**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

| **(Mark One)**                                         | ** ** |
|--------------------------------------------------------|------------|
| ** **                                             | ** ** |
| x                                                      |       | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d)** |   |
| ** **                                             | ** ** | **OF  THE SECURITIES EXCHANGE ACT OF 1934** | ** ** |
| ** **                                             | ** ** | ** ** | ** ** |
| **FOR THE QUARTERLY PERIOD ENDED SEPTEMBER  30, 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 phone number of

principal executive offices)

 

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

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

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.

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

 

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

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

 

70,409,225 shares of Common Stock, $0.01 parvalue, were outstanding at October 31, 2007.

 

 

----

 

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

 

Table of Contents

 
| **Part I.**  | **Financial Information**                                                                   | **Page No.** |
|--------------|---------------------------------------------------------------------------------------------|--------------|
| ** **   | ** **                                                                                  |         |
| 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-43         |
|         |                                                                                        |         |
| Item 3.      | Quantitative and Qualitative Disclosures  About Market Risk                                 | I-71         |
|         |                                                                                        |         |
| Item 4.      | Controls and Procedures                                                                     | I-71         |
|         |                                                                                        |         |
| **Part II.** | **Other Information**                                                                       |         |
| ** **   | ** **                                                                                  |         |
| Item 1.      | Legal Proceedings                                                                           | II-1         |
|         |                                                                                        |         |
| Item 1A.     | Risk Factors                                                                                | II-1         |
|         |                                                                                        |         |
| Item 6.      | Exhibits                                                                                    | II-2         |

 

----

 

**PARTI. FINANCIAL INFORMATION**

 

**Item 1. FINANCIAL STATEMENTS**

 

**Review by Independent Registered PublicAccounting Firm**

 

A review of the interim consolidated financial statements included inthis Quarterly Report on Form 10-Q for the three and nine months endedSeptember 30, 2007 and 2006 has been performed by PricewaterhouseCoopersLLP, the company’s independent registered public accounting firm. Their reporton the interim consolidated financial statements follows. This report is notconsidered a “report” within the meaning of Sections 7 and 11 of the SecuritiesAct of 1933, and, therefore, the independent accountants’ liability underSection 11 does not extend to it.

 

I-1

----

 

**Reportof Independent Registered Public Accounting Firm**

 

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

 

We have reviewed the accompanying consolidated balance sheet of W. R.Grace & Co. and its subsidiaries as of September 30, 2007, andthe related consolidated statements of operations, shareholders’ equity(deficit) and comprehensive income (loss) for each of the three-month andnine-month periods ended September 30, 2007 and September 30, 2006and the consolidated statements of cash flows for the nine-month periods endedSeptember 30, 2007 and September 30, 2006. These interim financialstatements are the responsibility of the Company’s management.

 

We conducted our review in accordance with the standards of the PublicCompany Accounting 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. Asdiscussed in Notes 1 and 2 to the interim consolidated financial statements, onApril 2, 2001, the Company and substantially all of its domestic subsidiariesvoluntarily filed for protection under Chapter 11 of the United StatesBankruptcy Code, which raises substantial doubt about the Company’s ability tocontinue as a going concern in its present form. Management’s intentions withrespect to this matter are also described in Notes 1 and 2. The accompanyinginterim consolidated financial statements do not include any adjustments thatmight result from the outcome 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 consolidatedstatements of operations, cash flows, shareholders’ equity (deficit) andcomprehensive income (loss) for the year then ended, management’s assessment ofthe effectiveness of the Company’s internal control over financial reporting asof December 31, 2006 and the effectiveness of the Company’s internalcontrol over financial reporting as of December 31, 2006; and in ourreport dated March 1, 2007, we expressed (i) an unqualified opinionon those consolidated financial statements with an explanatory paragraphrelating to the Company’s ability to continue as a going concern and,(ii) unqualified opinions on management’s assessment of the effectivenessof the Company’s internal control over financial reporting and on theeffectiveness of the Company’s internal control over financial reporting. Theconsolidated financial statements and management’s assessment of theeffectiveness of internal control over financial reporting referred to aboveare not presented herein. In our opinion, the information set forth in theaccompanying 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               |
| November 8, 2007          |

