaterially change the amounts and classifications reported in the ConsolidatedFinancial Statements.

Pursuant to SOP90-7, Grace’s pre-petition and future liabilities that are subject tocompromise are required to be reported separately on the balance sheet at anestimate of the amount that will ultimately be allowed by the Bankruptcy Court.As of March 31, 2007, such pre-petition liabilities include fixed obligations(such as debt and contractual commitments), as well as estimates of costsrelated to contingent liabilities (such as asbestos-related litigation,environmental remediation, and other claims). Obligations of Grace subsidiariesnot covered by the Filing continue to be classified on the Consolidated BalanceSheets based upon maturity dates or the expected dates of payment. SOP 90-7 also requiresseparate reporting of certain expenses, realized gains and losses, andprovisions for losses 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 notrecorded the benefit of any assets that may be available to fundasbestos-related and other liabilities under the litigation settlements with 

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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, 2007, was $1,328.2 million comprised of $115.0 million incash from Fresenius and $1,213.2 million in cash and stock from Cryovac.Payments under the Sealed Air settlement will be made directly to the asbestostrust by Cryovac, and will be accounted for as a satisfaction of a portion ofGrace’s recorded asbestos-related liability and a credit to shareholders’equity.

Grace’sConsolidated Balance Sheets separately identify the liabilities that are “subjectto compromise” 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.

Components of liabilitiessubject to compromise are as follows:
| **(In millions)**                       | ** ** | **March 31,  2007** | ** **  | **December 31,  2006** | ** ** |
|----------------------------------------------|------------|--------------------------|-------------|-----------------------------|------------|
|                                         | ** ** | ** **               |        |                        |       |
| Debt,  pre-petition plus accrued interest    | ** ** | **$**                    | **755.5**   |                        | $          | 739.5 |   |
| Asbestos-related  liability                  | ** ** | **1,700.0**              |        | 1,700.0                     |       |
| Income taxes(1)                              | ** ** | **101.7**                |        | 141.2                       |       |
| Environmental  remediation                   | ** ** | **358.3**                |        | 361.1                       |       |
| Postretirement  benefits other than pension  | ** ** | **73.8**                 |        | 72.7                        |       |
| Unfunded special  pension arrangements       | ** ** | **96.0**                 |        | 95.6                        |       |
| Retained  obligations of divested businesses | ** ** | **31.9**                 |        | 18.0                        |       |
| Accounts payable                             | ** ** | **31.7**                 |        | 31.7                        |       |
| Other accrued  liabilities                   | ** ** | **75.6**                 |        | 71.2                        |       |
| Reclassification  to current liabilities(2)  | ** ** | **(9.4**                 | **)**       | (9.4                        | )          |
| **Total Liabilities Subject to  Compromise** | ** ** | **$**                    | **3,215.1** |                        | $          | 3,221.6 |   |

 

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*(1)**       Amounts as of March 31, 2007 and December31, 2006 are net of expected refunds of $56.9 million and $15.0 million,respectively.*

*(2)**       As of March 31, 2007 and December 31, 2006, approximately $9.4 millionof certain pension and postretirement benefit obligations subject to compromisehave been presented in other current liabilities in the Consolidated BalanceSheet in accordance with SFAS No. 158.*

Note that theunfunded special pension arrangements reflected above exclude non-U.S. pension plansand qualified U.S. pension plans that became underfunded subsequent to theFiling. Contributions to qualified U.S. pension plans are subject to BankruptcyCourt approval.

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

Set forth below isa reconciliation of the changes in pre-filing date liability balances for theperiod from the Filing Date through March 31, 2007.
| **(In millions)**                                                                              | ** ** | **Cumulative  Since  Filing** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| 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 |       | (332.9                        | )          |
| Expense/(income)  items:                                                                            |       |                          |       |
| Interest on pre-petition liabilities                                                                |       | 294.0                         |       |
| Employee-related accruals                                                                           |       | 36.9                          |       |
| Provision for asbestos-related contingencies                                                        |       | 744.8                         |       |
| Provision for estimate of environmental  contingencies                                              |       | 295.6                         |       |
| Provision for income tax contingencies                                                              |       | (9.4                          | )          |
| Balance sheet  reclassifications                                                                    |       | (35.1                         | )          |
| Balance, end of period                                                                              |       | $                             | 3,215.1    |   |

 

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 ofpre-petition bank credit facilities, beginning January 1, 2006, Grace agreed topay interest on pre-petition bank debt at the prime rate, adjusted for periodicchanges, and compounded quarterly. The effective rates for the quarters endedMarch 31, 2007 and 2006 were 8.25% and 7.43%, respectively.  From the Filing Date through December 31,2005, Grace accrued interest on pre-petition bank debt at a negotiated fixedannual rate of 6.09%, compounded quarterly.

For the holders ofclaims who, but for the Chapter 11 filing, would be entitled under a contractor otherwise to accrue or be paid interest on such claim in a non-default (ornon-overdue payment) situation under applicable non-bankruptcy law, Graceaccrues interest at 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 otherholders of allowed general unsecured claims, Grace accrues interest at a rateof 4.19% per annum, compounded annually.

***Chapter 11 Expenses***
| ** **                         | ** ** | **Three Months  Ended  March 31,** | ** ** |
|------------------------------------|------------|----------------------------------------------|------------|
| **(In millions)**             | ** ** | **2007**                                     | ** ** | **2006** | ** ** |
| Legal and  financial advisory fees | ** ** | **$**                                        | **20.1**   |   | $ | 10.8 |   |
| Interest income                    | ** ** | **(2.3**                                     | **)**      | (2.1 | ) |
| Chapter 11 expenses,  net          | ** ** | **$**                                        | **17.8**   |   | $ | 8.7 |   |

 

Pursuant to SOP90-7, interest income earned on the Debtors’ cash balances must be offsetagainst Chapter 11 expenses.

***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,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(In millions)**                                                                                          | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Net sales,  including intercompany                                                                              | ** ** | **$**                                            | **354.5**  |   | $ | 353.8 |   |
| Cost of goods  sold, including intercompany, exclusive of depreciation and amortization  shown separately below | ** ** | **259.2**                                        |       | 274.1 |   |
| Selling, general  and administrative expenses, exclusive of net pension expense shown  separately below         | ** ** | **73.0**                                         |       | 81.4 |   |
| Research and  development expenses                                                                              | ** ** | **11.1**                                         |       | 9.9 |   |
| Depreciation and  amortization                                                                                  | ** ** | **13.6**                                         |       | 14.5 |   |
| Net pension  expense                                                                                            | ** ** | **9.1**                                          |       | 10.7 |   |
| Interest expense  and related financing costs                                                                   | ** ** | **19.3**                                         |       | 15.7 |   |
| Other (income)  expense, net                                                                                    | ** ** | **(12.0**                                        | **)**      | (8.9 | ) |
| Chapter 11  expenses, net of interest income                                                                    | ** ** | **17.7**                                         |       | 8.7 |   |
|                                                                                                            | ** ** | **391.0**                                        |       | 406.1 |   |
| Income (loss)  before income taxes and equity in net income of non-filing entities                              | ** ** | **(36.5**                                        | **)**      | (52.3 | ) |
| Benefit from  (provision for) income taxes                                                                      | ** ** | **3.4**                                          |       | 11.1 |   |
| Income (loss)  before equity in net income of non-filing entities                                               | ** ** | **(33.1**                                        | **)**      | (41.2 | ) |
| Equity in net  income of non-filing entities                                                                    | ** ** | **37.9**                                         |       | 41.3 |   |
| **N****et income (loss)**                                                                                       | ** ** | **$**                                            | **4.8**    |   | $ | 0.1 |   |

 

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**W. R. Grace & Co. – Chapter 11 Filing EntitiesDebtor-in-Possession Condensed Statements of Cash Flows**

 
| ** **                                                                                     | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(In millions)**                                                                         | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| **Operating Activities**                                                                       |       |                                             |       |   |   |
| Net income (loss)                                                                              | ** ** | **$**                                            | **4.8**    |   | $ | 0.1 |   |
| Reconciliation to net  cash provided by (used for) operating activities:                       | ** ** | ** **                                       |       |   |   |
| Chapter 11  expenses, net of interest income                                                   | ** ** | **17.7**                                         |       | 8.7 |   |
| (Benefit from)  provision for income taxes                                                     | ** ** | **(3.4**                                         | **)**      | (11.1 | ) |
| Equity in net  income of non-filing entities                                                   | ** ** | **(37.9**                                        | **)**      | (41.3 | ) |
| Other non-cash  items, net                                                                     | ** ** | **30.5**                                         |       | 28.5 |   |
| Contributions to  defined benefit pension plans                                                | ** ** | **(17.5**                                        | **)**      | (10.0 | ) |
| Cash paid to  resolve contingencies subject to Chapter 11                                      | ** ** | **(10.3**                                        | **)**      | — |   |
| Chapter 11  expenses paid                                                                      | ** ** | **(18.2**                                        | **)**      | (12.4 | ) |
| Changes in other  assets and liabilities, excluding the effect of businesses acquired/divested | ** ** | **(58.9**                                        | **)**      | (59.5 | ) |
| **Net cash provided by (used for)  operating activities**                                      | ** ** | **(93.2**                                        | **)**      | (97.0 | ) |
|                                                                                           | ** ** | ** **                                       |       |   |   |
| **Investing Activities**                                                                       | ** ** | ** **                                       |       |   |   |
| Capital expenditures                                                                           | ** ** | **(15.9**                                        | **)**      | (19.1 | ) |
| Loan repayments and  other                                                                     | ** ** | **59.2**                                         |       | 17.7 |   |
| **Net cash provided by (used for)  investing activities**                                      | ** ** | **43.3**                                         |       | (1.4 | ) |
|                                                                                           | ** ** | ** **                                       |       |   |   |
| **Net cash provided by (used for)  financing activities**                                      | ** ** | **13.5**                                         |       | 1.5 |   |
|                                                                                           | ** ** | ** **                                       |       |   |   |
| **Net increase (decrease) in cash  and cash equivalents**                                      | ** ** | **(36.4**                                        | **)**      | (96.9 | ) |
| Cash and cash  equivalents, beginning of period                                                | ** ** | **233.8**                                        |       | 269.2 |   |
| Cash and cash equivalents, end of period                                                       | ** ** | **$**                                            | **197.4**  |   | $ | 172.3 |   |

 

**W. R. Grace & Co. – Chapter 11 Filing EntitiesDebtor-in-Possession Balance Sheets**
| **(In millions)**                                         | ** ** | **March 31,  2007** | ** **  | **December 31,  2006** | ** ** |
|----------------------------------------------------------------|------------|--------------------------|-------------|-----------------------------|------------|
| **ASSETS**                                                     | ** ** | ** **               | ** **  | ** **                  | ** ** |
| **Current Assets**                                             | ** ** | ** **               | ** **  | ** **                  | ** ** |
| ** **                                                     | ** ** | ** **               | ** **  | ** **                  | ** ** |
| Cash and cash  equivalents                                     | ** ** | **$**                    | **197.4**   |                        | $          | 233.8 |   |
| Trade accounts  receivable, net                                | ** ** | **121.9**                |        | 117.9                       |       |
| Receivables from  non-filing entities, net                     | ** ** | **73.9**                 |        | 53.2                        |       |
| Inventories                                                    | ** ** | **88.5**                 |        | 72.9                        |       |
| Other current assets                                           | ** ** | **52.3**                 |        | 60.9                        |       |
| **Total Current Assets**                                       | ** ** | **534.0**                |        | 538.7                       |       |
|                                                           |       |                     |        |                        |       |
| Properties and  equipment, net                                 | ** ** | **395.1**                |        | 394.5                       |       |
| Cash value of life  insurance policies, net of policy loans    | ** ** | **91.0**                 |        | 89.2                        |       |
| Deferred income taxes                                          | ** ** | **682.2**                |        | 687.1                       |       |
| Asbestos-related  insurance                                    | ** ** | **500.0**                |        | 500.0                       |       |
| Loans receivable from  non-filing entities, net                | ** ** | **213.7**                |        | 237.7                       |       |
| Investment in  non-filing entities                             | ** ** | **648.1**                |        | 660.3                       |       |
| Other assets                                                   | ** ** | **92.5**                 |        | 90.8                        |       |
| **Total Assets**                                               | ** ** | **$**                    | **3,156.6** |                        | $          | 3,198.3 |   |
| ** **                                                     | ** ** | ** **               | ** **  | ** **                  | ** ** |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY (DEFICIT)**       | ** ** | ** **               | ** **  | ** **                  | ** ** |
| **Liabilities Not Subject to  Compromise**                     | ** ** | ** **               | ** **  | ** **                  | ** ** |
| Current liabilities                                            | ** ** | **$**                    | **178.8**   |                        | $          | 212.0 |   |
| Minority interest in  consolidated entities                    | ** ** | **48.8**                 |        | 58.4                        |       |
| Other liabilities                                              | ** ** | **236.1**                |        | 256.1                       |       |
| **Total Liabilities Not Subject  to Compromise**               | ** ** | **463.7**                |        | 526.5                       |       |
|                                                           |       |                     |        |                        |       |
| **Liabilities Subject to  Compromise**                         | ** ** | **3,215.1**              |        | 3,221.6                     |       |
| **Total Liabilities**                                          | ** ** | **3,678.8**              |        | 3,748.1                     |       |
| ** **                                                     | ** ** | ** **               | ** **  | ** **                  | ** ** |
| **Shareholders’ Equity (Deficit)**                        | ** ** | **(522.2**               | **)**       | (549.8                      | )          |
| ** **                                                     | ** ** | ** **               | ** **  |                        |       |
| **Total Liabilities and Shareholders’ Equity  (Deficit)** | ** ** | **$**                    | **3,156.6** |                        | $          | 3,198.3 |   |

 

In addition toGrace’s financial reporting obligations as prescribed by the U.S. Securitiesand Exchange Commission (“SEC”), the Debtors are also required, under the rulesand regulations of the Bankruptcy Code, to periodically file certain statementsand schedules 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 the 

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financial positionor results of operations of Grace on a consolidated basis, and should not berelied on for such purposes.

**3.****              Asbestos-RelatedLitigation**

Grace is adefendant in property damage and personal injury lawsuits relating topreviously sold asbestos-containing products. As of the Filing Date, Grace wasa defendant in 65,656 asbestos-related lawsuits, 17 involving claims forproperty damage (one of which has since been dismissed), and the remainderinvolving 129,191 claims for personal injury. Due to the Filing, holders ofasbestos-related claims are stayed from continuing to prosecute pendinglitigation and from commencing new lawsuits against the Debtors. Separatecreditors’ committees representing the interests of property damage and personalinjury claimants, and a legal representative of future personal injuryclaimants, have been appointed in the Chapter 11 Cases. Grace’s obligationswith respect to present and future claims will be determined through theChapter 11 process.

***Property Damage Litigation***–******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 380asbestos property damage cases (which involved thousands of buildings) filedprior to the Filing Date, 140 were dismissed without payment of any damages orsettlement amounts; judgments after trial were entered in favor of Grace innine cases (excluding cases settled following appeals of judgments in favor ofGrace); judgments after trial were entered in favor of the plaintiffs in eightcases (one of which is on appeal) for a total of $86.1 million; 207 propertydamage cases were settled for a total of $696.8 million; and 16 cases remainoutstanding (including the one on appeal). Of the 16 remaining cases, eightrelate to ZAI and eight relate to a number of former asbestos-containingproducts (two of which also are alleged to involve ZAI).

Approximately4,300 additional property damage claims were filed prior to the March 31, 2003claims bar date established by the Bankruptcy Court. (The bar date did not applyto ZAI claims.) Such claims were reviewed in detail by Grace, categorized intoclaims with sufficient information to be evaluated or claims that requireadditional information and, where sufficient information existed, the estimatedcost of resolution was considered as part of Grace’s recorded asbestos-relatedliability. (Approximately 200 claims did not contain sufficient information topermit an evaluation.) Grace has objected to virtually all property damageclaims on a number of different bases, including: no authorization to file aclaim; the claim was previously settled or adjudicated; no or insufficientdocumentation; failure to identify a Grace product; the expiration of theapplicable statute of limitations and/or statute of repose, and/or laches; anda defense that the product in place is not hazardous. As of April 30, 2007,following the reclassification, withdrawal or expungement of claims,approximately 519 property damage claims remain outstanding.

Eight of the ZAIcases were filed as purported class action lawsuits in 2000 and 2001. Inaddition, ten lawsuits were filed as purported class actions in 2004 and 2005with respect to persons and homes in Canada. These cases seek damages andequitable relief, including the removal, replacement and/or disposal of allsuch insulation. The plaintiffs assert that this product is in millions ofhomes and that the cost of removal could be several thousand dollars per home.As a result of the Filing, the eight U.S. cases have been stayed.

Based on Grace’s investigationof the claims described in these lawsuits, and testing and analysis of thisproduct by Grace and others, Grace believes that the product was and continuesto be safe for its intended purpose and poses little or no threat to humanhealth. The plaintiffs in the ZAI lawsuits (and the U.S. government in theMontana criminal proceeding described in Note 12) dispute Grace’s position onthe safety of ZAI. On October 18, 2004, the Bankruptcy Court held a hearing onmotions filed by the parties to address a number of important legal and factualissues regarding the ZAI claims.  OnDecember 14, 2006,the Bankruptcy Court issued an opinion and order holding that, although ZAI iscontaminated with asbestos and can release asbestos fibers when disturbed, thereis no unreasonable risk of harm from ZAI. The ZAI claimants intend to appeal such opinion and order.  The Bankruptcy Court has scheduled a conference 

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in May 2007 to consider whether any of theclaimant’s theories of liability still need to be addressed and what claims, ifany, may still remain.  Grace’s recordedasbestos-related liability at March 31, 2007 assumes the risk of lossfrom ZAI litigation is not probable.  IfGrace’s view as to risk of loss is not sustained, management believes the costto resolve the matter would be material.

***Personal Injury Litigation***–****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.

Cumulativelythrough the Filing Date, 16,354 asbestos personal injury lawsuits involvingapproximately 35,720 claims were dismissed without payment of any damages orsettlement amounts (primarily on the basis that Grace products were notinvolved) and approximately 55,489 lawsuits involving approximately 163,698claims were disposed of (through settlements and judgments) for a total of$645.6 million.  As of the Filing Date,129,191 claims for personal injury were pending against Grace. Grace believesthat a substantial number of additional personal injury claims would have beenreceived between the Filing Date and March 31, 2007 had such claims not beenstayed by the Bankruptcy Court.

***Asbestos-Related Liability***–****The total recordedasbestos-related liability as of March 31, 2007 and December 31, 2006 was$1,700.0 million and is included in “liabilities subject to compromise” in theaccompanying Consolidated Balance Sheets. Grace adjusted its asbestos-related liability in the fourth quarter of2004 based on its proposed plan of reorganization as discussed in Note 2. Theamount recorded at March 31, 2007 and December 31, 2006 includes the $1,613million maximum amount reflected as a condition precedent to the Plan and $87million related to pre-Chapter 11 contractual settlements and judgmentsincluded in general unsecured claims.

Under the Plan,Grace is requesting that the Bankruptcy Court determine the aggregate dollaramount, on a net present value basis, that must be funded on the effective dateof the Plan into an asbestos trust (established under Section 524(g) of theBankruptcy Code) to pay all asbestos-related personal injury and propertydamage claims (including ZAI) entitled to payment under the Plan and relatedtrust administration costs and expenses on the later of the effective date ofthe Plan or when allowed (the “Funding Amount”). It is a condition toconfirmation of the Plan that the Bankruptcy Court shall conclude that theFunding Amount is not greater than $1,613 million. This amount, which should besufficient to fund over $2 billion in pending and future claims, was based inpart on Grace’s 2004 evaluation of (1) existing but unresolved personal injuryand property damage claims, (2) actuarially-based estimates of future personalinjury claims, (3) the risk of loss from ZAI litigation, (4) proposed claimpayments reflected in the Plan, and (5) the cost of the trust administrationand litigation.  Based upon these andother factors, Grace was prepared to settle its asbestos-related claims at thisamount as part of a consensual plan of reorganization.  As part of the estimation and litigationprocess, the amounts proposed to or adopted by the Bankruptcy Court may bematerially different than this amount.

The BankruptcyCourt has entered separate case management orders for estimating liability forpending and future personal injury claims and adjudicating pending propertydamage claims, excluding ZAI claims. Trial dates for estimating liability for personal injury claims arecurrently scheduled to begin in the fall of 2007.  Hearings for the adjudication of variousissues regarding property damage claims are scheduled for the second quarter of2007.   The Debtors expect that theestimated liability will provide the basis for determining the Funding Amountto be paid into the trust on the effective date of the Plan.

For personalinjury claims, the Bankruptcy Court has ordered that all claimants with claimspending as of the Filing Date (other than settled but unpaid claims) mustcomplete detailed questionnaires providing information on, among other things,their medical 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 

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supplementalquestionnaires to be completed on or before January 12, 2007.

The Bankruptcy Court hasalso established proceduresand deadlines forfiling proofs of claims for asbestos personal injury claims pending as of theFiling Date.  Claimants asserting claims subject to enforceable writtensettlement agreements dated prior to the Filing Date, which have not been fullypaid or satisfied,were required to file proofs of claim by October 16, 2006.  Claimants asserting claims that arenot subject to such settlement agreements were required to file proofs of claim by November 15, 2006.

Grace iscataloguing, analyzing and reconciling the information furnished with theproofs of claim and questionnaires. Grace expects that the estimation process for personal injury claimswill include the compilation of data from the questionnaires, review andanalysis of such data by experts, the preparation of expert reports, includingestimates of the number of personal injury claims expected to be filed in thefuture, and depositions of witnesses and other pretrial discovery proceedings.Grace expects the process to conclude with the estimation hearing that iscurrently scheduled to begin in the fall of 2007.  Grace expects to adjust its recordedasbestos-related liability as necessary to reflect rulings made by theBankruptcy Court following the estimation trial after consideration of allevidence presented by Grace, the official committees and the representative offuture asbestos claimants; such adjustments may be material.

For propertydamage claims, the case management order provides that estimation will bepreceded by litigation on certain common threshold issues affecting asubstantial majority of claims. Such litigation will consist of determining,among other things, (1) whether asbestos-containing products formerlymanufactured by Grace are hazardous in place, and (2) compliance with theapplicable statute of limitations.  Gracewill also ask****the Bankruptcy Courtto rule on Grace’s specific objections to individual claims and groups ofclaims.

The Funding Amountwill primarily be a function of the number of property damage and personalinjury claims entitled to be paid under the Plan, and the amount payable perclaim. Through the estimation process, Grace will seek to demonstrate that mostclaims 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 agrees 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 ishighly uncertain and will depend on a number of Bankruptcy Court rulingsfavorable to Grace’s position.

Conversely, theasbestos claimants committees and the representative of future asbestosclaimants continue to assert that Grace’s asbestos-related liabilities aresubstantially higher than $1,613 million, and in fact are in excess of Grace’sbusiness value.  If the Court accepts theposition of the asbestos claimants committees, then any plan of reorganizationlikely would result in the loss of all or substantially all equity value bycurrent shareholders. Therefore, due to the significant uncertainties of thisprocess and asbestos litigation generally, Grace is not able to estimate aprobable Funding Amount that would be accepted by the Bankruptcy Court.

However, as Graceis willing to proceed with confirmation of the Plan with a Funding Amount of upto $1,613 million (assuming that other conditions precedent to confirmation ofthe Plan are satisfied, including the availability of the payment from Cryovacdirectly to the asbestos trust under the settlement agreement described in Note2), Grace’s recorded asbestos-related liability reflects the maximum amountallowed as a condition precedent under the Plan. This amount, plus $87.0million for pre-Chapter 11 contractual settlements and judgments, brings thetotal recorded asbestos-related liability as of March 31, 2007 and December 31,2006 to $1,700 million. Any differences between the Plan as filed and asapproved for confirmation could fundamentally change the accounting measurementof Grace’s asbestos-related liability and that change could be material.

***Insurance Rights*** –****Grace previously purchased insurancepolicies that provided coverage for years 1962 to 1985 with respect toasbestos-related lawsuits and claims. For the most part, coverage for years1962 through 1972 has been exhausted, leaving coverage for years 1973 through1985 available for pending and future asbestos claims.  Since 1985, insurance coverage forasbestos-related liabilities has not been commercially available to Grace.

With one exception, coverage disputes regarding Grace’s primaryinsurance policies have been 

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settled, and the settlement amounts paid in full. Grace’s excesscoverage is for loss above certain levels. The levels vary from policy to policy, creating “layers” of excesscoverage, some of which are triggered before others.

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 for settled insurers available underthese settlement agreements is approximately $487 million.  With respect to asbestos-related personalinjury claims, the settlement agreements generally require that the claims bespread over the claimant’s exposure period and that each insurer pay a pro rataportion of each claim based on the amount of coverage provided during each yearof the total exposure period.

Presently, Grace has no agreements in place with insurers withrespect to approximately $430 million of excess coverage, which is atlayers of coverage that have not yet been triggered, but certain layers wouldbe triggered if the Plan were approved at the recorded asbestos-relatedliability of $1,700 million. Grace believes that any allowed ZAI claims alsowould be covered under the settlement agreements and unsettled policiesdiscussed above to the extent they relate to installations of ZAI occurringafter July 1, 1973.

In addition, Grace has approximately $253 million of excesscoverage with insolvent or non-paying insurance carriers. Non-paying carriersare those that, although technically solvent, are not currently meeting theirobligations to pay claims. Grace has filed and continues to file claims in theinsolvency proceedings of insolvent carriers. Grace is currently receivingdistributions from some of these insolvent carriers and expects to receivedistributions in the future. Settlement amounts are recorded as income whenreceived.

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 $90.0million 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, 2007approximated $91.4 million, including interest earned on the account. Fundswill be distributed from this account directly to claimants at the direction ofthe escrow agent pursuant to the terms of a confirmed plan of reorganization oras otherwise ordered by the Bankruptcy Court. Grace will record the amount in the escrow account as an asset andreduce its asbestos insurance receivable balance when all contingencies for therelease of such amount are satisfied.

As of March 31, 2007, including the settlement discussed above andafter subtracting previous reimbursements by insurers and allowing fordiscounts pursuant to certain settlement agreements, there remainsapproximately $917 million of excess coverage from 55 presently solventinsurers. Grace estimates that, assuming the resolution value ofasbestos-related claims equal to the recorded liability of $1,700 million(which should fund claim payments in excess of $2 billion), it should beentitled to approximately $500 million of insurance recovery.  This amount was determined by estimating theaggregate and per year payout for claims over time and applying the expectedinsurance recovery factor to such claims. However, the ultimate amount ofinsurance recovered on such claims will depend on a number of factors that canonly be determined at the time claims are paid including: the nature of theclaim (PI, PD or ZAI), the relevant exposure years, the timing of payment, thesolvency of insurers and the legal status of policy rights. Accordingly, Grace’srecorded estimate of insurance recovery may differ materially from actualamounts received.

# **4.****              IncomeTaxes**

As disclosed inNote 1, Grace adopted FIN 48 as of January 1, 2007. Under FIN 48, Grace mayrecognize the tax benefit from an uncertain tax position only if it is morelikely than not that the tax position will be sustained upon examination by thetaxing authorities, based on the technical merits of the position. The taxbenefits recognized in the financial statements from such a position should bemeasured based on the largest benefit that has a greater than fifty percentlikelihood of being realized upon ultimate settlement.

The effect of theimplementation of FIN 48 was to reduce Grace’s accumulated deficit as ofJanuary 1, 2007 by $2.2 million. This amount primarily reflected recognition ofU.S. federal tax benefits relating to certain expenses incurred in defense ofcreditor claims and various alternative minimum tax benefits arising from prioryear audits, offset by certain increases to reserves on foreign income andundistributed foreign earnings.  Theamount of unrecognized tax benefits at January 1, 2007 was 

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$200.2 million. Ifthis amount were recognized it would affect Grace’s effective tax rate.  However, to the extent that such recognitioninvolves an increase in U.S. net operating losses, an additional tax chargecould be required on undistributed foreign earnings. The $200.2 million ofunrecognized tax benefits includes $45.0 million related to the deductionof certain capital losses in Grace’s 1999 U.S. tax return, as further describedbelow, the benefit of which has not been recorded by Grace for financialreporting purposes.

Grace accruespotential interest and any associated penalties related to uncertain taxpositions in “benefit from (provision for) income taxes” in the ConsolidatedStatements of Operations. The total amount of interest and penalties (on agross basis) accrued on uncertain tax positions as of January 1, 2007 was $59.1million. During the three months ended March 31, 2007, Grace accrued additionalgross interest and penalties of $2.7 million.

Grace files U.S.federal income tax returns as well as income tax returns in various states andforeign jurisdictions. In many cases, Grace’s uncertain tax positions arerelated to tax years that remain subject to examination by the relevant taxingauthorities. The following table summarizes these open tax years by majorjurisdiction:
| **Tax  Jurisdiction**  | ** ** | **Examination in  Progress** | ** ** | **Examination Not  Yet Initiated** |
|------------------------|------------|------------------------------|------------|------------------------------------|
| United States  (1) (2) |       | 1993-2004                    |       | 2005-2006                          |
| Germany (1)            |       | 1998-2001                    |       | 2002-2006                          |
| United Kingdom         |       | None                         |       | 2005-2006                          |
| Singapore              |       | None                         |       | 2002-2006                          |
| France                 |       | None                         |       | 2004-2006                          |
| Italy                  |       | None                         |       | 2000-2006                          |

 

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

*(2)**       In the U.S., the IRS is currently examining tax years 2002-2004.  Tax years 1993-1996 and 1997-2001 have beenexamined and partially resolved and there are still pending issues in appeals orpending legal proceedings as described below.*

Basedupon the outcome of these examinations, or as a result of the expiration ofstatute of limitations for specific jurisdictions, it is reasonably possiblethat there may be a material change to Grace’s aggregate recorded liabilitiesfor uncertain tax positions in the next twelve months with respect to thefollowing matters:

1)**                                     **Withrespect to the 1993-1996 federal income tax audit there is one issueoutstanding related to $7.0 million of research and experimentation creditsthat the Internal Revenue Service (“IRS”) is challenging.  Grace is currently engaged in settlementdiscussions with the IRS regarding this matter.

2)**                                     **Withrespect to the IRS examination of the 1997-2001 tax years, Grace has receivedrevised examination reports from the IRS, which include the review of lossescarried back to 1988-1989 (collectively, the “Examination Reports”) asserting,in the aggregate, approximately $32.5 million of net additional tax plusaccrued interest.  The most significantissue addressed in the Examination Reports concerns the carryback of aspecified liability loss from the 1998 tax period to the 1989 taxable year.  On March 22, 2007, Grace received a Notice ofDeficiency with respect to the carryback of the specified liability loss andcertain other issues.  Grace expects tocommence tax court litigation to resolve the issues relating to the Notice ofDeficiency.  Another unresolved issuerelates to the 1999 recognition of a capital loss on the disposal of shares ofa company formed to assist Grace with its environmental remediation needs.  The amount at issue is $45 million and Graceis defending its position administratively through the IRS appeals process.

3)**                                     **Withrespect to losses arising in the years 1997-2002 eligible for carryback, Gracefiled refund claims for previous years totaling $51.6 million.  Grace’s right to receive these refunds is notdependent on the outcome of the R&E credits or the specified liability losscarryback issues described above.  Theserefund claims may effectively reduce the amount of interest exposure in Grace’srecorded liabilities.  However, Gracecannot currently estimate the ultimate impact of these specific items or othersthat may result from audit resolution or statute of limitations expiration.

Other Tax Matters

In January 2007, Grace settled with the IRS on thematter related to federal income tax withholding and Federal InsuranceContributions Act taxes for calendar years 1993 through 1998 of a Gracesubsidiary that formerly operated a temporary staffing business for health carepersonnel. Grace paid a $13.0 million settlement and received an 

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indemnification payment of approximately $2.7 millionfrom its former partner in the business.

As of March 31, 2007, Grace had $279.7 million in U.S.net operating loss (“NOL”) carryforwards. As reflected in Grace’s accrual related to future foreign earningsrepatriations, Grace anticipates the utilization of these NOLs to reduce thetax cost of future dividends from its non-U.S. affiliates.  Grace anticipates generating additional NOLsupon emergence from bankruptcy as contemplated in the Plan.  Because Grace did not pay a significantamount of U.S. taxes in prior years and/or has already received or applied fortax refunds from available NOL carryback years, it expects to carryforward mostof its NOLs after emergence from bankruptcy. Under federal income tax law, acorporation is generally permitted to carryforward NOLs for a 20-year periodfor deduction against future taxable income. Grace’s ability to deduct NOLcarryforwards could be significantly limited if it were to undergo an ownershipchange during or as a result of the Chapter 11 proceeding.  During the course of the bankruptcyproceeding, the Bankruptcy Court entered an order that places certainlimitations on trading in Grace common stock or options convertible into Gracecommon stock.  Pursuant to theselimitations, Grace intends to object to any purchase of Grace common stock oroptions that would potentially contribute to an ownership change.  However, Grace can provide no assurance thatthese limitations will prevent an ownership change or that its ability toutilize net operating loss carryforwards will not be significantly limited as aresult of Grace’s reorganization.

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

Components ofother (income) expense are as follows:

**Other (Income) Expense**
| ** **                                                       | ** ** | **Three Months  Ended  March 31,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------------|------------|
| **(In millions)**                                           | ** ** | **2007**                                     | ** ** | **2006** | ** ** |
| COLI income, net                                                 | ** ** | **$**                                        | **(2.0**   | **)** | $ | (1.2 | ) |
| Interest income                                                  | ** ** | **(2.1**                                     | **)**      | (1.4 | ) |
| Net (gain) loss  on sales of investments and disposals of assets | ** ** | **(0.2**                                     | **)**      | 1.8 |   |
| Currency  translation – intercompany loan                   | ** ** | **(2.8**                                     | **)**      | (3.0 | ) |
| Value of  currency contracts                                     | ** ** | **2.1**                                      |       | 2.8 |   |
| Other currency  transaction effects                              | ** ** | **0.4**                                      |       | 1.0 |   |
| Cash received on  previously written off receivable              | ** ** | **(0.9**                                     | **)**      | — |   |
| Other  miscellaneous income                                      | ** ** | **(2.5**                                     | **)**      | (1.9 | ) |
| Total other (income)  expense                                    | ** ** | **$**                                        | **(8.0**   | **)** | $ | (1.9 | ) |

 

# **6.****              OtherBalance Sheet Accounts**

| **(In millions)**                                                       | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **Inventories**                                                              | ** ** | ** **               |       |                        |       |
| Raw materials                                                                | ** ** | **$**                    | **75.6**   |                        | $          | 59.6 |   |
| In process                                                                   | ** ** | **39.2**                 |       | 41.4                        |       |
| Finished  products                                                           | ** ** | **212.2**                |       | 189.8                       |       |
| General  merchandise                                                         | ** ** | **33.6**                 |       | 35.6                        |       |
| Less: Adjustment  of certain inventories to a last-in/first-out (LIFO) basis | ** ** | **(53.8**                | **)**      | (41.8                       | )          |
|                                                                         | ** ** | **$**                    | **306.8**  |                        | $          | 284.6 |   |
| **Other  Assets**                                                            | ** ** | ** **               |       |                        |       |
| Deferred charges                                                             | ** ** | **$**                    | **40.1**   |                        | $          | 38.1 |   |
| Long-term  receivables, less allowances of $0.5 (2006 - $0.5)                | ** ** | **8.1**                  |       | 7.9                         |       |
| Patents,  licenses and other intangible assets, net                          | ** ** | **83.2**                 |       | 84.9                        |       |
| Investments in  unconsolidated affiliates and other                          | ** ** | **0.6**                  |       | 0.6                         |       |
|                                                                         | ** ** | **$**                    | **132.0**  |                        | $          | 131.5 |   |
| **Other  Current Liabilities**                                               | ** ** | ** **               |       |                        |       |
| Accrued  compensation                                                        | ** ** | **$**                    | **59.7**   |                        | $          | 90.4 |   |
| Deferred tax  liability                                                      | ** ** | **7.2**                  |       | 6.7                         |       |
| Customer volume  rebates                                                     | ** ** | **24.6**                 |       | 41.8                        |       |
| Accrued commissions                                                          | ** ** | **9.4**                  |       | 13.5                        |       |
| Accrued  reorganization fees                                                 | ** ** | **26.5**                 |       | 24.9                        |       |
| Income tax  payable                                                          | ** ** | **18.0**                 |       | 13.9                        |       |
| Other accrued  liabilities                                                   | ** ** | **86.1**                 |       | 81.4                        |       |
|                                                                         | ** ** | **$**                    | **231.5**  |                        | $          | 272.6 |   |
| **Other  Liabilities**                                                       | ** ** | ** **               |       |                        |       |
| Long-term self  insurance reserve                                            | ** ** | **$**                    | **8.0**    |                        | $          | 8.0 |   |
| Retained  obligations of divested businesses                                 | ** ** | **5.3**                  |       | 5.3                         |       |
| Long-term  incentive compensation                                            | ** ** | **5.6**                  |       | 12.2                        |       |
| Other accrued  liabilities                                                   | ** ** | **22.1**                 |       | 17.8                        |       |
|                                                                         | ** ** | **$**                    | **41.0**   |                        | $          | 43.3 |   |

 

Accruedcompensation in the table above includes salaries and wages as well asestimated current amounts due under the annual and long-term incentiveprograms.

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**7.****              Life Insurance**

Graceis the beneficiary of life insurance policies on certain current and formeremployees with a net cash surrender value of $91.0 million and $89.2 million atMarch 31, 2007 and December 31, 2006, respectively. The policies were acquiredto fund various employee benefit programs and other long-term liabilities andare structured to provide cash flow (primarily tax-free) over an extendednumber of years.