 

I-2

----

 

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

**Consolidated Statements of Operations(Unaudited)**

*In millions, except per share amounts*

 
| ** **                                                                                                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales                                                                                                                                 |       | **$**                                                | 783.1      | ** **                                          | $          | 741.4 |   | **$** | 2,311.5 | ** ** | $ | 2,129.1 |   |
|                                                                                                                                      |       | ** **                                           | ** ** |                                                |       | ** ** | ** ** |   |   |
| Cost of goods sold, exclusive of depreciation  and amortization shown separately below                                                    |       | **518.4**                                            | ** ** | 483.6                                               |       | **1,531.0** | ** ** | 1,391.4 |   |
| Selling, general and administrative  expenses, exclusive of net pension expense and depreciation and amortization  shown separately below |       | **142.6**                                            | ** ** | 149.4                                               |       | **408.5** | ** ** | 420.7 |   |
| Depreciation and amortization                                                                                                             |       | **28.3**                                             | ** ** | 29.2                                                |       | **83.5** | ** ** | 85.7 |   |
| Research and development expenses                                                                                                         |       | **19.5**                                             | ** ** | 14.9                                                |       | **55.0** | ** ** | 44.3 |   |
| Net pension expense                                                                                                                       |       | **13.1**                                             | ** ** | 15.9                                                |       | **38.9** | ** ** | 47.5 |   |
| Interest expense and related financing  costs                                                                                             |       | **17.4**                                             | ** ** | 18.8                                                |       | **57.1** | ** ** | 54.5 |   |
| Provision for environmental remediation                                                                                                   |       | **—**                                           | ** ** | —                                              |       | **12.0** | ** ** | 30.0 |   |
| Chapter 11 expenses, net of interest income                                                                                               |       | **21.3**                                             | ** ** | 12.0                                                |       | **62.7** | ** ** | 32.2 |   |
| Other (income) expense, net                                                                                                               |       | **(4.9**                                             | **)**      | (6.3                                                | )          | **(20.6** | **)** | (22.1 | ) |
|                                                                                                                                      |       | **755.7**                                            | ** ** | 717.5                                               |       | **2,228.1** | ** ** | 2,084.2 |   |
| Income (loss) before income taxes and  minority interest                                                                                  |       | **27.4**                                             | ** ** | 23.9                                                |       | **83.4** | ** ** | 44.9 |   |
| Benefit from (provision for) income taxes                                                                                                 |       | **(7.4**                                             | **)**      | 2.4                                                 |       | **(31.6** | **)** | (5.4 | ) |
| Minority interest in consolidated entities                                                                                                |       | **(3.3**                                             | **)**      | (7.9                                                | )          | **(9.8** | **)** | (26.2 | ) |
| **Net income (loss)**                                                                                                                     |       | **$**                                                | **16.7**   | ** **                                          | $          | 18.4 |   | **$** | **42.0** | ** ** | $ | 13.3 |   |
| ** **                                                                                                                                |       | ** **                                           | ** ** |                                                |       | ** ** | ** ** |   |   |
| **Basic earnings (loss) per share:**                                                                                                      |       | ** **                                           | ** ** |                                                |       | ** ** | ** ** |   |   |
| Net income (loss)                                                                                                                         |       | **$**                                                | **0.24**   | ** **                                          | $          | 0.27 |   | **$** | **0.60** | ** ** | $ | 0.20 |   |
| Weighted average number of basic shares                                                                                                   |       | **70.2**                                             | ** ** | 68.3                                                |       | **69.9** | ** ** | 67.7 |   |
|                                                                                                                                      |       | ** **                                           | ** ** |                                                |       | ** ** | ** ** |   |   |
| **Diluted earnings (loss) per share:**                                                                                                    |       | ** **                                           | ** ** |                                                |       | ** ** | ** ** |   |   |
| Net income (loss)                                                                                                                         |       | **$**                                                | **0.23**   | ** **                                          | $          | 0.27 |   | **$** | **0.59** | ** ** | $ | 0.20 |   |
| Weighted average number of diluted shares                                                                                                 |       | **71.5**                                             | ** ** | 68.5                                                |       | **71.5** | ** ** | 68.1 |   |

 

The Notes to Consolidated FinancialStatements are an integral part of these statements.