The followingtables summarize activity in these policies for the three months ended March31, 2007 and 2006, and the components of net cash value at March 31, 2007 andDecember 31, 2006:

**Life Insurance – Activity Summary**
| ** **                                            | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(In millions)**                                | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Earnings on policy  assets                            | ** ** | **$**                                            | **1.9**    |   | $ | 1.6 |   |
| Interest on  policy loans                             | ** ** | **0.1**                                          |       | (0.4 | ) |
| Policy loan  repayments                               | ** ** | **—**                                       |       | — |   |
| Proceeds from  termination of life insurance policies | ** ** | **—**                                       |       | — |   |
| Net investing  activity                               | ** ** | **(0.2**                                         | **)**      | 0.2 |   |
| Change in net  cash value                             | ** ** | **$**                                            | **1.8**    |   | $ | 1.4 |   |
| Tax-free proceeds  received                           | ** ** | **$**                                            | **—** |   | $ | 0.1 |   |

 

**Components of Net CashValue**
| ** **                            | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(In millions)**                | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| Gross cash value                      | ** ** | **$**              | **116.4**  |                  | $          | 114.7 |   |
| Principal –  policy loans        | ** ** | **(24.5**          | **)**      | (25.0                 | )          |
| Accrued interest  – policy loans | ** ** | **(0.9**           | **)**      | (0.5                  | )          |
| Net cash value                        | ** ** | **$**              | **91.0**   |                  | $          | 89.2 |   |
| Insurance benefits in  force          | ** ** | **$**              | **197.5**  |                  | $          | 197.9 |   |

 

Grace’s financialstatements display income statement activity and balance sheet amounts on a netbasis, reflecting the contractual interdependency of policy assets andliabilities.

**8.****              Debt**

**Components of Debt**
| **(In millions)**                                    | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|-----------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **Debt  payable within one year**                         | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Other short-term  borrowings                              | ** ** | **$**                    | **2.1**    |                        | $          | 3.3 |   |
|                                                      | ** ** | ** **               | ** ** | ** **                  | ** ** |
| **Debt  payable after one year**                          | ** ** | ** **               | ** ** | ** **                  | ** ** |
| DIP facility                                              | ** ** | **$**                    | **—** |                        | $          | — |   |
| Other long-term  borrowings                               | ** ** | **0.2**                  |       | 0.2                         |       |
|                                                      | ** ** | **$**                    | **0.2**    |                        | $          | 0.2 |   |
|                                                      |       |                     |       |                        |       |
| **Debt  Subject to Compromise**                           |       |                     |       |                        |       |
| Bank borrowings                                           | ** ** | **$**                    | **500.0**  |                        | $          | 500.0 |   |
| Other borrowings                                          | ** ** | **15.0**                 |       | 13.8                        |       |
| Accrued interest                                          | ** ** | **240.5**                |       | 225.7                       |       |
|                                                      | ** ** | **$**                    | **755.5**  |                        | $          | 739.5 |   |
| Annualized weighted  average interest rates on total debt | ** ** | **8.2**                  | **%**      | 7.9                         | %          |

 

In April 2001, theDebtors entered into the DIP facility for a two-year term in the aggregateamount of $250 million. The DIP facility is secured by a priority lien onsubstantially all assets of the Debtors with the exclusion of the capital stockof non-U.S. subsidiaries, and bears interest based on the London InterbankOffered Rate (LIBOR). The Debtors have extended the term of the DIP facilitythrough April 1, 2008. Grace had no outstanding borrowings under the DIPfacility as of March 31, 2007 and December 31, 2006; however, $49.0 million and$55.4 million of standby letters of credit were issued and outstanding underthe facility as of March 31, 2007 and December 31, 2006, respectively. Theletters of credit, which reduce available funds under the facility, were issuedprimarily for trade-related matters such as performance bonds, and certaininsurance and environmental matters.

In January 2007, Grace’s principal German subsidiaryentered into a line of credit arrangement with a German financing company inthe maximum aggregate amount of €50.0 million secured by the accountsreceivable of the German subsidiary.  Thefinancing arrangement will terminate on December 31, 2009, and includesfinancing costs based on the EURIBOR rate of interest, plus a minimum annualfee. The line was secured to provide liquidity for either Grace’s plan ofreorganization or to fund growth in that region.  Grace has not drawn on this line of credit todate.  As of March 31, 2007, Grace hadaccess to approximately €53.9 million in available credit under variousnon-U.S. credit facilities (equivalent to $71.9 million).

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

Under itsCertificate of Incorporation, the Company is authorized to issue 300,000,000shares of common stock, $0.01 par value. Of the common stock unissued at March31, 2007, approximately 3,666,029 shares were reserved for issuance pursuant tostock options and other stock incentives. Since the Filing Date, Grace has notgranted any stock options. During the quarter ended March 31, 2007, 915,813stock options were exercised for aggregate proceeds of $14.2 million.

For additionalinformation, see Notes 15 and 17 to the Consolidated Financial Statements inGrace’s 2006 Form 10-K.

**10.****             Earnings (Loss) PerShare**

The followingtable shows a reconciliation of the numerators and denominators used incalculating basic and diluted earnings (loss) per share.

**Earnings (Loss) Per Share**
| **(In millions, except per share**    | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------------|------------|
| **amounts)**                                              | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| **Numerators**                                            | ** ** | ** **                                       |       |   |   |
| Net income (loss)                                         | ** ** | **$**                                            | **4.8**    |   | $ | 0.1 |   |
| **Denominators**                                          | ** ** | ** **                                       |       |   |   |
| Weighted average common shares – basic calculation   | ** ** | **69.4**                                         |       | 67.0 |   |
| Dilutive effect of employee stock options                 | ** ** | **1.1**                                          |       | 0.3 |   |
| Weighted average common shares – diluted calculation | ** ** | **70.5**                                         |       | 67.3 |   |
| **Basic  earnings (loss) per share**                      | ** ** | **$**                                            | **0.07**   |   | $ | 0.00 |   |
| **Diluted earnings (loss) per  share**                    | ** ** | **$**                                            | **0.07**   |   | $ | 0.00 |   |

 

Stock options thatcould potentially dilute basic earnings (loss) per share (that were excludedfrom the computation of diluted earnings (loss) per share because theirexercise prices were greater than the average market price of the commonshares) averaged approximately 5.7 million for the three months ended March 31,2006.  In comparison, there were noanti-dilutive options outstanding for the three months ended March 31, 2007.

**11.****             Comprehensive Income(Loss)**

The followingtables present the pre-tax, tax and after-tax components of Grace’s othercomprehensive income (loss) for the three months ended March 31, 2007 and 2006:

**Three Months EndedMarch 31, 2007**
| **(In millions)**                                                             | ** ** | **Pre-Tax  Amount** | ** ** | **Tax  Benefit/  (Expense)** | ** ** | **After-  Tax  Amount** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------|------------|
| Gain (loss) from  hedging activities                                               |       | $                   | 1.9        |                         | $          | (0.8                    | )          | **$** | **1.1** | ** ** |
| 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**                 | ** ** |
| Other comprehensive  income (loss)                                                 |       | $                   | 7.1        |                         | $          | (0.7                    | )          | **$** | **6.4** | ** ** |

 

**Three Months Ended March 31, 2006**
| **(In millions)**                    | ** ** | **Pre-Tax  Amount** | ** ** | **Tax  Benefit** | ** ** | **After-Tax  Amount** | ** ** |
|-------------------------------------------|------------|---------------------|------------|------------------|------------|-----------------------|------------|
| ** **                                |       |                |       |             |       |                  |       |
| Gain (loss) from  hedging activities      |       | $                   | (0.9       | )                | $          | 0.3                   |       | $ | (0.6 | ) |
| Foreign currency  translation adjustments |       | 1.0                 |       | —           |       | 1.0                   |       |
| Other comprehensive  income (loss)        |       | $                   | 0.1        |             | $          | 0.3                   |       | $ | 0.4 |   |

 

The followingtable presents the components of Grace’s accumulated other comprehensive income(loss) at March 31, 2007 and December 31, 2006:

**Components ofAccumulated Other Comprehensive Income (Loss)**
| **(In millions)**                                   | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|----------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Hedging  activities (net of tax)                         | ** ** | **$**                    | **(0.2**   | **)**                       | $          | (1.3 | ) |
| Defined benefit  pension and other postretirement plans: | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Net prior service credit (net of tax)                    | ** ** | **8.0**                  |       | 9.1                         |       |
| Net deferred actuarial loss (net of tax)                 | ** ** | **(403.5**               | **)**      | (404.2                      | )          |
| Benefit plans,  net                                      | ** ** | **(395.5**               | **)**      | (395.1                      | )          |
| Foreign currency  translation                            | ** ** | **11.3**                 |       | 5.6                         |       |
| Accumulated other  comprehensive income (loss)           | ** ** | **$**                    | **(384.4** | **)**                       | $          | (390.8 | ) |

 

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Accumulated othercomprehensive income (loss) related to the defined benefit pension and otherpostretirement plans at March 31, 2007 represents the accumulation of netactuarial losses of $403.5 million as well as net prior service credits of $8.0million. These amounts are net of tax and are amortized as a component of netperiodic benefit cost. For the quarter ended March 31, 2007, $1.7 million ofbenefit was recognized related to prior service credits and $6.7 million ofexpense was recognized for amortization of accumulated actuarial losses. Inaddition, $5.5 million of additional loss was recognized for changes in fundedstatus during the quarter.

From time to time,Grace enters into commodity derivatives such as forward contracts or optioncontracts directly with natural gas suppliers, and fixed-rate swaps withfinancial institutions to mitigate the risk of volatility of natural gas pricesin the United States.  Under fixed-rateswaps, Grace locks in a fixed rate with a financial institution for future naturalgas purchases, purchases its natural gas from a supplier at the prevailingmarket rate, and settles with the bank for any difference in the rates, thereby“swapping” a variable rate for a fixed rate. Grace purchases forward contracts, swaps and/or options for a portion ofits expected natural gas requirements. Grace’s forward contracts for natural gas qualify for the normalpurchases and normal sales exception from SFAS No. 133, as they do not containnet settlement provisions, and result in physical delivery of natural gas fromsuppliers.  Therefore, the fair values ofthese contracts are not recorded in the Consolidated Balance Sheets.  The outstanding swaps and options aretreated as effective cash flow hedges for accounting purposes and revalued atthe end of each quarter, with corresponding adjustments to other comprehensiveincome (loss).

Grace is a globalenterprise, which operates in over 40 countries with local currency generallydeemed to be the functional currency for accounting purposes. The foreigncurrency translation amount represents the adjustments necessary to translatethe balance sheets valued in local currencies to the U.S. dollar as of the endof each period presented, and to translate revenues and expenses at averageexchange rates for each period presented. 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 outstanding foreigncurrency forward contracts and options were treated as effective cash flowhedges and/or net investments hedges, as appropriate, for accounting purposesand revalued at the end of each quarter, with corresponding adjustments toother comprehensive income (loss).

**12.****             Commitments andContingent Liabilities**

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

***Environmental Remediation* –**Grace issubject to loss contingencies resulting from extensive and evolving federal,state, local and foreign environmental laws and regulations relating to thegeneration, storage, handling, discharge and disposition of hazardous wastesand other materials. Grace accrues for anticipated costs associated withinvestigative and remediation efforts where an assessment has indicated that aprobable liability has been incurred and the cost can be reasonably estimated.These accruals do not take into account any discounting for the time value ofmoney.

Grace’senvironmental liabilities are reassessed whenever circumstances become betterdefined or remediation efforts and their costs can be better estimated. Theseliabilities are evaluated based on currently available information, including theprogress of remedial investigation at each site, the current status ofdiscussions with regulatory authorities regarding the method and extent ofremediation at each site, existing technology, prior experience in contaminatedsite remediation and the apportionment of costs among potentially responsibleparties. Grace expects that the funding of environmental remediation activitieswill be affected by the Chapter 11 proceedings.

At March 31, 2007,Grace’s estimated liability for environmental investigative and remediationcosts totaled $358.3 million, as compared with $361.1 million at December 31,2006. 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. Grace’s estimated environmental liabilities are included in “liabilitiessubject to compromise” in the accompanying Consolidated Balance Sheets.

Net cashexpenditures charged against previously established reserves for the threemonths ended March 31, 2007 and 2006 were $2.8 million and $2.1 million,respectively.

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*VermiculiteRelated Matters*

EPA Cost RecoveryClaim - As a result of a 2002 district court ruling, Grace isrequired to reimburse the U.S. Government for $54.5 million (plus interest) incosts expended through December 2001, and for all appropriate future costs tocomplete asbestos-related remediation relating to Grace’s former vermiculitemining and processing activities in the Libby, Montana area.  These costs include cleaning and/or demolitionof contaminated buildings, excavation and removal of contaminated soil, healthscreening of Libby residents and former mine workers, and investigation andmonitoring costs.

Grace’s totalestimated liability for asbestos remediation related to its former vermiculiteoperations in Libby, including the cost of remediation at vermiculiteprocessing sites outside of Libby, at March 31, 2007 and December 31, 2006 was$255.0 million and $255.2 million, respectively.  The estimated obligation as of each date includes$164.4 million for asserted reimbursable costs through 2005 (which includes the$54.5 million charge discussed above). The estimate as of each date does not include the cost to remediate theGrace-owned mine site at Libby or other nearby properties that may requireremediation, which costs are not currently estimable. Grace’s estimate of costsis based on EPA spending data through December 31, 2005, public commentsregarding the EPA’s spending plans, discussions of spending forecasts with EPArepresentatives, analysis of other information made available from the EPA, andevaluation of probable remediation costs at vermiculite processing sites.However, the EPA’s cost estimates have increased regularly and substantiallyover the course of this remediation. Consequently, as the EPA’s spending onthese matters increases, or the expected time frame increases, Grace’sliability for remediation will increase. Grace has been informed that the EPA is attempting to estimate thefuture cost of this environmental remediation. This information may require Grace to increase its estimate of liabilityand the increase could be material.

Montana Criminal Proceeding**–**OnFebruary 7, 2005, the United States Department of Justice announced theunsealing of a grand jury indictment against Grace and seven current or formersenior level employees *(United States ofAmerica v. W. R. Grace & Co. et al)* relating to Grace’s formervermiculite mining and processing activities in Libby, Montana.  The indictment accuses the defendants of (1)conspiracy to violate environmental laws and obstruct federal agencyproceedings; (2) violations of the federal Clean Air Act; and (3) obstructionof justice.

Grace purchasedthe Libby mine in 1963 and operated it until 1990; vermiculite processingactivities continued until 1992. The grand jury charges that the conspiracytook place from 1976 to 2002.  Accordingto the U.S. Department of Justice, Grace could be subject to fines in an amountequal to twice the after-tax profit earned from its Libby operations or twicethe alleged loss suffered by victims, plus additional amounts for restitutionto victims. The indictment alleges that such after-tax profits were $140million. Grace has categorically denied any criminal wrongdoing and intends to vigorouslydefend itself at trial.

In March 2005, theU.S. District Court for the District of Montana entered a scheduling ordersetting a trial date of September 11, 2006. In July 2006, the District Court dismissed a portion of the conspiracycount of a superseding indictment alleging conspiracy to knowingly endangerresidents of the Libby area and others in violation of the Clean Air Act.  In August 2006, the District Court granted amotion by the defendants to exclude as evidence sample results that includedminerals that do not constitute asbestos under the Clean Air Act.  The Government has appealed these and otherrulings to the Ninth Circuit Court of Appeals, which has scheduled oralargument for June 2007.  As a result ofthe appeal, the trial has been delayed until September 2007 or later pendingresolution of the appeals.

The U.S.Bankruptcy Court previously granted Grace’s request to advance legal anddefense costs to the employees, 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, 2007 and 2006, respectively, total expense forGrace and the employees was $2.5 million and $10.1 million, which is includedin selling, general and administrative expenses in the accompanyingConsolidated Statements of Operations.

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 is pending, Grace expects legal feesfor this matter to 

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be $3 million to $5 million per quarter.  Grace intends to expense such costs as theyare incurred.

New Jersey Lawsuit– On June 1, 2005, the New Jersey Department of Environmental Protection (“DEP”)filed a lawsuit against Grace and two former employees in the Superior Court ofNew Jersey Law Division: Mercer County *(N.J.Dept. of Environmental Protection v. W.R. Grace & Co. et al.)*seeking civil penalties for alleged misrepresentations and false statementsmade in a Preliminary Assessment/Site Investigation Report and NegativeDeclarations submitted by Grace to the DEP in 1995 pursuant to the New JerseyIndustrial Site Recovery Act. Grace submitted the report, which was prepared byan independent environmental consultant, in connection with the closing ofGrace’s former plant in Hamilton Township, New Jersey. Grace is also aware thatthe State of New Jersey and the U.S. Department of Justice each may beconducting criminal investigations related to Grace’s former operations of theHamilton plant.

Grace purchasedthe Hamilton plant assets in 1963 and ceased operations in 1994. During theoperating period, Grace produced spray-on fire protection products andvermiculite-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 for this site and now seek approximately $3.4million with respect to the Hamilton plant site.

Grace is unable atthis time to assess the effect of this lawsuit or the pending criminalinvestigations on Grace’s results of operations, cash flows, or liquidity, oron its bankruptcy proceeding.

*Non-Vermiculite Related Matters*

At March 31, 2007and December 31, 2006, Grace’s estimated liability for remediation of sites notrelated to its former vermiculite mining and processing activities was $103.3million and $105.9 million, respectively. This liability relates to Grace’scurrent and former operations, including its share of liability for off-sitedisposal 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. As Grace receives new information and continues itsclaims evaluation process, its estimated liability may change materially.

***Purchase Commitments*–** Grace engages in purchase commitments to minimize the volatility of majorcomponents of direct manufacturing costs including natural gas, certain metals,asphalt, amines and other materials. Such commitments are for quantities that Grace fully expects to use inits normal operations.

***Guarantees and Indemnification Obligations***–****Grace is a party to many contractscontaining guarantees and indemnification obligations. These contractsprimarily consist of:

·                  Contractsproviding for the sale of a former business unit or product line in which Gracehas agreed to indemnify the buyer against liabilities arising prior to theclosing of the transaction, including environmental liabilities. Theseliabilities are included in “liabilities subject to compromise” in theaccompanying Consolidated Balance Sheets.

·                  Guaranteesof real property lease obligations of third parties, typically arising out of(a) leases entered into by former subsidiaries of Grace, or (b) the assignmentor sublease of a lease by Grace to a third party. These obligations areincluded in “liabilities subject to compromise” in the accompanyingConsolidated Balance Sheets.

·                  Licensesof intellectual property by Grace to third parties in which Grace has agreed toindemnify the licensee against third party infringement claims.

·                  Contractsentered into with third party consultants, independent contractors, and otherservice providers in which Grace has agreed to indemnify such parties againstcertain liabilities in connection with their performance. Based on historicalexperience and the likelihood that such parties will make a claim againstGrace, Grace believes that such indemnification obligations are immaterial.

·                  Productwarranties with respect to certain products sold to customers in the ordinarycourse of business. These warranties typically provide that product willconform to specifications. Grace generally does not establish a liability forproduct warranty based on a percentage of sales or other formula. Grace accruesa warranty liability on a transaction-specific basis depending on theindividual facts and circumstances related to 

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each sale. Both theliability and annual expense related to product warranties are immaterial tothe Consolidated Financial Statements.

***Financial Assurances***– Financialassurances have been established for a variety of purposes, including insuranceand environmental matters, asbestos settlements and appeals, trade-relatedcommitments and other matters.  At March31, 2007, Grace had gross financial assurances issued and outstanding of $278.6million, comprised of $137.0 million of surety bonds issued by variousinsurance companies, and $141.6 million of standby letters of credit and otherfinancial assurances issued by various banks. As discussed in Note 8, $49.0 millionof these financial assurances have been issued 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 $3.3 million through March 31, 2007. 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.

***Accounting for Contingencies***–****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.Accruals recorded for such contingencies have been included in “liabilitiessubject to compromise” in the accompanying Consolidated Balance Sheets. Theamounts of these liabilities as ultimately determined through the Chapter 11proceedings could be materially different from amounts recorded at March 31,2007.

**13.****             Pension Plans andOther Postretirement Benefit Plans**

***Pension Plans***– Grace maintainsdefined benefit pension plans covering employees of certain units who meet ageand service requirements. Benefits are generally based on final average salaryand 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 ofmethods, as required under local laws and customs.

Grace alsoprovides, through nonqualified plans, supplemental pension benefits in excessof U.S. qualified pension plan limits imposed by federal tax law. These planscover officers and higher-level employees and serve to increase the combinedpension amount to the level that they otherwise would have received under theU.S. qualified pension plans in the absence of such limits. The nonqualifiedplans are unfunded and Grace pays the costs of benefits as they are incurred.

Atthe December 31, 2006 measurement date for Grace’s defined benefit pensionplans (the “Plans”), the projected benefit obligation (“PBO”) was approximately$1,433 million as measured under U.S. generally accepted accountingprinciples.  On a quarterly basis, Grace analyzes therollforward of pension assets and pension liabilities along with the resultingfunded status to assure that the Consolidated Balance Sheet reflects an updatedestimate of these measures each period. Funded status is adjusted for actual contributions, benefit payments,return on assets and other identifiable and material actuarial changes.Discount rates are also evaluated for reasonableness each period.

At March 31, 2007,Grace’s recorded pension liability for underfunded and unfunded plans was $441.8million ($339.9 million included in “underfunded defined benefit pension plans”,$10.7 million included in “other current liabilities”, and $91.2 millionrelated 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 ($210.6 million); and2) the PBO of unfunded pay-as-you-go plans ($231.2 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,” 

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which requiresthat the future costs of postretirement health care and life insurance benefitsbe 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 2007 measurementpurposes, per capita costs, before retiree contributions, were assumed toinitially increase at a rate of 7.0%. The rate is assumed to decrease gradually to 5.0% through 2010 andremain at that level thereafter.  A onepercentage point increase or decrease in assumed health care medical cost trendrates would have a negligible impact on Grace’s postretirement benefitobligations.

The components of netperiodic benefit cost (income) for Grace’s pension and postretirement plans forthe three months ended March 31, 2007 and 2006 are as follows:

**Components ofNet Periodic Benefit Cost (Income)**
| ** **                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                   | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | **Pension**                                          | ** ** | ** ** | ** ** | **Pension** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | ** **                                           | ** ** | **Non-** | ** ** | **Post-** | ** ** | ** ** | ** ** | **Non-** | ** ** | **Post-** | ** ** |
| **(In millions)**                       | ** ** | **U.S.**                                             | ** ** | **U.S.** | ** ** | **retirement** | ** ** | **U.S.** | ** ** | **U.S.** | ** ** | **retirement** | ** ** |
| Service cost                                 | ** ** | **$**                                                | **4.2**    | ** ** | **$** | **2.0** | ** ** | **$** | **0.1** |   | $ | 4.3 |   | $ | 2.0 |   | $ | 0.1 |   |
| Interest cost                                | ** ** | **14.4**                                             | ** ** | **5.0** | ** ** | **1.1** |   | 14.5 |   | 4.2 |   | 1.1 |   |
| Expected return  on plan assets              | ** ** | **(14.8**                                            | **)**      | **(5.2** | **)** | **—** |   | (13.9 | ) | (4.3 | ) | — |   |
| Amortization of  prior service cost (credit) | ** ** | **0.6**                                              | ** ** | **0.2** | ** ** | **(2.5** | **)** | 0.6 |   | 0.1 |   | (3.2 | ) |
| Amortization of  net deferred actuarial loss | ** ** | **4.9**                                              | ** ** | **1.4** | ** ** | **0.4** |   | 5.3 |   | 2.0 |   | 0.4 |   |
| **Net periodic benefit cost  (income)**      | ** ** | **$**                                                | **9.3**    | ** ** | **$** | **3.4** | ** ** | **$** | **(0.9** | **)** | $ | 10.8 |   | $ | 4.0 |   | $ | (1.6 | ) |

 

***Plan Contributions and Funding*** – Subject to any required approval ofthe Bankruptcy Court, Grace intends to satisfy its obligations under the Plansand to comply with all of the requirements of the Employee Retirement IncomeSecurity Act of 1974 (“ERISA”).  ForERISA purposes, funded status is calculated on a different basis than underU.S. generally accepted accounting principles. Grace has obtained Bankruptcy Court approval to fund all minimumrequired payments under the Plans through April 2007.  These payments reflect the impact of thePension Protection Act of 2006, which extended the interest rates requiredunder the Pension Funding Equity Act of 2004 for plan years commencing in 2006and 2007. In that regard, Grace contributed $71 million in 2006, $16 million inJanuary 2007, and $21 million in April 2007, to the trusts that hold assets ofthe Plans.  While Grace intends tocontinue to fund all minimum required payments under the Plans, there can be noassurance that the Bankruptcy Court will continue to approve these payments.

Contributions tonon-U.S. pension plans are not subject to Bankruptcy Court approval and Graceintends to fund such plans based on applicable legal requirements, andactuarial and trustee 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.

**14.****             Operating SegmentInformation**

Grace is a globalproducer of specialty chemicals and materials. It generates revenues from twooperating segments: Grace Davison, which includes silica- and alumina-basedcatalysts and materials used in a wide range of industrial applications; andGrace Performance Chemicals, which includes specialty chemicals and materialsused in commercial and residential construction and in rigid food and beveragepackaging. Intersegment sales, eliminated in consolidation, are notmaterial.  The following table presentsinformation related to Grace’s operating segments for the three month periodsended March 31, 2007 and 2006, respectively. Only those corporate expensesdirectly related to the operating segments are allocated for reportingpurposes. All remaining corporate items are reported separately and labeled assuch.

**Operating Segment Data**
| ** **                    | ** ** | **Three Months  Ended  March 31,** | ** ** |
|-------------------------------|------------|----------------------------------------------|------------|
| **(In millions)**        | ** ** | **2007**                                     | ** ** | **2006** | ** ** |
| **Net  Sales**                |       |                                         |       |   |   |
| Grace Davison                 | ** ** | **$**                                        | **387.7**  |   | $ | 356.4 |   |
| Grace  Performance Chemicals  | ** ** | **327.9**                                    |       | 302.2 |   |
| **Total**                     | ** ** | **$**                                        | **715.6**  |   | $ | 658.6 |   |
| **Pre-tax  Operating Income** | ** ** | ** **                                   |       |   |   |
| Grace Davison                 | ** ** | **$**                                        | **45.0**   |   | $ | 36.0 |   |
| Grace Performance  Chemicals  | ** ** | **36.2**                                     |       | 34.2 |   |
| Corporate costs               | ** ** | **(20.6**                                    | **)**      | (22.4 | ) |
| **Total**                     | ** ** | **$**                                        | **60.6**   |   | $ | 47.8 |   |

 

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Corporate costsinclude expenses of corporate headquarters functions incurred in support ofcore operations, 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 followingtable presents information related to the geographic areas in which Graceoperated for the three months ended March 31, 2007 and 2006, respectively.Sales are attributed to geographic areas based on customer location.

**Geographic Area Data**
| ** **                 | ** ** | **Three Months  Ended  March 31,** | ** ** |
|----------------------------|------------|----------------------------------------------|------------|
| **(In millions)**     | ** ** | **2007**                                     | ** ** | **2006** | ** ** |
| **Net  Sales**             |       |                                         |       |   |   |
| United States              | ** ** | **$**                                        | **245.8**  |   | $ | 239.3 |   |
| Canada and Puerto Rico     | ** ** | **20.8**                                     |       | 40.6 |   |
| Total North America        | ** ** | **266.6**                                    |       | 279.9 |   |
| Germany                    | ** ** | **35.6**                                     |       | 30.3 |   |
| Europe, other than Germany | ** ** | **259.5**                                    |       | 216.7 |   |
| Total Europe               | ** ** | **295.1**                                    |       | 247.0 |   |
| Asia Pacific               | ** ** | **110.7**                                    |       | 98.3 |   |
| Latin America              | ** ** | **43.2**                                     |       | 33.4 |   |
| **Total**                  | ** ** | **$**                                        | **715.6**  |   | $ | 658.6 |   |

 

The pre-taxoperating income for Grace’s operating segments for the three months endedMarch 31, 2007 and 2006, respectively, is reconciled below to income (loss)before income taxes and minority interest presented in the accompanyingConsolidated Statements of Operations.

**Reconciliationof Operating Segment Data to Financial Statements**
| ** **                                                       | ** ** | **Three Months** | ** ** |
|------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                       | ** ** | **Ended**             | ** ** |
| ** **                                                       | ** ** | **March 31,**    | ** ** |
| **(In millions)**                                           | ** ** | **2007**              | ** ** | **2006** | ** ** |
|                                                             | ** ** | ** **            |       |   |   |
| Pre-tax  operating income – core operations                 | ** ** | **$**                 | **60.6**   |   | $ | 47.8 |   |
| Minority  interest in consolidated entities                      | ** ** | **2.4**               |       | 6.8 |   |
| Chapter 11  expenses, net of interest income                     | ** ** | **(17.8**             | **)**      | (8.7 | ) |
| Net gain (loss)  on sales of investments and disposals of assets | ** ** | **0.2**               |       | (1.8 | ) |
| Interest expense  and related financing costs                    | ** ** | **(19.4**             | **)**      | (15.8 | ) |
| Other, net                                                       | ** ** | **(3.9**              | **)**      | (16.9 | ) |
|                                                             | ** ** | ** **            | ** ** |   |   |
| Income (loss) before  income taxes and minority interest         | ** ** | **$**                 | **22.1**   |   | $ | 11.4 |   |

 

Minority interestprimarily pertains to Advanced Refining Technologies LLC (“ART”), a jointventure between Grace and Chevron Products Company, in which Grace has a 55%economic interest.

**15.****             Minority Interest inConsolidated Entities**

Within both Grace Davison and Grace PerformanceChemicals, Grace conducts certain business activities in various countriesthrough joint ventures with unaffiliated third parties.  The following tables present summaryfinancial statistics for Grace’s combined businesses subject to profit sharing:
| ** **                            | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------|------------|--------------------------------------------------|------------|
| **(In millions)**                | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Sales                                 | ** ** | **$**                                            | **95.3**   |   | $ | 97.5 |   |
| Income before  taxes                  | ** ** | **5.8**                                          |       | 16.4 |   |
| Net income                            | ** ** | **5.6**                                          |       | 15.4 |   |
| Minority interests in  net income     | ** ** | **2.4**                                          |       | 6.8 |   |
| Dividends paid to  minority interests | ** ** | **11.8**                                         |       | — |   |
|                                       |            |                                                  |            |  |  |  |  |

 
| **(In millions)**                           | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Cash                                             | ** ** | **$**                    | **55.2**   |                        | $          | 65.5 |   |
| Other current  assets                            | ** ** | **145.2**                |       | 136.7                       |       |
| Total assets                                     | ** ** | **210.4**                |       | 212.4                       |       |
| Total  liabilities                               | ** ** | **85.3**                 |       | 66.9                        |       |
| Shareholders’  equity                       | ** ** | **125.1**                |       | 145.5                       |       |
| Minority interests in  shareholders’ equity | ** ** | **55.6**                 |       | 65.0                        |       |
|                                                  |            |                          |            |                             |            |  |  |

 

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**Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

**Financial Summary for March 31,2007**

Following is asummary analysis of key financial measures of our performance for the threemonths ended March 31, 2007 compared with the prior year period.

·                  Salesincreased 8.7% primarily as a result of higher selling prices in response tocost inflation and to added sales volume in all geographic regions except NorthAmerica.  Sales increased 8.8% for theGrace Davison operating segment and 8.5% for the Grace Performance Chemicalsoperating segment.  Geographically, saleswere up 19.5% in Europe, 12.6% in Asia Pacific and 29.3% in Latin America, anddown 4.8% in North America, where sales were adversely affected by the reorderpattern of certain refining catalysts and a lower level of residentialconstruction in the United States.

·                  Netincome for each period has been primarily affected by: 1) the performance ofour businesses – which we categorize as “core operations”; and 2) the costs ofChapter 11, litigation and other nonoperating liabilities – which we categorizeas “noncore activities”.

·                  Netincome for the three months ended March 31, 2007 and 2006 was $4.8 million and$0.1 million, respectively.

·                  Pre-taxoperating income from core operations was $60.6 million compared with $47.8million in the prior year quarter, a 26.8% increase.  Pre-tax operating income of the Grace Davisonoperating segment was $45.0 million, up 25.0%, which we attribute principallyto sales increases across most product groups and to lower unit manufacturingcosts.  Pre-tax operating income of theGrace Performance Chemicals operating segment was $36.2 million, up 5.8%, whichwe attribute primarily to higher sales of construction and packaging productsin regions other than North America. Corporate operating costs were $1.8 million lower than the first quarterof 2006 due primarily to a decrease in pension expense that resulted fromrecent plan contributions and higher investment returns.

·                  Operatingcash flow was a negative $49.0 million compared with a negative $37.1 millionfor the prior year period. The 2007 cash flow includes an increase in cashcontributions to defined benefit pension plans, increased payments related toChapter 11 proceedings, and dividends paid to joint venture partners.

·                  Thepre-tax loss from noncore activities was $5.8 million compared with $20.1million in the prior year period. The decrease is principally due to reducedcosts for the Montana criminal proceeding, in which certain pre-trial rulingsare pending appeal.

We are attemptingto resolve 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 proceeding. Theseliabilities and contingencies may result in continued volatility in net incomein the future.

**Description of Core Business**

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

***Grace Davison***includes:

·                  Catalystsand chemical additives used by petroleum refiners, including fluid catalyticcracking, or FCC, catalysts, that help to “crack” the hydrocarbon chain indistilled crude oil to produce transportation fuels and other petroleum-basedproducts, and FCC additives used to reduce sulfur in gasoline, maximizepropylene production from refinery FCC units, and reduce emissions of sulfuroxides, nitrogen oxides and carbon monoxide from refinery FCC units;

·                  Hydroprocessingcatalysts used by petroleum refiners in process reactors to upgrade heavy oilsinto lighter, more useful products by removing impurities such as nitrogen,sulfur and heavy metals, allowing less expensive feedstocks to be used in thepetroleum refining process;

·                  Specialtycatalysts, including polyolefin catalysts and catalyst supports that areessential components in the manufacture of 

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polyethylene andpolypropylene resins, and other chemical catalysts used in a variety ofindustrial, environmental and consumer applications;

·                  Silica-basedand silica-alumina-based engineered materials used in:

·                  industrialmarkets, such as coatings, plastics and rubber, precision investment casting,refractory, insulating glass windows, desiccants, and gas and liquidspurification;

·                  consumerapplications, such as food products, toothpaste, pharmaceutical and personalcare products, and the processing of edible oils and beverages;

·                  digitalmedia coatings for ink jet papers; and

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

We conduct ourhydroprocessing catalyst business through Advanced Refining Technologies, LLC (“ART”),our joint venture with Chevron Products Company (“Chevron”).  We report 100% of the revenues of the ARTjoint venture, but only receive 55% of the income after minority interest isallocated to Chevron.

Key externalfactors for our FCC catalysts and hydroprocessing catalysts are the economicsof the petroleum refining industry, specifically the impacts of demand fortransportation fuels and petrochemical products, and crude oil supply.  FCC catalysts are consumed at a relativelysteady rate and replaced regularly, while most hydroprocessing catalysts areconsumed over a period of years and replaced in an irregular pattern.

Sales of our otherthree Grace Davison product groups are affected by general economic conditionsincluding the underlying growth rate of targeted end-use applications.

***Grace Performance Chemicals***includes:

·                  Specialtychemicals and materials, including concrete admixtures and fibers used toimprove the durability and working properties of concrete, additives used incement processing to improve energy efficiency, enhance the characteristics offinished cement and improve ease of use, building materials used in commercialand residential construction and renovation to protect buildings from water,vapor and air penetration, and fireproofing materials used to protect buildingsin the event of fire; and

·                  Darex® packaging products and technologies, primarilyspecialty sealants and coatings used in rigid food and beverage packages,including can and closure sealants used to seal and enhance the shelf life ofcan and bottle contents, and coatings for cans and closures that prevent metalcorrosion, protect package contents from the influence of metal and ensureproper adhesion of sealing compounds.

Constructionproducts sales are primarily impacted by global non-residential constructionactivity and U.S. residential construction activity.

Our packagingtechnologies sales are affected by regional economic conditions as well as anongoing shift in demand away from metal containers to plastic packaging forfoods and beverages. This shift has caused a decline in can sealant usage overrecent years, but provides opportunities for increased sales of closuresealants, coatings and other products for plastic packaging.

***Global scope*** – We operate our businesson a global scale with approximately 66% of our revenue (see table below) andover 50% of our operating properties outside the United States. We conductbusiness in more than 40 countries and in more than 20 currencies. We manageour operating segments on a global basis, to serve global markets.  Currency fluctuations in relation to the U.S.dollar affect our reported earnings, net assets and cash flows.

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The table belowshows the sales in each of our operating segments, and domestic andinternational sales, as a percentage of our total sales.

**Percentage ofTotal Grace Sales**
| ** **                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------|------------|--------------------------------------------------|------------|
| ** **                   | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Grace Davison                | ** ** | **54.2**                                         | **%**      | 54.1 | % |
| Grace  Performance Chemicals | ** ** | **45.8**                                         | **%**      | 45.9 | % |
| **Total**                    | ** ** | **100.0**                                        | **%**      | 100.0 | % |
| Grace U.S.                   | ** ** | **34.3**                                         | **%**      | 36.3 | % |
| Grace non-U.S.               | ** ** | **65.7**                                         | **%**      | 63.7 | % |
| **Total**                    | ** ** | **100.0**                                        | **%**      | 100.0 | % |

 

**Voluntary Bankruptcy Filing**

In response to asharply increasing number of asbestos-related personal injury claims, on April2, 2001, Grace and 61 of our United States subsidiaries and affiliates,including W. R. Grace & Co.–Conn., filed voluntary petitions forreorganization under Chapter 11 of the United States Bankruptcy Code in theUnited States Bankruptcy Court for the District of Delaware. Our non-U.S.subsidiaries and certain of our U.S. subsidiaries were not included in theChapter 11 filing.