 

I-3

----

 

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

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

*In millions*

 
| ** **                                                                                                              | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                              | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| **OPERATING ACTIVITIES**                                                                                                |       |                                                |       |   |   |
| Net income (loss)                                                                                                       |       | **$**                                               | **42.0**   | ** ** | $ | 13.3 |   |
| Reconciliation to net cash provided by  (used for) operating activities:                                                |       | ** **                                          | ** ** |   |   |
| Depreciation and amortization                                                                                           |       | **83.5**                                            | ** ** | 85.7 |   |
| Chapter 11 expenses, net of interest income                                                                             |       | **62.7**                                            | ** ** | 32.2 |   |
| (Benefit from) provision for income taxes                                                                               |       | **31.6**                                            | ** ** | 5.4 |   |
| Income taxes paid, net of refunds                                                                                       |       | **(35.8**                                           | **)**      | (36.2 | ) |
| Minority interest in consolidated entities                                                                              |       | **9.8**                                             | ** ** | 26.2 |   |
| Dividends paid to minority interests in  consolidated entities                                                          |       | **(12.0**                                           | **)**      | (0.1 | ) |
| Interest accrued on pre-petition  liabilities subject to compromise                                                     |       | **56.2**                                            | ** ** | 53.1 |   |
| Net (gain) loss on sales of investments and  disposals of assets                                                        |       | **(2.8**                                            | **)**      | (2.6 | ) |
| Net pension expense                                                                                                     |       | **38.9**                                            | ** ** | 47.5 |   |
| Payments under defined benefit pension  arrangements                                                                    |       | **(85.5**                                           | **)**      | (109.5 | ) |
| Payments under postretirement benefit plans                                                                             |       | **(4.6**                                            | **)**      | (10.7 | ) |
| Net income from life insurance policies                                                                                 |       | **(3.0**                                            | **)**      | (2.2 | ) |
| Provision for uncollectible receivables                                                                                 |       | **(0.4**                                            | **)**      | 3.2 |   |
| Provision for environmental remediation                                                                                 |       | **12.0**                                            | ** ** | 30.0 |   |
| Expenditures for environmental remediation                                                                              |       | **(7.1**                                            | **)**      | (8.7 | ) |
| Expenditures for retained obligations of  divested businesses                                                           |       | **(0.8**                                            | **)**      | (2.7 | ) |
| Changes in assets and liabilities,  excluding effect of businesses acquired/divested and foreign currency  translation: |       | ** **                                          | ** ** |   |   |
| Working capital items (trade accounts  receivable, inventories and accounts payable)                                    |       | **(45.4**                                           | **)**      | (59.7 | ) |
| Other accruals and non-cash items                                                                                       |       | **(7.3**                                            | **)**      | 17.0 |   |
| **Net cash provided by (used for) operating  activities before Chapter 11 expenses and settlements**                    | ** ** | **132.0**                                           | ** ** | 81.2 |   |
| Cash paid to resolve contingencies subject  to Chapter 11                                                               | ** ** | **(10.3**                                           | **)**      | — |   |
| Chapter 11 expenses paid                                                                                                | ** ** | **(55.9**                                           | **)**      | (31.8 | ) |
| **Net cash provided by (used for) operating  activities**                                                               |       | **65.8**                                            | ** ** | 49.4 |   |
| ** **                                                                                                              |       | ** **                                          | ** ** |   |   |
| **INVESTING ACTIVITIES**                                                                                                |       | ** **                                          | ** ** |   |   |
| Capital expenditures                                                                                                    |       | **(89.8**                                           | **)**      | (82.5 | ) |
| Purchase of marketable securities                                                                                       |       | **(25.0**                                           | **)**      | — |   |
| Purchase of equity investment                                                                                           |       | **(6.3**                                            | **)**      | — |   |
| Proceeds from sales of investments and  disposals of assets                                                             |       | **5.5**                                             | ** ** | 7.3 |   |
| Proceeds from sale of product line                                                                                      |       | **21.8**                                            | ** ** | — |   |
| Businesses acquired, net of cash acquired                                                                               |       | **(5.5**                                            | **)**      | (20.0 | ) |
| Net investment in life insurance policies                                                                               |       | **(1.2**                                            | **)**      | 0.2 |   |
| **Net cash provided by (used for) investing  activities**                                                               |       | **(100.5**                                          | **)**      | (95.0 | ) |
| ** **                                                                                                              |       | ** **                                          | ** ** |   |   |
| **FINANCING ACTIVITIES**                                                                                                |       | ** **                                          | ** ** |   |   |
| Net payments of loans secured by cash value  of life insurance policies                                                 |       | **(0.1**                                            | **)**      | (0.1 | ) |
| Net (repayments) borrowings under credit  arrangements                                                                  |       | **0.7**                                             | ** ** | 0.5 |   |
| Fees under debtor-in-possession credit  facility                                                                        |       | **(2.0**                                            | **)**      | (1.8 | ) |
| Proceeds from exercise of stock options                                                                                 |       | **20.2**                                            | ** ** | 15.8 |   |
| **Net cash provided by (used for) financing  activities**                                                               |       | **18.8**                                            | ** ** | 14.4 |   |
| Effect of currency exchange rate changes on  cash and cash equivalents                                                  |       | **14.6**                                            | ** ** | 10.2 |   |
| **Increase (decrease) in cash and cash  equivalents**                                                                   |       | **(1.3**                                            | **)**      | (21.0 | ) |
| Cash and cash equivalents, beginning of  period                                                                         |       | **536.3**                                           | ** ** | 474.7 |   |
| Cash and cash equivalents, end of period                                                                                |       | **$**                                               | **535.0**  | ** ** | $ | 453.7 |   |