Under Chapter 11,we have continued to operate as debtors-in-possession under court protectionfrom creditors and claimants, while using the Chapter 11 process to develop andimplement a plan for addressing the asbestos-related claims. Since the Chapter11 filing, the bankruptcy court has approved all motions necessary to conductnormal business activities.

On January 13,2005, we filed an amended plan of reorganization and related documents with thebankruptcy court. The plan of reorganization is supported by committeesrepresenting general unsecured creditors and equity holders, but is notsupported by committees representing asbestos personal injury claimants andasbestos property damage claimants or the representative of future asbestosclaimants. Under the terms of the plan of reorganization, a trust would beestablished to which all pending and future asbestos-related claims would bechanneled for resolution. The plan of reorganization can become effective onlyafter a vote of eligible creditors and with the approval of the bankruptcycourt and the U.S. District Court for the District of Delaware. See “Plan ofReorganization” below for more information.

**Critical Accounting Estimates**

See the “CriticalAccounting Estimates” heading in Item 7 of our Form 10-K for the year endedDecember 31, 2006 for a discussion of our critical accounting estimates.  The following represent changes to ourcritical accounting estimates implemented during the three months ended March31, 2007:

***Income Taxes***– Effective January 1, 2007, we began to measure andrecord tax contingency accruals in accordance with Financial AccountingStandards Board Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes” (“FIN 48”).  Under FIN 48, werecognize the tax benefit from an uncertain tax position only if it is morelikely than not that the tax position will be sustained upon examination by thetaxing authorities, based on the technical merits of the position. We measuretax benefits in our financial statements from such a position as the largestbenefit that has a greater than fifty percent likelihood of being realized uponultimate settlement.  Unrecognized taxbenefits are tax benefits claimed in our tax returns that do not meet theserecognition and measurement standards.

***Pension and Other Postretirement Benefits Expenses andLiabilities***– On aquarterly basis, we analyze the rollforward of pension assets and pensionliabilities along with the resulting funded status to assure that theConsolidated Balance Sheet reflects an updated estimate of these measures eachperiod.  Funded status is adjusted foractual contributions, benefit payments, return on assets and other identifiableand material actuarial changes. Discount rates are also evaluated forreasonableness each period.

**Summary Financial Information andMetrics**

Set forth below isa chart that lists our key operating statistics, and dollar and percentagechanges for the three month periods ended March 31, 2007 and 2006. Please referto this Analysis of Continuing Operations chart when reading Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

In the Analysis ofContinuing Operations chart, as well as in the financial information presentedthroughout Management’s Discussion and Analysis of Financial Condition andResults of Operations, we present our financial results in the same manner 

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as results arereviewed internally.  We break out our resultsof operations by operating segment and between “core operations” and “noncoreactivities.” Core operations comprise the financial results of Grace Davison,Grace Performance Chemicals, and the costs of corporate activities thatdirectly or indirectly support our business operations. In contrast, noncoreactivities comprise all other events and transactions not directly related tothe generation of operating revenue or the support of our core operations andgenerally relate to our former operations and products. See “Pre-tax Income(Loss) from Noncore Activities” for more information about noncore activities.We use pre-tax income from core operations as the performance factor indetermining certain incentive compensation and as the profitability factor inall significant business decisions.

Pre-tax incomefrom core operations, pre-tax income (loss) from noncore activities, pre-taxincome from core operations as a percentage of sales, and pre-tax income fromcore operations before depreciation and amortization do not purport torepresent income 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 incomefrom core operations has material limitations as an operating performancemeasure because it excludes income and expenses that comprise our noncoreactivities, which include, among other things, provisions for asbestos-relatedlitigation and environmental remediation, income from insurance settlements,and legal defense costs, all of which have been material components of our netincome (loss). Pre-tax income from core operations before depreciation andamortization also has material limitations as an operating performance measuresince it excludes the impact of depreciation and amortization expense.  Our business is substantially dependent onthe successful deployment of our capital assets; therefore, depreciation andamortization expense is a necessary element of our costs and ability togenerate revenue. We compensate for the limitations of these measurements byusing these indicators together with net income (loss) as measured under U.S.generally accepted accounting principles to present a complete analysis of ourresults of operations.  You shouldevaluate pre-tax income from core operations and pre-tax income from coreoperations before depreciation and amortization in conjunction with net income(loss) for a more complete analysis of our financial results.

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**Analysis of Continuing Operations**
| ** **                                                                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                   | ** ** | ** **                                       | ** ** | ** ** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| **(In millions)**                                                                       | ** ** | **2007**                                         | ** ** | **2006** | ** ** | **Fav (Unfav)** | ** ** | **Fav (Unfav)** | ** ** |
| **Net Sales:**                                                                               | ** ** | ** **                                       |       |   |   |   |   |   |   |
| Grace Davison                                                                                | ** ** | **$**                                            | **387.7**  |   | $ | 356.4 |   | $ | 31.3 |   | 8.8 | % |
| Grace Performance  Chemicals                                                                 | ** ** | **327.9**                                        |       | 302.2 |   | 25.7 |   | 8.5 | % |
| **Total  Grace net sales**                                                                   | ** ** | **$**                                            | **715.6**  |   | $ | 658.6 |   | $ | 57.0 |   | 8.7 | % |
| **Pre-tax  operating income:**                                                               | ** ** | ** **                                       |       |   |   |   |   |   |   |
| Grace Davison*(1)*                                                                           | ** ** | **$**                                            | **45.0**   |   | $ | 36.0 |   | $ | 9.0 |   | 25.0 | % |
| Grace Performance  Chemicals*(2)*                                                            | ** ** | **36.2**                                         |       | 34.2 |   | 2.0 |   | 5.8 | % |
| Corporate costs:                                                                             | ** ** | ** **                                       |       |   |   |   |   |   |   |
| Support functions                                                                            | ** ** | **(11.1**                                        | **)**      | (10.7 | ) | (0.4 | ) | (3.7 | )% |
| Pension, performance-related compensation, and other                                         | ** ** | **(9.5**                                         | **)**      | (11.7 | ) | 2.2 |   | 18.8 | % |
| Total Corporate costs                                                                        | ** ** | **(20.6**                                        | **)**      | (22.4 | ) | 1.8 |   | 8.0 | % |
| **Pre-tax  income from core operations**                                                     | ** ** | **60.6**                                         |       | 47.8 |   | 12.8 |   | 26.8 | % |
| **Pre-tax  income (loss) from noncore activities**                                           | ** ** | **(5.8**                                         | **)**      | (20.1 | ) | 14.3 |   | 71.1 | % |
| Interest expense                                                                             | ** ** | **(19.4**                                        | **)**      | (15.8 | ) | (3.6 | ) | (22.8 | )% |
| Interest income                                                                              | ** ** | **2.1**                                          |       | 1.4 |   | 0.7 |   | 50.0 | % |
| **Income  (loss) before Chapter 11 expenses and income taxes**                               | ** ** | **37.5**                                         |       | 13.3 |   | 24.2 |   | 182.0 | % |
| Chapter 11 expenses, net of interest income                                                  | ** ** | **(17.8**                                        | **)**      | (8.7 | ) | (9.1 | ) | (104.6 | )% |
| Benefit from (provision for) income taxes                                                    | ** ** | **(14.9**                                        | **)**      | (4.5 | ) | (10.4 | ) | NM |   |
| **Net  income (loss)**                                                                       | ** ** | **$**                                            | **4.8**    |   | $ | 0.1 |   | $ | 4.7 |   | NM |   |
| **Key  Financial Measures:**                                                                 | ** ** | ** **                                       |       |   |   |   |   |   |   |
| **Pre-tax income from core operations as a  percentage of sales:**                           |       |                                             |       |   |   |   |   |   |   |
| Grace Davison                                                                                | ** ** | **11.6**                                         | **%**      | 10.1 | % | NM |   | 1.5 | pts |
| Grace Performance  Chemicals                                                                 | ** ** | **11.0**                                         | **%**      | 11.3 | % | NM |   | (0.3 | )pts |
| Total Core Operations                                                                        | ** ** | **8.5**                                          | **%**      | 7.3 | % | NM |   | 1.2 | pts |
| Total Core Operations adjusted for profit sharing of  joint ventures*(3)*                    | ** ** | **8.8**                                          | **%**      | 8.3 | % | NM |   | 0.5 | pts |
| **Pre-tax income from core operations before  depreciation and amortization**                | ** ** | **$**                                            | **88.2**   |   | $ | 75.9 |   | $ | 12.3 |   | 16.2 | % |
| **As a percentage of sales**                                                                 | ** ** | **12.3**                                         | **%**      | 11.5 | % | NM |   | 0.8 | pts |
| **Depreciation and amortization**                                                            | ** ** | **$**                                            | **27.6**   |   | $ | 28.1 |   | $ | 0.5 |   | 1.8 | % |
| **Gross profit percentage (sales less cost of  goods sold as a percent of sales)***(4)***:** | ** ** | ** **                                       |       |   |   |   |   |   |   |
| Grace Davison                                                                                | ** ** | **28.4**                                         | **%**      | 28.2 | % | NM |   | 0.2 | pts |
| Grace Performance Chemicals                                                                  | ** ** | **33.2**                                         | **%**      | 33.5 | % | NM |   | (0.3 | )pts |
| Total Grace                                                                                  | ** ** | **30.5**                                         | **%**      | 30.5 | % | NM |   | 0.0 | pts |
| **Net  Consolidated Sales by Region:**                                                       | ** ** | ** **                                       |       |   |   |   |   |   |   |
| North America                                                                                | ** ** | **$**                                            | **266.6**  |   | $ | 279.9 |   | $ | (13.3 | ) | (4.8 | )% |
| Europe                                                                                       | ** ** | **295.1**                                        |       | 247.0 |   | 48.1 |   | 19.5 | % |
| Asia Pacific                                                                                 | ** ** | **110.7**                                        |       | 98.3 |   | 12.4 |   | 12.6 | % |
| Latin America                                                                                | ** ** | **43.2**                                         |       | 33.4 |   | 9.8 |   | 29.3 | % |
| **Total**                                                                                    | ** ** | **$**                                            | **715.6**  |   | $ | 658.6 |   | $ | 57.0 |   | 8.7 | % |

 

----

NM = Not meaningful
| *(1)* | *Grace Davison pre-tax operating income includes  minority interest related to the Advanced Refining Technologies joint  venture.* |
|-------|------------------------------------------------------------------------------------------------------------------------------------|
| *(2)* | *Grace Performance Chemicals pre-tax operating  income includes minority interests related to consolidated joint ventures.*        |
| *(3)* | *Reflects the add-back of minority interests in  consolidated entities.*                                                           |
| *(4)* | *Includes depreciation and amortization related to  manufacturing of products.*                                                    |

 

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**Grace Overview**

The following is an overview of our financial performance for the threemonths ended March 31, 2007 compared with the prior year period.

***Net Sales***–****Thefollowing table identifies the quarter-over-quarter increase or decrease insales attributable to changes in product volume, product price and/or mix, andthe impact of foreign currency translation.

**Net SalesVariance Analysis**
| ** **                   | ** ** | **Three Months Ended March 31, 2007 as a  Percentage Increase (Decrease) from  Three Months Ended March 31, 2006** | ** ** |
|------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                   | ** ** | **Volume**                                                                                                                                                                                    | ** ** | **Price/Mix** | ** ** | **Currency  Translation** | ** ** | **Total** | ** ** |
| Grace Davison                |       | 3.5                                                                                                                                                                                           | %          | 1.9 | % | 3.4 | % | 8.8 | % |
| Grace Performance  Chemicals |       | 2.6                                                                                                                                                                                           | %          | 2.9 | % | 3.0 | % | 8.5 | % |
| Net sales                    |       | 3.1                                                                                                                                                                                           | %          | 2.4 | % | 3.2 | % | 8.7 | % |
| **By Region:**               | ** ** | ** **                                                                                                                                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| North America                |       | (4.7                                                                                                                                                                                          | )%         | (0.1 | )% | 0.0 | % | (4.8 | )% |
| Europe                       |       | 10.6                                                                                                                                                                                          | %          | 1.2 | % | 7.7 | % | 19.5 | % |
| Asia Pacific                 |       | (6.0                                                                                                                                                                                          | )%         | 16.5 | % | 2.1 | % | 12.6 | % |
| Latin America                |       | 30.5                                                                                                                                                                                          | %          | (1.2 | )% | 0.0 | % | 29.3 | % |

 

Sales for thethree months ended March 31, 2007 were favorably impacted by higher volume(including acquisitions), foreign currency effects, product mix and sellingprice increases in response to cost inflation. Favorable currency effects contributed $21.2 million or 3.2 percentagepoints of the sales growth.  Acquisitionscontributed $4.0 million or 0.6 percentage points of the sales growth.

***Pre-tax Income from Core Operations***– Corporate costs include corporatefunctional costs (such as financial and legal services, human resources,communications and information technology), the cost of corporate governance(including directors and officers liability insurance) and pension costsrelated to both corporate employees and to the effects of changes in assets andliabilities for all of our pension plans. Corporate costs for the three months ended March 31, 2007 decreasedcompared with the same period in 2006 primarily due to lower pension costs fromthe effect of contributions made to defined benefit pension plans and higherinvestment returns in recent years.

We value our U.S.inventories under the last-in/first- out method, or LIFO, and our non-U.S. inventoriesunder the first-in/first-out, or FIFO, method. LIFO was selected in 1974 forU.S. financial reporting and tax purposes because it generally results in abetter 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 11.9% higher and 15.6% lower forthe three months ended March 31, 2007 and 2006, respectively. The significantchange in inventory valuations between FIFO and LIFO relates primarily to theprice volatility, over the past several quarters, of commodity metals andnatural gas used in Grace Davison products and production processes.  We attempt to mitigate price volatilitythrough hedging techniques such as layering our required supply under fixeddelivery contracts, entering into commodity option and swap contracts withsuppliers and financial institutions, and by negotiating sales contracts thatpermit the partial pass-through of market price increases for these volatilecommodity items.

We normallyattempt to lock in raw material costs through long-term supply contracts andtargeted hedging programs. Arrangements and programs can span a few months toseveral years. Major raw materials include natural gas, certain metals,petroleum-based materials and certain industrial chemicals. The actual cost ofthese raw materials can differ significantly from spot prices at any point intime.  Our reported gross profit for theperiods presented has been favorably impacted by certain raw material supplyarrangements and unfavorably affected by others, relative to the then-currentmarket price. We expect that new supply agreements and hedging arrangementswill result in raw material costs that can be significantly favorable orunfavorable compared with prior periods. We attempt to mitigateperiod-over-period commodity-driven cost changes through utilization andcustomer pricing strategies; however, gross profit margins still are likely tobe affected when compared over time.

Within both GraceDavison and Grace Performance Chemicals, we conduct certain business activitiesin various countries through joint ventures with unaffiliated thirdparties.  Minority interest inconsolidated entities decreased due to lower earnings of our joint ventures.

***Pre-tax Income (Loss) fromNoncore Activities***–****Pre-tax income (loss) from noncore activitiesreflects financial matters unrelated to our core operations.  This category of costs and income is expectedto be volatile as potentially material items

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are addressed through our Chapter 11 proceedingsand/or as the financial implications of our legal contingencies becomeapparent. Some noncore activities are shown as separate items on theConsolidated Statement of Operations. Those not separately listed are primarily included in selling, generaland administrative expenses and in other (income) expense. The table belowshows the components of noncore activities, and the captions in which eachcomponent is presented in the Consolidated Statements of Operations:
| ** **                                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(In millions)**                                       | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| COLI income, net                                             | ** ** | **$**                                            | **2.0**    |   | $ | 1.2 |   |
| Translation  effects – intercompany loan                | ** ** | **2.8**                                          |       | 3.0 |   |
| Value of  currency contracts                                 | ** ** | **(2.1**                                         | **)**      | (2.8 | ) |
| Gain on sale of  real estate                                 | ** ** | **0.6**                                          |       | — |   |
| Other                                                        | ** ** | **(0.4**                                         | **)**      | (1.2 | ) |
| **Total  other income (expense), net**                       | ** ** | **$**                                            | **2.9**    |   | $ | 0.2 |   |
| D&O  insurance cost – portion related to Chapter 11 | ** ** | **$**                                            | **(1.5**   | **)** | $ | (1.5 | ) |
| Asbestos  administration                                     | ** ** | **(2.7**                                         | **)**      | (2.9 | ) |
| Postretirement  benefit costs – divested businesses     | ** ** | **0.6**                                          |       | 0.9 |   |
| Stock  appreciation rights                                   | ** ** | **—**                                       |       | (2.6 | ) |
| Legal defense  costs                                         | ** ** | **(2.6**                                         | **)**      | (10.4 | ) |
| Other                                                        | ** ** | **(0.5**                                         | **)**      | (1.1 | ) |
| **Total  selling, general and administrative expenses**      | ** ** | **$**                                            | **(6.7**   | **)** | $ | (17.6 | ) |
| Net pension  costs – divested businesses                | ** ** | **(2.0**                                         | **)**      | (2.7 | ) |
| **Total  net pension expense**                               | ** ** | **$**                                            | **(2.0**   | **)** | $ | (2.7 | ) |
| **Total pre-tax income (loss)  from noncore activities**     | ** ** | **$**                                            | **(5.8**   | **)** | $ | (20.1 | ) |

 

Pre-tax income(loss) from noncore activities in the three months ended March 31, 2007 wasattributable primarily to: (1) legal defense costs of $2.6 million related tothe Montana and New Jersey legal proceedings (see Note 12 to the ConsolidatedFinancial Statements for more information).  Pre-tax income (loss) from noncore activitiesin the three months ended March 31, 2006 was attributable primarily to: (1)legal defense costs of $10.4 million related to the Montana and New Jerseylegal proceedings, and (2) an accrual for stock appreciation rights of $2.6million.

InMarch 2004, we began accounting for currency fluctuations on a €293 millionintercompany loan between our subsidiaries in the United States and Germany asa component of operating results instead of as a component of othercomprehensive income. This change was prompted by an analysis of new tax lawsin 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, weentered into a series of foreign currency forward contracts with a U.S. bank tomitigate future currency fluctuations on the remaining loan balance. Contractamounts of €200.7 million were extended in June 2005 at varying rates and haveterms that coincide with loan repayments due periodically through December2008.  As part of the contract extension,we were required to pay a settlement premium of $9.3 million to the bank. Weexpect to recover this settlement premium over time as the contracts aresettled at rates greater than the initial rates in the May 2004 foreigncurrency forward contracts.  For thethree months ended March 31, 2007 and 2006, respectively, €18.2 million and€11.0 million of loan principal was repaid. For the three months ended March31, 2007 and 2006, we recognized a $2.1 and a $2.8 million contract loss,respectively, offset by a $2.8 million and a $3.0 million foreign currencygain, respectively.

***Chapter 11 Expenses***–****Although we are unable to measure precisely 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 representative of future asbestos claimants, incur, reduced by interestincome earned on cash and cash equivalents held by our entities subject toChapter 11. We pay for the costs of all committees, and the committees’advisors.  These costs fluctuate with theactivity in our Chapter 11 proceedings.

Chapter 11expenses increased due to a higher level of activity in our bankruptcyproceeding related to claims adjudication and estimation.  Our pre-tax income from core operationsincluded expenses for Chapter 11-related compensation charges of $3.1 million and$3.2 million for the three months ended March 31, 2007 and 2006,respectively.  Because of the uncertainoutcome of the Chapter 11 proceeding and the volatility and speculative natureof Grace common stock, we changed our long-term incentive compensation from anequity-based to a cash-based program.

We incur numerousother indirect costs to manage the Chapter 11 proceedings such as: managementtime devoted to Chapter 11 matters; added cost of

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debt capital;added costs of general business insurance, including D&O liabilityinsurance premiums; and lost business and acquisition opportunities due to thecomplexities and restrictions of operating under Chapter 11.

***Interest******Expense*** – Net interest expense for thethree months ended March 31, 2007 increased compared with the prior year perioddue to the increase in the prime interest rate used to accrue interest onpre-petition bank debt. The plan of reorganization states that each holder ofan allowed general unsecured claim shall be paid in full, plus post-petition interest. Post-petition interest shall accrue through the date ofpayment as follows:

·                  Forthe 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, adjustedfor periodic changes, and compounded quarterly. The effective rates onpre-petition bank debt for the three months ended March 31, 2007 and 2006 were8.25% and 7.43%, respectively.

·                  Forthe holders of claims who, but for the Chapter 11 filing, would be entitledunder a contract or otherwise to accrue or be paid interest on such claim in anon-default (or non-overdue payment) situation under applicable non-bankruptcylaw, the rate provided in the contract between the Grace entity and theclaimant or such rate as may otherwise apply under applicable non-bankruptcylaw.

·                  Forall other holders of allowed general unsecured claims, at a rate of 4.19% perannum, compounded annually.

The effectiveinterest rates for the three months ended March 31, 2007 and 2006 were 7.00%and 6.42%, respectively.  Such interest,which under the plan of reorganization is payable 85% in cash and 15% in Gracecommon stock, will not be paid until the plan of reorganization is confirmedand funded.

***Income Taxes***–****Income tax provision at the federalcorporate rate of 35% for the three months ended March 31, 2007 and 2006 was$6.9 million and $1.6 million, respectively.  The primary differences between these amounts and the overall provisionfor income taxes are due to interest on tax contingencies and thenon-deductibility of certain Chapter 11 expenses.  The increase in our income tax provision isprimarily driven by our increased pre-tax income from core operations.  The adoption of FIN 48 did not have amaterial effect on our income tax provision in the three months ended March 31,2007.

**OperatingSegment Overview**

The following is an overview of financial measures of the performance ofour operating segments for the three months ended March 31, 2007 compared withthe prior year period.

***Grace Davison***

**Net Sales by Region**
| ** **              | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|
| **(In millions)**  | ** ** | **2007**                                             | ** ** | **2006** | ** ** | **$ Change  Fav  (Unfav)** | ** ** | **% Change  Fav  (Unfav)** | ** ** |
|                    |       |                                                 |       |   |   |   |   |   |   |
| North America           | ** ** | **$**                                                | **125.9**  |   | $ | 132.7 |   | $ | (6.8 | ) | (5.1 | )% |
| Europe                  | ** ** | **180.1**                                            |       | 154.4 |   | 25.7 |   | 16.6 | % |
| Asia Pacific            | ** ** | **63.8**                                             |       | 58.1 |   | 5.7 |   | 9.8 | % |
| Latin America           | ** ** | **17.9**                                             |       | 11.2 |   | 6.7 |   | 59.8 | % |
| **Total Grace Davison** | ** ** | **$**                                                | **387.7**  |   | $ | 356.4 |   | $ | 31.3 |   | 8.8 | % |

 

*Sales*

The key factors contributing to the Grace Davison sales increase were:

·                  Sellingprice increases implemented to partially offset cost inflation of certaincommodity raw materials;

·                  Highervolume of fluid cracking catalysts in most geographic regions from strongereconomic activity and from the success of strategic growth initiatives; and

·                  Favorabletranslation effects from sales denominated in foreign currencies.

European salesincreased from the prior year period due to growth in volume and higher sellingprices.  North American sales decreasedfrom the prior year period, primarily as a result of order patterns in the U.S.and lower sales in Canada of hydroprocessing catalysts.  Asia Pacific and Latin America salesincreased with strong volume growth in Latin America and Asia Pacific from newbusiness.

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

Grace Davisonoperating income increased compared with 2006 primarily due to higher sellingprices and a better product mix, coupled with lower operating expenses as apercentage of sales, reflecting successful growth and productivity initiatives.

We report 100% of salesfor the Advanced Refining Technologies LLC joint venture, but only account for55% of the income in our measure of operating performance. Income of this jointventure decreased from the prior year quarter due to order patterns in the U.S.,lower sales in Canada and higher material costs.

***Grace Performance Chemicals***

**Net Sales by Region**
| ** **                             | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|
| **(In millions)**                 | ** ** | **2007**                                             | ** ** | **2006** | ** ** | **$ Change  Fav  (Unfav)** | ** ** | **% Change  Fav  (Unfav)** | ** ** |
|                                   |       |                                                 |       |   |   |   |   |   |   |
| North America                          | ** ** | **$**                                                | **140.7**  |   | $ | 147.2 |   | $ | (6.5 | ) | (4.4 | )% |
| Europe                                 | ** ** | **115.0**                                            |       | 92.6 |   | 22.4 |   | 24.2 | % |
| Asia Pacific                           | ** ** | **46.9**                                             |       | 40.2 |   | 6.7 |   | 16.7 | % |
| Latin America                          | ** ** | **25.3**                                             |       | 22.2 |   | 3.1 |   | 14.0 | % |
| **Total Grace Performance  Chemicals** | ** ** | **$**                                                | **327.9**  |   | $ | 302.2 |   | $ | 25.7 |   | 8.5 | % |

 

*Sales*

The key factorscontributing to the Grace Performance Chemicals sales increase were:

·                  Highervolumes of commercial construction products worldwide;

·                  Highervolume and selling prices for Darex® packaging technologies worldwide; and

·                  Favorabletranslation effects from sales denominated in foreign currencies.

Sales in Europeand Asia Pacific increased from the prior year period primarily as a result ofstrong economic activity in those regions and favorable weatherconditions.  Sales in North Americadecreased from the prior year period primarily due to reduced volumes ofconstruction products from a nearly 30% reduction in U.S. housing starts.  Latin American sales primarily benefited fromincreased sales of Darex® products.

*OperatingIncome and Margin*

Grace Performance Chemicals operating income increased primarily due tosales volume growth in geographic regions other than North America and sellingprice increases in response to raw material cost inflation, partially offset bylower sales of construction products in the United States.

***Operating Returns on Assets Employed***–****The following tables setforth the Grace Davison and Grace Performance Chemicals total asset positionand pre-tax return on average total assets as of March 31, 2007 and December31, 2006.  We use the measure pre-taxreturn on average total assets as an indicator of our efficiency in using ourassets and allocating our resources to generate earnings.  We devote significantly higher capital to themanufacture of Grace Davison products than to the manufacture of GracePerformance Chemicals products. Conversely, non-manufacturing costs, particularlyselling expenses, are significantly higher for Grace Performance Chemicals thanfor Grace Davison.

**Grace****Davison**
| **(In millions)**                                       | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                                                         |       |                     |       |                        |       |
| Trade  receivables                                           | ** ** | **$**                    | **190.6**  |                        | $          | 180.4 |   |
| Inventory                                                    | ** ** | **203.7**                |       | 192.3                       |       |
| Other current  assets                                        | ** ** | **27.7**                 |       | 15.8                        |       |
| Total current assets                                         | ** ** | **422.0**                |       | 388.5                       |       |
| Properties and  equipment, net                               | ** ** | **401.0**                |       | 402.3                       |       |
| Goodwill and  other intangible assets                        | ** ** | **107.9**                |       | 108.4                       |       |
| Total assets                                                 | ** ** | **$**                    | **930.9**  |                        | $          | 899.2 |   |
| Pre-tax return on  average total assets (trailing 12 months) | ** ** | **19.5**                 | **%**      | 18.7                        | %          |

 

Grace Davison’stotal assets increased by $31.7 million due to higher trade receivables causedby increased sales, and higher inventory in response to sales growth andseasonality.

**Grace****Performance Chemicals**
| **(In millions)**                                       | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                                                         |       |                     |       |                        |       |
| Trade receivables                                            | ** ** | **$**                    | **255.3**  |                        | $          | 245.1 |   |
| Inventory                                                    | ** ** | **103.1**                |       | 92.2                        |       |
| Other current assets                                         | ** ** | **17.6**                 |       | 16.9                        |       |
| Total current assets                                         | ** ** | **376.0**                |       | 354.2                       |       |
| Properties and  equipment, net                               | ** ** | **243.6**                |       | 242.0                       |       |
| Goodwill and other  intangible assets                        | ** ** | **92.5**                 |       | 92.6                        |       |
| Other assets                                                 | ** ** | **6.2**                  |       | 6.0                         |       |
| Total assets                                                 | ** ** | **$**                    | **718.3**  |                        | $          | 694.8 |   |
| Pre-tax return on  average total assets (trailing 12 months) | ** ** | **25.1**                 | **%**      | 25.2                        | %          |

 

Grace PerformanceChemicals’ total assets increased by $23.5 million, mainly due to higher tradereceivables as a result of increased sales and higher inventory to supportsales growth.

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**NoncoreLiabilities**

We have a numberof financial 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 followingtable summarizes our net noncore liabilities at March 31, 2007 and December 31,2006:

**Net****Noncore Liabilities**
| **(In millions)**                 | ** ** | **March 31,  2007** | ** **   | **December 31,  2006** | ** ** |
|----------------------------------------|------------|--------------------------|--------------|-----------------------------|------------|
| ** **                             | ** ** | ** **               | ** **   | ** **                  | ** ** |
| 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             | ** ** | **(358.3**               | **)**        | (361.1                      | )          |
| Postretirement  benefits               | ** ** | **(73.8**                | **)**        | (72.7                       | )          |
| Income taxes                           | ** ** | **(101.7**               | **)**        | (141.2                      | )          |
| Retained  obligations and other        | ** ** | **(37.2**                | **)**        | (23.3                       | )          |
| **Net noncore liability**              | ** ** | **$**                    | **(1,771.0** | **)**                       | $          | (1,798.3 | ) |

 

The resolution ofmost of these noncore recorded and contingent liabilities will be determinedthrough the Chapter 11 proceedings. We cannot predict with any certainty how,and for what amounts, any of these contingencies will be resolved. The amountsof these liabilities as ultimately determined through the Chapter 11proceedings could be materially different from amounts recorded at March 31,2007.

**Plan ofReorganization**

As described under“Voluntary Bankruptcy Filing” in Notes 1 and 2 to the Consolidated FinancialStatements, Grace and our principal U.S. operating subsidiary aredebtors-in-possession under Chapter 11 of the bankruptcy code. Our non-U.S.subsidiaries, although not part of the Chapter 11 filing, are owned directly orindirectly by our principal operating subsidiary or other filing entities.Consequently, we expect that any Chapter 11 plan of reorganization, includingour proposed plan of reorganization, will involve the combined value of ourglobal businesses 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 that amended ouroriginal plan of reorganization and disclosure statement filed on November 13,2004 to address certain objections of creditors and other interested parties.The plan of reorganization is supported by committees representing generalunsecured creditors and shareholders, but is not supported by committeesrepresenting asbestos personal injury claimants and asbestos property damageclaimants or the representative of future asbestos claimants.  See Note 2 to the Consolidated FinancialStatements for more information on the plan of reorganization.

***Risks of the Plan of Reorganization*** –We intend to address all pending and future asbestos-related claims and allother pre-petition claims as outlined in the plan of reorganization. However,we may not be successful in obtaining approval of the plan of reorganization bythe bankruptcy court.  Instead, amaterially different plan of reorganization may ultimately be approved and,under the ultimate plan of reorganization, the interests of our shareholderscould be substantially diluted or cancelled. The value of Grace common stock followinga plan of reorganization, and the extent of any recovery bynon-asbestos-related creditors, will depend principally on the amount of ourasbestos-related liability under a confirmed plan of reorganization.

Our proposed planof reorganization assumes several fundamental conditions including that:

·                  Ourasbestos-related liabilities can be resolved at a net present value cost of nomore than $1,700 million (including $87 million for pre-petitionasbestos-related contractual settlements and judgments), including all propertydamage claims (including claims related to our former Zonolite AtticInsulation, or ZAI, product) and all pending and future personal injury claims;and

·                  Thebenefit of assets from litigation settlement agreements with Sealed Air Corporationand its subsidiary, Cryovac, Inc., and Fresenius Medical Care Holdings, Inc.will be available to satisfy liabilities under the plan of reorganization.

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There can be noguarantee that these two fundamental conditions can be met. The measure of ourasbestos-related liabilities could be settled by the bankruptcy court (inconformity with the plan of reorganization or otherwise), by a negotiation withinterested parties, and/or under an alternative plan.

Any resolution,other than that reflected in the plan of reorganization, could have a materialadverse effect on the percentage of Grace common stock to be retained by ourcurrent shareholders beyond that reflected in the proforma financialinformation presented below. We will adjust our financial statements and theproforma effects of the plan of reorganization as facts and circumstanceswarrant.

***Proforma Financial Information*** – Theunaudited proforma financial information presented below reflects theaccounting effects of our proposed plan of reorganization (1) as if it were putin effect on the date of our most recent consolidated balance sheet – March 31,2007, and (2) as if it were in effect for (a) the full year ended December 31,2006, and (b) the three months ended March 31, 2007. Proforma adjustments fortax effects have been applied at a 35% tax rate.  The proforma financial information includedherein, may not be consistent with the plan of reorganization documents filedon January 13, 2005 due to subsequent changes in operations and accountingestimates. Such proforma financial statements reflect how our assets,liabilities, equity and income would be affected by the plan of reorganizationas follows:

A.                 Borrowings UnderNew Debt Agreements and Contingencies

The plan of reorganization reflects the assumptionthat $1,000 million in debt financing will be available to fund settled claimspayable at the effective date of the plan of reorganization (approximately $800million) and to provide working capital (approximately $200 million) for continuingoperations.  No such financing currentlyexists but, we expect, based on discussions with prospective lenders, oursustained level of core operations while we have operated under Chapter 11, andpublicly available information regarding funding available to comparablecompanies, that we could obtain financing at this level before the plan ofreorganization is effective.  Inaddition, the proforma financial information reflects $150 million incontingencies to pay professional and bank fees, other non-operatingliabilities and their related tax effects that will not become liabilitiesuntil the effective date of the plan of reorganization. The $26.3 millionadjustment to increase deferred taxes reflects the tax impact on $150 millionin contingencies as described above, of which we estimate 50% would bedeductible for tax purposes. Proforma adjustments related to the borrowingsunder new debt financing and contingencies have been denoted by the capitalletter **“A”** in the proforma balancesheet presented below.

B.                   Fresenius andSealed Air Settlements

The plan ofreorganization reflects the value, in the form of cash and securities, expectedto be realized under litigation settlement agreements as follows: $115.0million of cash from Fresenius; and, $1,213.2 million of estimated value fromCryovac, Inc., a subsidiary of Sealed Air (calculated as of March 31, 2007) inthe form of $512.5 million of cash plus accrued interest at 5.5% from December21, 2002 compounded annually (approximately $131.9 million), and 18 millionshares (reflecting a recent two-for-one stock split) of Sealed Air common stockvalued at $31.60 per share (approximately $568.8 million). Tax accounts havebeen adjusted to reflect the satisfaction of our recorded liabilities by way ofthese third-party agreements. The Fresenius settlement amount will be payabledirectly to Grace and will be accounted for as income; however, we havepresented the amount of the settlement as a proforma balance sheet adjustmentonly in order to avoid distorting the predictive value of the proformastatement of operations with this one-time gain. Payments under the Sealed Airsettlement will be paid directly to the asbestos trust by Cryovac and will beaccounted for as satisfaction of a portion of our recorded asbestos-relatedliability and a credit to shareholders’ equity. Both the Sealed Air andFresenius settlements are subject to the fulfillment of specified conditions.The $(40.3) million adjustment to deferred income taxes in the proforma balancesheet below represents the tax impact of the $115.0 million Freseniussettlement.  The $(424.6) millionadjustment to deferred income taxes represents the tax impact of the $1,213.2million Sealed Air settlement. Proforma adjustments related to the Freseniusand Sealed Air settlements have been denoted by the capital letter **“B”** in the proforma balance sheet presentedbelow.

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C.      Payment of Pre-Petition Liabilities

The plan of reorganization reflects the transfer offunds and securities to settle estimated obligations payable under the plan ofreorganization at the effective date. We would be required to issueapproximately 16.9 million shares of Grace common stock, based on the closingprice per share of $26.42 on March 31, 2007, for total proceeds of $446.9million, and utilize cash of $1,080.1 million to settle these estimatedobligations (see the adjustments denoted by the capital letter **“C”** in the proforma balance sheetbelow).  The following table provides acalculation of the proforma share issuance:

**Proforma Issuance of Shares**
| **($ and shares in millions)**                                                 | ** ** | **March 31, 2007** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
|                                                                                               |       |                         |       |
| Payment of  asbestos claims                                                                        |       | $                            | 356.8      |   |
| Less: portion  related to general unsecured claims                                                 |       | (87.0                        | )          |
|                                                                                               |       | $                            | 269.8      |   |
| Value of  unsecured claims paid with equity (15%)                                                  |       | 177.1                        |       |
| Equity value  distributable at emergence (16.9 million shares)                                     |       | $                            | 446.9      |   |
| Equity value  distributable post-emergence for PI-AO claims (4.9 million shares)                   |       | 130.0                        |       |
| Total value of  equity to satisfy claims                                                           |       | $                            | 576.9      |   |
| Closing price of  shares at 3/31/07                                                                |       | $                            | 26.42      |   |
| Proforma shares  to satisfy asbestos and general unsecured claims and post-emergence PI-AO  claims |       | 21.8                         |       |
| Add: Shares  issuable upon exercise of in-the-money stock options                                  |       | 3.7                          |       |
| **Proforma issuance of shares**                                                                    |       | 25.5                         |       |

 

In our proformapresentation, we have assumed that our emergence from bankruptcy will give riseto 1) the payment of pre-petition liabilities, 2) the Fresenius/Sealed Airpayments, and 3) the securing of emergence financing by non-U.S. subsidiariesand payment of dividends as further described below

The paymentsresult in changing the source of our tax assets from reserves fortax-deductible obligations such as asbestos claims and environmental claims totime-limited tax net operating losses (see the adjustments denoted by thecapital letter **“D”** in the proformabalance sheet below).  We have assumednon-asbestos and pass-through liabilities will be paid in cash when due.  A portion of the funding required to meet ouremergence obligations will involve repatriating monies through a dividend fromcertain non-U.S. subsidiaries.  Webelieve that the reserve related to repatriation of funds presently recordedwill be adequate to absorb the U.S. tax effects of this dividend, assuming thatwe employ (as intended) certain tax planning strategies to preserve our netoperating losses.