 

The Notes to Consolidated FinancialStatements are an integral part of these statements.

 

I-4

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

**Consolidated Balance Sheets**

*In millions, except par value and shares*

 
| ** **                                                                                                                          | ** ** | **September 30,  2007** | ** **  | **December 31,  2006** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|-------------|-----------------------------|------------|
| ** **                                                                                                                          | ** ** | **(Unaudited)**              | ** **  | ** **                  | ** ** |
| **ASSETS**                                                                                                                          | ** ** | ** **                   | ** **  | ** **                  | ** ** |
| **Current Assets**                                                                                                                  |       |                         |        |                        |       |
| Cash and cash equivalents                                                                                                           |       | **$**                        | **535.0**   | ** **                  | $          | 536.3 |   |
| Marketable securities                                                                                                               |       | **28.5**                     | ** **  | 3.3                         |       |
| Trade accounts receivable, less allowance  of $5.6 (2006 - $6.6)                                                                    |       | **492.9**                    | ** **  | 426.3                       |       |
| Inventories                                                                                                                         |       | **298.7**                    | ** **  | 284.6                       |       |
| Deferred income taxes                                                                                                               |       | **38.8**                     | ** **  | 37.8                        |       |
| Other current assets                                                                                                                |       | **77.1**                     | ** **  | 80.5                        |       |
| **Total Current Assets**                                                                                                            |       | **1,471.0**                  | ** **  | 1,368.8                     |       |
| ** **                                                                                                                          |       | ** **                   | ** **  |                        |       |
| Properties and equipment, net of  accumulated depreciation and amortization of $1,565.1  (2006 - $1,510.5)                          |       | **681.2**                    | ** **  | 664.5                       |       |
| Goodwill                                                                                                                            |       | **120.8**                    | ** **  | 116.5                       |       |
| Cash value of life insurance policies, net  of policy loans                                                                         |       | **93.5**                     | ** **  | 89.2                        |       |
| Deferred income taxes                                                                                                               |       | **716.4**                    | ** **  | 728.5                       |       |
| Asbestos-related insurance                                                                                                          |       | **500.0**                    | ** **  | 500.0                       |       |
| Overfunded defined benefit pension plans                                                                                            |       | **71.3**                     | ** **  | 38.4                        |       |
| Other assets                                                                                                                        |       | **140.2**                    | ** **  | 131.5                       |       |
| **Total Assets**                                                                                                                    |       | **$**                        | **3,794.4** | ** **                  | $          | 3,637.4 |   |
| ** **                                                                                                                          |       | ** **                   | ** **  |                        |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY  (DEFICIT)**                                                                            |       | ** **                   | ** **  |                        |       |
| **Liabilities Not Subject to Compromise**                                                                                           |       | ** **                   | ** **  |                        |       |
| **Current Liabilities**                                                                                                             |       | ** **                   | ** **  |                        |       |
| Debt payable within one year                                                                                                        |       | **$**                        | **4.1**     | ** **                  | $          | 3.3 |   |
| Accounts payable                                                                                                                    |       | **191.8**                    | ** **  | 172.7                       |       |
| Other current liabilities                                                                                                           |       | **324.4**                    | ** **  | 272.6                       |       |
| **Total Current Liabilities**                                                                                                       |       | **520.3**                    | ** **  | 448.6                       |       |
| ** **                                                                                                                          |       | ** **                   | ** **  |                        |       |
| Debt payable after one year                                                                                                         |       | **0.3**                      | ** **  | 0.2                         |       |
| Deferred income taxes                                                                                                               |       | **54.6**                     | ** **  | 58.9                        |       |
| Minority interest in consolidated entities                                                                                          |       | **62.7**                     | ** **  | 65.0                        |       |
| Underfunded and unfunded defined benefit  pension plans                                                                             |       | **258.3**                    | ** **  | 349.6                       |       |
| Other liabilities                                                                                                                   |       | **40.2**                     | ** **  | 43.3                        |       |
| **Total Liabilities Not Subject to Compromise**                                                                                     |       | **936.4**                    | ** **  | 965.6                       |       |
| ** **                                                                                                                          |       | ** **                   | ** **  |                        |       |
| **Liabilities Subject to Compromise—Note 2**                                                                                   |       | ** **                   | ** **  |                        |       |
| Pre-petition debt plus accrued interest                                                                                             |       | **787.2**                    | ** **  | 739.5                       |       |
| Accounts payable                                                                                                                    |       | **31.7**                     | ** **  | 31.7                        |       |
| Income tax contingencies                                                                                                            |       | **99.1**                     | ** **  | 141.2                       |       |
| Asbestos-related contingencies                                                                                                      |       | **1,700.0**                  | ** **  | 1,700.0                     |       |
| Environmental contingencies                                                                                                         |       | **366.0**                    | ** **  | 361.1                       |       |
| Postretirement benefits                                                                                                             |       | **166.4**                    | ** **  | 158.9                       |       |
| Other liabilities and accrued interest                                                                                              |       | **113.4**                    | ** **  | 89.2                        |       |
| **Total Liabilities Subject to Compromise**                                                                                         |       | **3,263.8**                  | ** **  | 3,221.6                     |       |
| **Total Liabilities**                                                                                                               |       | **4,200.2**                  | ** **  | 4,187.2                     |       |
| ** **                                                                                                                          |       | ** **                   | ** **  |                        |       |
| **Commitments and Contingencies**                                                                                                   |       | ** **                   | ** **  |                        |       |
| ** **                                                                                                                          |       | ** **                   | ** **  |                        |       |
| **Shareholders’ Equity (Deficit)**                                                                                             |       | ** **                   | ** **  |                        |       |
| Common stock issued, par value $0.01;  300,000,000 shares authorized; outstanding: 2007 – 70,227,725 (2006 –  68,915,022) |       | **0.8**                      | ** **  | 0.8                         |       |
| Paid-in capital                                                                                                                     |       | **428.4**                    | ** **  | 423.8                       |       |
| Accumulated deficit                                                                                                                 |       | **(443.4**                   | **)**       | (487.6                      | )          |
| Treasury stock, at cost: shares: 2007 -  6,752,035; (2006 - 8,064,738)                                                              |       | **(80.4**                    | **)**       | (96.0                       | )          |
| Accumulated other comprehensive income  (loss)                                                                                      |       | **(311.2**                   | **)**       | (390.8                      | )          |
| **Total Shareholders’ Equity (Deficit)**                                                                                       |       | **(405.8**                   | **)**       | (549.8                      | )          |
| **Total Liabilities and Shareholders’ Equity  (Deficit)**                                                                      |       | **$**                        | **3,794.4** | ** **                  | $          | 3,637.4 |   |