The followingtable presents a detailed description of the proforma tax effects of thesepayments on the balance of both (i) net operating loss carryforwards and (ii)temporary differences, net of valuation allowance.

**Summary of Change in Deferred TaxAsset Balances**
| **(In millions)**                  | ** ** | **Tax Effects of  Net Operating  Loss Carry-  Forwards** | ** ** | **Temporary  Differences, Net  of Valuation  Allowance** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| **March  31, 2007 Balance As Reported** |       | $                                                                            | 97.9       |                                                               | $          | 626.3 |   |
| **Proforma  Adjustments:**              |       |                                                                         |       |                                                               |       |
| Contingent  liabilities                 |       | —                                                                       |       | 26.3                                                               |       |
| Fresenius payment                       |       | (40.3                                                                        | )          | —                                                             |       |
| Sealed Air  payment                     |       | —                                                                       |       | (424.6                                                             | )          |
| **Emergence  Payments & Other:**    |       |                                                                         |       |                                                               |       |
| Accrued interest                        |       | 60.7                                                                         |       | (60.7                                                              | )          |
| Asbestos claims                         |       | 124.9                                                                        |       | (124.9                                                             | )          |
| Environmental  claims                   |       | 84.5                                                                         |       | (84.5                                                              | )          |
| Special pensions                        |       | 4.9                                                                          |       | (4.9                                                               | )          |
| Insurance  recovery                     |       | (175.0                                                                       | )          | 175.0                                                              |       |
| Repatriation of  foreign earnings       |       | (123.0                                                                       | )          | 123.0                                                              |       |
| Other                                   |       | 13.0                                                                         |       | (13.0                                                              | )          |
| Subtotal                                |       | (10.0                                                                        | )          | 10.0                                                               |       |
| **March 31, 2007 Proforma Balance**     |       | $                                                                            | 47.6       |                                                               | $          | 238.0 |   |

 

D.                  Proforma Consolidated Statement of Operations andCapital Structure

The proforma income adjustments to our March 31, 2007and December 31, 2006 Consolidated Statements of Operations consist of:

·                  The elimination of all recorded chargesand expenses directly related to Chapter 11, as these costs would not continueafter effectiveness of the Plan, and the elimination of provisions recorded forenvironmental remediation obligations as we expect this risk would be resolvedunder the Plan (these eliminations are denoted by the capital letter **“E”** in the proforma statements ofoperations below);

·                  Adjustments to reduce Selling, Generaland Administrative Expenses and Other Income to eliminate noncore legalexpenses, and noncore insurance income related to asbestos litigation, as theliabilities to which these noncore activities relate would be resolved as part ofthe Plan (these adjustments are denoted by the letter **“F”** in the proforma statements ofoperations below);

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·                  The elimination of interest expenseassociated with pre-petition bank debt, and the addition of interest expenseassociated with the new $1,000.0 million in financing as discussed above, whichresults in the net increase in interest expense denoted by the adjustmentsmarked by the letter **“G”** in theproforma statements of operations below;

·                  The tax effects of the proformastatements of operations adjustments at our effective tax rate (see theadjustments denoted by the capital letter **“H”**in the proforma statements of operations below); and

·                  The addition of new shares of Gracecommon stock related to the assumed financing of the plan of reorganization(see the adjustments denoted by the capital letter **“I”** in the proforma statements of operations below).

Proforma expenses for both periods presented reflectan assumed 7.4% average interest rate on outstanding borrowings, based onmarket conditions as of March 31, 2007 and December 31, 2006.  A hypothetical 1/8 percent variance ininterest rates would increase or decrease our proforma net income (loss) byapproximately $0.1 million for the three months ended March 31, 2007 and byapproximately $0.7 million for the year ended December 31, 2006.

For purposes ofproforma earnings per share and proforma share capital, we used the tradingprice of $26.42 per share as of March 31, 2007 and $19.80 per share as ofDecember 31, 2006 for calculating issued and outstanding shares. At the pershare valuation of $26.42 as of March 31, 2007, we assume that 16.9 millionshares will be issued at the effective date of the plan of reorganization tofund asbestos and general unsecured claims, 4.9 million shares would be issuableupon exercise of warrants to satisfy our estimate of PI-AO claims, and 3.7million shares would be issued upon exercise of in-the-money stock options. Wepresent the trading value solely to show proforma Consolidated Statements ofOperations. This trading value may not be indicative of the actual tradingvalue of Grace common stock following the effective date of the plan ofreorganization.  If our distributablevalue per share at the effective date of the plan of reorganization is belowapproximately $6.00 per share, we would be required to revalue our balancesheet for a change in control. (The trading value of Grace common stock overthe twelve-month period ended March 31, 2007 was between $8.12 and $26.83 pershare.) These proforma financial statements reflect no change in assets orincome related to this potential accounting outcome.

E.                    Non-asbestos Contingencies

The accompanying proformafinancial information assumes all non-asbestos related contingencies (includingenvironmental, tax and civil and criminal litigation) are settled for recordedamounts as of March 31, 2007.  Certainliabilities are assumed to be paid at the effective date of the plan ofreorganization based on our estimate of amounts that will be determinable andpayable. The remainder, which would also be subject to the plan ofreorganization, if approved, is assumed to be paid subsequent to the effectivedate of the plan of reorganization as amounts are either not due until a laterdate or will be determined through post-effective-date litigation. The ultimatevalue of such claims may change materially as Chapter 11 and other legalproceedings further define our non-asbestos related obligations.

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**W. R. Grace & Co andSubsidiariesProforma Condensed Consolidated Balance Sheet**
| ** **                                                                      | ** ** | ** **                                     | ** ** | **Proforma Adjustments**                                                | ** **        | ** **                             | ** **        |
|---------------------------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------------------------------|-------------------|----------------------------------------|-------------------|
| **(In millions)**                                                          | ** ** | **March 31, 2007  As Reported** | ** ** | **Borrowings Under  New Debt  Agreements and  Contingencies** | ** **        | **Sealed  Air/Fresenius  Settlements** | ** **        | **Payment of Pre-  Petition Liabilities** | ** ** | **March 31, 2007  Proforma** | ** ** |
| **ASSETS**                                                                      |       |                                           |       |                                                                         |              |                                   |              |   |   |   |   |
| **Current  Assets**                                                             | ** ** | ** **                                     | ** ** | ** **                                                                   | ** **        | ** **                             | ** **        | ** ** | ** ** | ** ** | ** ** |
| Cash and cash  equivalents                                                      |       | $                                              | 479.3      |                                                                         | $                 | 800.0                                  | **  A** | $ | 115.0 | **  B** | $ | (1,080.1 | )**C** | $ | 314.2 |   |
| Other current  assets                                                           |       | 869.1                                          |       | —                                                                       |              | —                                 |              | — |   | 869.1 |   |
| **Total Current Assets**                                                        |       | 1,348.4                                        |       | 800.0                                                                        |              | 115.0                                  |              | (1,080.1 | ) | 1,183.3 |   |
| Non-current operating assets                                                    |       | 964.1                                          |       | —                                                                       |              | —                                 |              | — |   | 964.1 |   |
| Cash value of  life insurance                                                   |       | 91.0                                           |       | —                                                                       |              | —                                 |              | — |   | 91.0 |   |
| Deferred income  taxes:                                                         |       |                                           |       |                                                                         |              |                                   |              |   |   |   |   |
| Net operating loss carryforwards                                                |       | 97.9                                           |       | —                                                                       |              | (40.3                                  | ) **B**           | (10.0 | )**D** | 47.6 | ** ** |
| Temporary differences, net of valuation allowance                               |       | 626.3                                          |       | 26.3                                                                         | **  A** | (424.6                                 | ) **B**           | 10.0 | ** D** | 238.0 |   |
| Asbestos-related insurance                                                      |       | 500.0                                          |       | —                                                                       |              | —                                 |              | — |   | 500.0 |   |
| **Total Assets**                                                                |       | $                                              | 3,627.7    |                                                                         | $                 | 826.3                                  |              | $ | (349.9 | ) | $ | (1,080.1 | ) | $ | 3,024.0 |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY  (DEFICIT)**                        | ** ** | ** **                                     | ** ** | ** **                                                                   | ** **        | ** **                             | ** **        | ** ** | ** ** | ** ** | ** ** |
| Total current liabilities                                                       |       | $                                              | 436.8      |                                                                         | $                 | —                                 |              | $ | — |   | $ | (0.8 | )**C** | $ | 436.0 |   |
| Long-term debt                                                                  |       | 0.2                                            |       | 800.0                                                                        | **  A** | —                                 |              | — |   | 800.2 |   |
| Other noncurrent liabilities                                                    |       | 497.8                                          |       | —                                                                       |              | —                                 |              | — |   | 497.8 |   |
| **Total Liabilities Not Subject to Compromise**                                 |       | 934.8                                          |       | 800.0                                                                        |              | —                                 |              | (0.8 | )**C** | 1,734.0 |   |
| Bank debt/letters of credit/capital leases                                      |       | 755.5                                          |       | —                                                                       |              | —                                 |              | (755.5 | )**C** | — |   |
| Liability for asbestos-related litigation and claims                            |       | 1,700.0                                        |       | —                                                                       |              | (1,213.2                               | ) **B**      | (356.8 | )**C** | 130.0 | ** ** |
| Liability for environmental remediation                                         |       | 358.3                                          |       | —                                                                       |              | —                                 |              | (241.5 | )**C** | 116.8 |   |
| Liability for postretirement health and special pensions                        |       | 160.4                                          |       | —                                                                       |              | —                                 |              | (13.2 | )**C** | 147.2 |   |
| Liability for accounts payable and litigation                                   |       | 139.2                                          |       | —                                                                       |              | —                                 |              | (102.3 | )**C** | 36.9 |   |
| Liability for tax claims and contingencies                                      |       | 101.7                                          |       | —                                                                       |              | —                                 |              | (6.9 | )**C** | 94.8 |   |
| Other nonoperating liabilities, including plan of  reorganization contingencies |       | —                                         |       | 150.0                                                                        | **  A** | —                                 |              | (50.0 | )**C** | 100.0 | ** ** |
| **Total Liabilities Subject to Compromise**                                     |       | 3,215.1                                        |       | 150.0                                                                        |              | (1,213.2                               | )                 | (1,526.2 | ) | 625.7 |   |
| **Total Liabilities**                                                           |       | 4,149.9                                        |       | 950.0                                                                        |              | (1,213.2                               | )                 | (1,527.0 | ) | 2,359.7 |   |
| **Shareholders’ Equity (Deficit)**                                         | ** ** | ** **                                     | ** ** | ** **                                                                   | ** **        | ** **                             | ** **        | ** ** | ** ** | ** ** | ** ** |
| Share capital                                                                   |       | 427.9                                          |       | —                                                                       |              | —                                 |              | 446.9 | ** C** | 874.8 |   |
| Retained earnings and other equity items                                        |       | (950.1                                         | )          | (123.7                                                                       | ) **A**           | 863.3                                  | **  B** | — | ** ** | (210.5 | ) |
| **Total Shareholders’ Equity (Deficit)**                                   |       | (522.2                                         | )          | (123.7                                                                       | )                 | 863.3                                  |              | 446.9 |   | 664.3 |   |
| **Total Liabilities and Shareholders’Equity (Deficit)**                    |       | $                                              | 3,627.7    |                                                                         | $                 | 826.3                                  |              | $ | (349.9 | ) | $ | (1,080.1 | ) | $ | 3,024.0 |   |

 

Note: Proforma amounts inliabilities subject to compromise will be reclassed to liabilities not subjectto compromise after the proposed plan is in effect.

**W. R. Grace & Co. and SubsidiariesProforma Consolidated Statements of Operations**
| ** **                                                                                              | ** ** | **Year Ended December 31, 2006** | ** ** | **Three Month Period Ended March 31, 2007** | ** **  |
|---------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------------------------------------------------|-------------|
| **(In millions, except per share amounts)**                                    | ** ** | **As  Reported**                                     | ** ** | **Proforma  Adjustments**                                                 | ** **  | **Proforma** | ** ** | **As  Reported** | ** ** | **Proforma  Adjustments** | ** ** | **Proforma** | ** ** |
| **Net Sales**                                                                                           |       | $                                                    | 2,826.5    |                                                                      | $           | — |   | $ | 2,826.5 |   | $ | 715.6 |   | $ | — |   | $ | 715.6 |   |
| Cost of goods sold,  exclusive of depreciation and amortization shown separately below                  |       | 1,845.0                                              |       | —                                                                    |        | 1,845.0 |   | 478.7 |   | — |   | 478.7 |   |
| Selling, general and  administrative expenses, exclusive of net pension expense shown separately  below |       | 560.9                                                |       | (74.4                                                                     | )**F**      | 486.5 |   | 127.5 |   | (6.8 | )**F** | 120.7 | ** ** |
| Depreciation and  amortization                                                                          |       | 113.5                                                |       | —                                                                    |        | 113.5 |   | 27.6 |   | — |   | 27.6 |   |
| Research and development  expenses                                                                      |       | 63.8                                                 |       | —                                                                    |        | 63.8 |   | 17.8 |   | — |   | 17.8 |   |
| Net pension expense                                                                                     |       | 63.7                                                 |       | —                                                                    |        | 63.7 |   | 12.7 |   | — |   | 12.7 |   |
| Interest expense and  related financing costs                                                           |       | 73.2                                                 |       | (12.9                                                                     | )**G**      | 60.3 |   | 19.4 |   | (4.3 | )**G** | 15.1 |   |
| Provision for  environmental remediation                                                                |       | 30.0                                                 |       | (30.0                                                                     | )**E**      | — |   | — |   | — | ** E** | — |   |
| Chapter 11 expenses, net  of interest income                                                            |       | 49.9                                                 |       | (49.9                                                                     | )**E**      | — |   | 17.8 |   | (17.8 | )**E** | — |   |
| Other (income) expense,  net                                                                            |       | (34.3                                                | )          | 12.5                                                                      | ** F** | (21.8 | ) | (8.0 | ) | — | ** F** | (8.0 | ) |
| **Total costs and expenses**                                                                            |       | 2,765.7                                              |       | (154.7                                                                    | )           | 2,611.0 |   | 693.5 |   | (28.9 | ) | 664.6 |   |
| **Income (loss) before income  taxes and minority interest**                                            |       | 60.8                                                 |       | 154.7                                                                     |        | 215.5 |   | 22.1 |   | 28.9 |   | 51.0 |   |
| Benefit from (provision  for) income taxes                                                              |       | (8.1                                                 | )          | (37.3                                                                     | )**H**      | (45.4 | ) | (14.9 | ) | (4.0 | )**H** | (18.9 | ) |
| Minority interest in  consolidated entities                                                             |       | (34.4                                                | )          | —                                                                    |        | (34.4 | ) | (2.4 | ) | — |   | (2.4 | ) |
| **Net income (loss)**                                                                                   |       | $                                                    | 18.3       |                                                                      | $           | 117.4 |   | $ | 135.7 |   | $ | 4.8 |   | $ | 24.9 |   | $ | 29.7 |   |
| **Basic earnings (loss) per  common share**                                                             |       | $                                                    | 0.27       |                                                                      | $           | — |   | $ | 1.53 |   | $ | 0.07 |   | $ | — |   | $ | 0.33 |   |
| Weighted average number  of basic shares                                                                |       | 67.9                                                 |       | 20.6                                                                      | ** I** | 88.5 |   | 69.4 |   | 20.6 | ** I** | 90.0 | ** ** |
| **Diluted earnings (loss) per  common share**                                                           |       | $                                                    | 0.27       |                                                                      | $           | — |   | $ | 1.45 |   | $ | 0.07 |   | $ | — |   | $ | 0.31 |   |
| Weighted average number  of diluted shares                                                              |       | 68.3                                                 |       | 25.5                                                                      | ** I** | 93.8 |   | 70.5 |   | 25.5 | ** I** | 96.0 | ** ** |

 

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**Financial Condition, Liquidityand Capital Resources**

***Chapter 11-Related Information***– See Note 2 to the Consolidated FinancialStatements.

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

***Environmental Matters***–****See Note 12 to the 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, we contributean amount equal to 100% of employee contributions, up to 6% of an individualemployee’s salary or wages. Our costs related to this benefit plan were $3.0million and $4.8 million for the three month periods ended March 31, 2007 and2006, respectively.

***Defined BenefitPension Plans***–****Wesponsor defined benefit pension plans for our employees in the United States,Canada, the United Kingdom, Australia, Germany, Italy, France, Spain, Denmark,Netherlands, Japan, Philippines, South Korea, Taiwan, South Africa, Brazil andMexico and fund government sponsored programs in other countries where weoperate.  Certain of our sponsored plansare advance-funded and others are pay-as-you-go. The advance-funded plans areadministered by trustees who direct the management of plan assets and arrangeto have obligations paid when due out of a trust. The most significantadvance-funded plans cover our salaried employees in the U.S. and U.K. andemployees covered by collective bargaining agreements at certain of our U.S.facilities.