 

The Notes to Consolidated FinancialStatements are an integral part of these statements.

 

I-5

----

 

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

**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, June 30, 2007**                                   |       | $                                            | 429.5      |                     | $          | (460.1              | )          | $                                                         | (81.5      | )                                          | $          | (337.3 | ) | $ | (449.4 | ) |
| Net income (loss)                                            |       | —                                       |       | 16.7                     |       | —              |       | —                                                    |       | 16.7                                       |       |
| Stock plan activity                                          |       | (0.3                                         | )          | —                   |       | 1.1                 |       | —                                                    |       | 0.8                                        |       |
| Other comprehensive income (loss)                            |       | —                                       |       | —                   |       | —              |       | 26.1                                                      |       | 26.1                                       |       |
| **Balance, September 30, 2007**                              | ** ** | **$**                                        | **429.2**  | ** **               | **$**      | **(443.4**          | **)**      | **$**                                                     | **(80.4**  | **)**                                      | **$**      | **(311.2** | **)** | **$** | **(405.8** | **)** |
| ** **                                                   | ** ** | ** **                                   | ** ** | ** **               | ** ** | ** **          | ** ** | ** **                                                | ** ** | ** **                                 | ** ** |
| **Balance, December 31, 2006**                               |       | $                                            | 424.6      |                     | $          | (487.6              | )          | $                                                         | (96.0      | )                                          | $          | (390.8 | ) | $ | (549.8 | ) |
| Cumulative effect of adoption of FASB  Interpretation No. 48 |       | —                                       |       | 2.2                      |       | —              |       | —                                                    |       | 2.2                                        |       |
| **Balance, January 1, 2007**                                 |       | $                                            | 424.6      |                     | $          | (485.4              | )          | $                                                         | (96.0      | )                                          | $          | (390.8 | ) | $ | (547.6 | ) |
| Net income (loss)                                            |       | —                                       |       | 42.0                     |       | —              |       | —                                                    |       | 42.0                                       |       |
| Stock plan activity                                          |       | 4.6                                          |       | —                   |       | 15.6                |       | —                                                    |       | 20.2                                       |       |
| Other comprehensive income (loss)                            |       | —                                       |       | —                   |       | —              |       | 79.6                                                      |       | 79.6                                       |       |
| **Balance, September 30, 2007**                              | ** ** | **$**                                        | **429.2**  | ** **               | **$**      | **(443.4**          | **)**      | **$**                                                     | **(80.4**  | **)**                                      | **$**      | **(311.2** | **)** | **$** | **(405.8** | **)** |

 