The following table presents the components of netpension expense and cash contributions for the advance-funded and pay-as-you-goplans:

**Components of Net Pension Expense**
| ** **                                                          | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(In millions)**                                              | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Annual pension  benefits earned                                     | ** ** | **$**                                            | **6.2**    |   | $ | 6.3 |   |
| Interest on  opening liability – advance-funded plans          | ** ** | **16.5**                                         |       | 16.2 |   |
| Expected return  on funded assets                                   | ** ** | **(20.0**                                        | **)**      | (18.2 | ) |
| Net financing cost  (benefit) of advance-funded plans               | ** ** | **(3.5**                                         | **)**      | (2.0 | ) |
| Interest on  opening liability – pay-as-you-go plans           | ** ** | **2.9**                                          |       | 2.5 |   |
| Net pension  financing cost (benefit)                               | ** ** | **(0.6**                                         | **)**      | 0.5 |   |
| Amortization of:                                                    | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Plan changes related to prior service                               | ** ** | **0.8**                                          |       | 0.7 |   |
| Accumulated differences between actual and assumed  performance (1) | ** ** | **6.3**                                          |       | 7.3 |   |
| Net pension  catch-up expense                                       | ** ** | **7.1**                                          |       | 8.0 |   |
| **Total Net Pension Expense**                                       | ** ** | **$**                                            | **12.7**   |   | $ | 14.8 |   |

 

**Cash Contributions to DefinedBenefit Pension Plans**
| ** **                    | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------|------------|--------------------------------------------------|------------|
| **(In millions)**        | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| U.S.  advance-funded plans    | ** ** | **$**                                            | **16.2**   |   | $ | 8.7 |   |
| U.S.  pay-as-you-go plans     | ** ** | **1.3**                                          |       | 1.3 |   |
| Foreign advance-funded  plans | ** ** | **13.3**                                         |       | 2.1 |   |
| Foreign  pay-as-you-go plans  | ** ** | **1.6**                                          |       | 1.2 |   |
| **Total Cash Contributions**  | ** ** | **$**                                            | **32.4**   |   | $ | 13.3 |   |

 

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*(1)**       Primarily related to return on assets,termination, mortality, and data corrections*

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The followingtable presents the funded status of fully-funded, underfunded and unfundedpension plans as determined under U.S. generally accepted accounting principles:

**Funded Status of Pension Plans(3)**
| ** **                    | ** ** | **Fully-Funded (1) Pension Plans** | ** ** | **Underfunded (1) Pension Plans** | ** ** | **Unfunded (2) Pension Plans** | ** ** |
|-------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|------------------------------------------|------------|
| **(In millions)**        | ** ** | **March 31,  2007**                     | ** ** | **December 31,  2006**                 | ** ** | **March 31,  2007**                 | ** ** | **December 31,  2006** | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
| Projected  benefit obligation | ** ** | **$**                                        | **247.3**  |                                        | $          | 243.8                                    | ** ** | **$** | **961.2** |   | $ | 961.4 | ** ** | **$** | **231.2** |   | $ | 227.8 |   |
| Fair value of  plan assets    | ** ** | **296.5**                                    |       | 282.2                                       | ** ** | **750.6**                                |       | 738.5 | ** ** | **—** |   | — |   |
| Funded status (PBO  basis)    | ** ** | **$**                                        | **49.2**   |                                        | $          | 38.4                                     | ** ** | **$** | **(210.6** | **)** | $ | (222.9 | ) | **$** | **(231.2** | **)** | $ | (227.8 | ) |

 

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*(1)**       Plansintended to be advance-funded.*

*(2)**       Plans intended to be pay-as-you-go.*

*(3)  For ERISA purposes, funded status iscalculated on a different basis than under U.S. generally accepted accountingprinciples.*

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 $49.2 millionas of March 31, 2007, 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 $210.6 million as of March 31, 2007. Additionally, wehave several plans that are funded on a pay-as-you-go basis, and therefore, theentire PBO of $231.2 million at March 31, 2007 is unfunded.  The combined balance of the underfunded andunfunded plans was $441.8 million as of March 31, 2007 and is presented as aliability on the Consolidated Balance Sheet as follows - $10.7 million in “othercurrent liabilities,” $339.9 million in “underfunded defined benefit pensionplans” and $91.2 million in “liabilities subject to compromise.”

At the December31, 2006 measurement date for the U.S. advance-funded defined benefit pensionplans, the PBO was approximately $949 million as measured under U.S. generallyaccepted accounting principles. The PBO is measured as the present value (usinga 5.75% discount rate as of December 31, 2006) of vested and non-vestedbenefits earned from employee service to date, based upon current services andestimated future pay increases for active employees.  This discount rate is based on a high qualitybond portfolio designed to meet the payout pattern of the pension plans. Of theparticipants in the pension plans, approximately 82% are current retirees oremployees of our former businesses, which skews the payout pattern to thenearer term. Assets available to fund the PBO at December 31, 2006 wereapproximately $737 million, or approximately $212 million less than themeasured obligation.

Assets availableat March 31, 2007 to fund the PBO of the U.S. advance-funded defined benefitpension plans totaled approximately $749 million, up $12 million from December31, 2006, primarily as a result of current year contributions. It is ourintention to satisfy obligations under the pension plans and to comply with therequirements of the Employee Retirement Income Security Act of 1974 (“ERISA”).We have obtained bankruptcy court approval to fund all minimum requiredpayments under the Plans through April 2007. These payments reflect the impactof the Pension Protection Act of 2006, which extended the interest ratesrequired under the Pension Funding Equity Act of 2004 for plan years commencingin 2006 and 2007.  In that regard, wecontributed $71 million in 2006, $16 million in January 2007, and $21 millionin April 2007, to the trusts that hold assets of the Plans.  While we intend to continue to fund allminimum required payments under the Plans, there can be no assurance that thebankruptcy court will continue to approve the funding needs of the 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; $14.9million was funded during the three months ended March 31, 2007.

We expect totalpension expense for 2007 to be approximately $51 million, and benefit paymentsto retirees to aggregate approximately $109 million for all pension programs in2007.

***Postretirement Benefits Other Than Pensions***–****We provide certain health care and life insurance benefits forretired employees, a large majority of whom are retirees of divestedbusinesses. These plans are unfunded, and we pay the costs of benefits underthese plans as they are incurred. Our share of benefits under this program was$2.9 million during the three months ended March 31, 2007, compared with $2.2million in the prior year period. In addition, we received Medicare subsidypayments of $2.7 million during the three months ended March 31, 2007.  Our recorded liability for postretirementbenefits of $73.8 million at March 31, 2007 is stated at net present valuediscounted

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at 5.75% (asdiscussed under Defined Benefit Pension Plans). Our proposed plan ofreorganization provides for the continuation of these benefits.

***Cash Resources and Available Credit Facilities***–****AtMarch 31, 2007, we had $479.3 million in cash and cash equivalents and $91.0million in net cash value of life insurance. In addition, we had access tocommitted credit facilities in the U.S., Germany and France.  In the U.S., under the $250.0 million DIPfacility, $192.5 million was available at March 31, 2007, net of letters ofcredit and holdback provisions. The term of the DIP facility expiresApril 1, 2008. In Germany, under a €10.0 million line of credit, we had accessto €0.4 million at March 31, 2007, net of bankers guarantees and otherholdbacks. The term of the facility expires July 31, 2007.  In France, under a €3.5 million line ofcredit, we had access to €3.5 million at March 31, 2007, net of bankersguarantees. The term of the facility expires May 31, 2007 and is expected to berenewed for an additional one-year period. Webelieve that these funds and credit facilities will be sufficient to financeour business strategy while in Chapter 11.

In January 2007, our German subsidiary entered into aline of credit arrangement with a German financing company in the maximumaggregate amount of €50.0 million secured by the accounts receivable of theGerman subsidiary.  The financingarrangement will terminate on December 31, 2009, and includes financing costsbased on the EURIBOR rate of interest, plus a minimum annual fee. The line wassecured to provide liquidity for either our plan of reorganization or to fundgrowth in that region.  We have not drawnon this line of credit to date.  The€53.9 million of available credit (including the non-U.S. amounts above)approximated $71.9 million at March 31, 2007.

***Debt and Other Contractual Obligations***–******Total debtoutstanding at March 31, 2007 was $757.8 million, including $240.5 million of accruedinterest on pre-petition debt.  As aresult of the Chapter 11 filing, we are now in default on $515.0 million ofpre-petition debt, which, together with accrued interest thereon, has beenincluded in “liabilities subject to compromise” as of March 31, 2007. Theautomatic stay provided under the bankruptcy code prevents our lenders fromtaking any action to collect the principal amounts as well as related accruedinterest. However, we will continue to accrue and report interest on such debtduring the Chapter 11 proceedings unless further developments lead managementto conclude that it is probable that such interest will be compromised.

See Note 12 to theConsolidated Financial Statements for a discussion of financial assurances.

**Analysis of Cash Flows**

Ournet cash flow from operating activities for the three months ended March 31,2007 was a negative $49.0 million, compared with a negative $37.1 million forthe prior year period. We attribute the lower net cash flow in the firstquarter of 2007 to higher contributions to pension plans and dividends to jointventure partners. Net cash used for investing activities was $23.2 million,primarily relating to routine capital improvements and capacity expansion attwo sites in the United States.  Net cashinflow from financing activities was $12.4 million, primarily from cashreceived from stock option exercises.

***Cash Flow From Core Operations***–****The following table presents the components of net cash flow from core operations for the threemonths ended March 31, 2007 and 2006.

**Core Operations**
| ** **                                               | ** ** | **Three Months  Ended  March 31,** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------|------------|
| **(In millions)**                                   | ** ** | **2007**                                     | ** ** | **2006** | ** ** |
| **Cash  flows:**                                         | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Pre-tax  operating income                                | ** ** | **$**                                        | **60.6**   |   | $ | 47.8 |   |
| Depreciation and  amortization                           | ** ** | **27.6**                                     |       | 28.1 |   |
| **Pre-tax  income before depreciation and amortization** | ** ** | **88.2**                                     |       | 75.9 |   |
| Working capital  and other changes                       | ** ** | **(102.3**                                   | **)**      | (82.3 | ) |
| **Cash  flow before investing**                          | ** ** | **(14.1**                                    | **)**      | (6.4 | ) |
| Capital  expenditures                                    | ** ** | **(24.1**                                    | **)**      | (24.1 | ) |
| **Net cash flow from core  operations**                  | ** ** | **$**                                        | **(38.2**  | **)** | $ | (30.5 | ) |

 

We expect tocontinue to invest excess cash flow and/or other available capital resources inour core business base. These investments are likely to be in the form ofadditional plant capacity, product line extensions and geographic marketexpansions, and/or acquisitions in existing product lines.  Investments that are outside the ordinarycourse of business may be subject to bankruptcy court approval and review bythe Chapter 11 creditor committees.

***Cash Flow From Noncore Activities***– The cash flow from our noncoreactivities can be volatile.******Expenditures are generally governed by bankruptcy

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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 noncoreactivities for the three months ended March 31, 2007 and 2006.

**Noncore Activities**
| ** **                                     | ** ** | **Three Months  Ended  March 31,** | ** ** |
|------------------------------------------------|------------|----------------------------------------------|------------|
| **(In millions)**                         | ** ** | **2007**                                     | ** ** | **2006** | ** ** |
| **Cash  flows:**                               | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Pre-tax income  (loss) from noncore activities | ** ** | **$**                                        | **(5.8**   | **)** | $ | (20.1 | ) |
| Other non-cash  charges                        | ** ** | **0.5**                                      |       | 7.4 |   |
| Cash spending  for:                            |       |                                         |       |   |   |
| Tax settlement                                 | ** ** | **(10.3**                                    | **)**      | — |   |
| Environmental remediation                      | ** ** | **(2.8**                                     | **)**      | (2.1 | ) |
| Postretirement benefits                        | ** ** | **(0.2**                                     | **)**      | (2.2 | ) |
| Retained obligations and other                 | ** ** | **(0.4**                                     | **)**      | (0.7 | ) |
| **Net cash flow from noncore  activities**     | ** ** | **$**                                        | **(19.0**  | **)** | $ | (17.7 | ) |

 

Net cash flow from coreoperations and net cash flow from noncore activities do not represent income orcash flow as defined under generally accepted accounting principles, and youshould not consider them to be an alternative to such measures as an indicatorof our performance. We provide these measures to permit you to distinguishoperating results of our current business base from results and related assetsand liabilities of past businesses, discontinued products, and corporatelegacies and the effect of our Chapter 11 proceedings.

See the “ConsolidatedStatements of Cash Flows” included in the Consolidated Financial Statements formore information.

**Forward-Looking Statements**

This documentcontains, and our other public communications may contain, forward-lookinginformation, that is, information related to future, not past, events. Suchinformation generally includes the words “believes,” “plans,” “intends,” “targets,”“will,” “expects,” “anticipates,” or similar expressions.  Forward-looking information includes allstatements regarding our Chapter 11 proceeding (including the proformafinancial statements included in “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations”); expected financial position;results of operations; cash flows; financing plans; business strategy; budgets;capital and other expenditures; competitive positions; growth opportunities forexisting products; benefits from new technology and cost reduction initiatives,plans and objectives;  and markets forsecurities. For these statements, we claim the protection of the safe harborfor forward-looking statements contained in the Private Securities LitigationReform Act of 1995. Factors that could cause actual results to materiallydiffer from those contained in the forward-looking statements include:  our bankruptcy and proposed plan ofreorganization, our legal proceedings, especially the Montana criminalproceeding and the environmental proceedings, the cost and availability of rawmaterials and energy, our unfunded pension obligations, risks related toforeign operations, especially, security, regulation and currency risks, costsof compliance with environmental regulation and those factors set forth in ourmost recent Annual Report on Form 10-K, this quarterly report on Form 10-Q andcurrent reports on Form 8-K, which have been filed with the Securities andExchange Commission.  Like otherbusinesses, we are subject to risks and uncertainties that could cause ouractual results to differ materially from our projections or that could causeother forward-looking information to prove incorrect. Further, our reportedresults should not be considered as an indication of our future performance.Readers are cautioned not to place undue reliance on our projections andforward-looking information, which speak only as of the date thereof. Weundertake no obligation to publicly release any revisions to the projectionsand forward-looking information contained in this document, or to update themto reflect events or circumstances occurring after the date of this document.

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**Item 3.  QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

See the “MarketRisk” heading in Item 7 of our Form 10-K for the year ended December 31, 2006for disclosures required by this item. In March 2007, we entered into a foreign currency exchange rate forwardcontract to hedge a portion of our net investment in a foreign operation.  Specifically, Grace’s principal U.S.subsidiary entered into an agreement to acquire U.S. dollars in exchange forEuros (EUR) from a U.S. financial institution in order to hedge a portion ofthe value of its net investment in its principal German subsidiary.  The contract has a total notional value of EUR 20.0million (approximately $26.7 million based on the exchange rate as of March 31,2007) and a contractual exchange rate of $1.3414/EUR.  The contract matures on December 14, 2007.

**Item 4.  CONTROLS AND PROCEDURES**

*EVALUATIONOF DISCLOSURE CONTROLS AND PROCEDURES*

As of March 31,2007, 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 information relatingto Grace is made known to management, including Grace’s Chief Executive Officerand Chief Financial Officer, as appropriate to allow timely decisions regardingrequired disclosure.

*CHANGESIN INTERNAL CONTROL OVER FINANCIAL REPORTING*

There were nochanges in Grace’s internal control over financial reporting during the quarterended March 31, 2007 that have materially affected, or are reasonably likely tomaterially affect, Grace’s internal control over financial reporting.

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**PARTII.  OTHER INFORMATION**

**Item1.  LEGAL PROCEEDINGS**

Notes 2, 3 and 12to the interim consolidated financial statements in Part 1 of this Report areincorporated herein by reference.

**ERISALAWSUITS**

In June 2004, apurported class action complaint (*Evans v.Akers et al.*) was filed in U.S. District Court for the District ofMassachusetts against the Board of Directors, certain current and former Graceofficers and employees, and others, relating to the Grace 401(k) Savings andInvestment Plan. The complaint alleges that the decline in the price of Gracecommon stock from July 1999 through February 2004 resulted in significantlosses to S&I Plan participants. The complaint further alleges that thedefendants breached their fiduciary duties under the Employee Retirement IncomeSecurity Act of 1974, as amended, or ERISA, by failing to sell or take otherappropriate action with regard to Grace common stock held by the S&I Planduring that period, and by failing to disclose to S&I Plan participants therisk of investing in Grace common stock. The complaint seeks compensatorydamages for the S&I Plan from the defendants.

On October 26,2004, a purported class action complaint (*Bunchet al. v. W. R. Grace & Co. et al.*) also related to the S&IPlan was filed in the U.S. District Court for the Eastern District of Kentuckyagainst Grace, the Investment and Benefits Committee, the Board of Directors,certain current and former Grace officers and employees, and others. Thecomplaint alleges that Grace and its investment advisors breached fiduciaryduties under ERISA by selling Grace common stock from the S&I Plan at adistressed price. The complaint further alleges that Grace breached fiduciaryduties under ERISA by hiring State Street Bank and Trust Company, theinvestment manager for the S&I Plan that Grace retained in December 2003,to rapidly liquidate all of the employees’ Grace common stock investment at anartificially low sales price.

On July 21, 2005,the U.S. District Court for the Eastern District of Kentucky granted thedefendants’ motion to transfer the *Bunch*action to the U.S. District Court for the District of Massachusetts.  On August 23, 2005, the MassachusettsDistrict Court consolidated into one case both the *Bunch* action and the *Evans*action. Grace expects that it would have an obligation to indemnify the otherdefendants for any liability arising out of the consolidated lawsuit.

On December 6,2006, the Massachusetts District Court, in considering the *Evans* plaintiffs’ motion for classcertification, denied that motion and dismissed the *Evans* plaintiffs’ claims, on grounds that those plaintiffslacked standing to bring suit.  The *Evans* plaintiffs’ petitioned the U.S.Court of Appeals for the First Circuit to permit an interlocutory appeal ofthese decisions.  On April 9, 2007, theFirst Circuit denied the *Evans*plaintiffs’ petition.

On January 16,2007, the *Bunch* plaintiffs filedan amended complaint in the Massachusetts District Court alleging self-dealingby State Street and various theories purportedly supporting allegations ofbreaches of fiduciary duty by Grace and other defendants.  On February 2, 2007, Grace and State Streeteach filed motions with the District Court to dismiss the amended complaintagainst Grace and State Street, respectively. On March 1, 2007, the District Court denied each of these motions todismiss, and certified a class of plaintiffs comprising certain S&I Planparticipants.  On March 30, 2007, theDistrict Court granted Grace’s and State Street’s motion to strike the *Bunch* plaintiffs’ jury demand.

Grace has $50million of employers’ fiduciary liability insurance coverage that Gracebelieves would be available to pay liabilities arising out of this consolidatedlawsuit.  Since all Grace employees whohad interests in the S&I Plan during the relevant periods are members ofthe purported class and Messrs. Corcoran, McGowan, Norris, Poling, Shelnitz andTarola had interests in the S&I Plan during these periods, they have interestsin this litigation that may be adverse to Grace.

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**Item 1A.RISK FACTORS**

With respect to certain risk factors disclosed in the “RiskFactors” section of our Annual Report on Form 10-K for the year ended December31, 2006, more recent numerical measures and other information are available inthe “Financial Statements,” “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and “Quantitative and Qualitative DisclosuresAbout Market Risk” sections of this Report. These more recent measures and information are incorporated herein byreference.

**Item6.  EXHIBITS**

The following is a list of Exhibits filed as part ofthis Quarterly Report on Form 10-Q:
| 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, 2007 |   | By                    | /s/ A. E. Festa                                                                                       |   |
|              |   |                  | A. E. Festa  President and  Chief Executive Officer                                                   |
|              |   |                  |
| Date: May 9, 2007 |   | By                    | /s/ Robert M. Tarola                                                                                  |   |
|              |   |                  | Robert M. Tarola  Senior Vice President and  Chief Financial Officer  (Principal Accounting  Officer) |
|                   |        |                       |                                                                                                       |  |  |  |

 

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**EXHIBITINDEX**
| Exhibit No. | ** ** | **Description of Exhibit**                                                                                                                    |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                          |
|        |       |                                                                                                                                          |
| 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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