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

**Consolidated Statements of ComprehensiveIncome (Loss) (Unaudited)**

*In millions*

 
| ** **                                                                   | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Net income (loss)**                                                        |       | **$**                                                | **16.7**   | ** **                                          | $          | 18.4 |   | **$** | **42.0** | ** ** | $ | 13.3 |   |
| ** **                                                                   |       | ** **                                           | ** ** | ** **                                          |       |   |   | ** ** | ** ** | ** ** |   |   |   |
| **Other comprehensive income (loss):**                                       |       | ** **                                           | ** ** |                                                |       | ** ** | ** ** |   |   |
| Foreign currency translation adjustments                                     |       | **19.8**                                             | ** ** | 8.3                                                 |       | **34.4** | ** ** | 22.9 |   |
| Gain (loss) from hedging activities, net of  income taxes                    |       | **(0.2**                                             | **)**      | (0.4                                                | )          | **(0.3** | **)** | (0.7 | ) |
| Defined benefit pension and other  postretirement plans, net of income taxes |       | **6.5**                                              | ** ** | —                                              |       | **45.5** | ** ** | — |   |
| Total other comprehensive income (loss)                                      |       | **26.1**                                             | ** ** | 7.9                                                 |       | **79.6** | ** ** | 22.2 |   |
| **Comprehensive income (loss)**                                              |       | **$**                                                | **42.8**   | ** **                                          | $          | 26.3 |   | **$** | **121.6** | ** ** | $ | 35.5 |   |

 

The Notes to Consolidated FinancialStatements are an integral part of these statements.

 

I-6

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

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

 

**1.     Basisof Presentation and Summary of Significant Accounting and Financial ReportingPolicies**

 

W. R. Grace & Co., through its subsidiaries, is engaged inspecialty chemicals and specialty materials businesses on a worldwide basisthrough two operating segments: “Grace Davison,” which includes silica- andalumina-based catalysts and materials used in a wide range of industrialapplications; and “Grace Performance Chemicals,” which includes specialtychemicals and materials used in commercial and residential construction and inrigid food and beverage packaging.

 

W. R. Grace & Co. conducts substantially all of its businessthrough a direct, wholly-owned subsidiary, W. R. Grace & Co.-Conn. (“Grace-Conn.”).Grace-Conn. owns substantially all of the assets, properties and rights of W.R. Grace & Co. on a consolidated basis, either directly or throughsubsidiaries.

 

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

 

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

 

After a thorough review of these developments, the Board of Directorsconcluded that a federal court-supervised bankruptcy process provided the bestforum available to achieve fairness in resolving these claims and onApril 2, 2001 (the “Filing Date”), Grace and 61 of its United Statessubsidiaries and affiliates, including Grace-Conn. (collectively, the “Debtors”),filed voluntary petitions for reorganization (the “Filing”) under Chapter 11 ofthe United States Bankruptcy Code in the United States Bankruptcy Court for theDistrict of Delaware (the “Bankruptcy Court”). The cases were consolidated andare being jointly administered under case number 01-01139 (the “Chapter 11Cases”). Grace’s non-U.S. subsidiaries and certain of its U.S. subsidiarieswere not included in the Filing.

 

Under Chapter 11, the Debtors have continued to operate theirbusinesses as debtors-in-possession under court protection from creditors andclaimants, while using the Chapter 11 process to develop and implement a planfor addressing the asbestos- related claims. Since the Filing, all motionsnecessary to conduct normal business activities have been approved by theBankruptcy Court. (See Note 2 for Chapter 11-Related Information.)

 

***Basis ofPresentation*** — The interim Consolidated FinancialStatements presented herein are unaudited and should be read in conjunctionwith the Consolidated Financial Statements presented in the Company’s 2006Annual Report on Form 10-K. Such interim Consolidated Financial Statementsreflect all adjustments that, in the opinion of management, are necessary for afair presentation of the results of the interim periods presented; all suchadjustments are of a normal recurring nature. Potential accounting adjustmentsdiscovered during normal reporting and accounting processes are evaluated onthe basis of materiality, both individually and in the aggregate, and arerecorded in the accounting period discovered, unless a restatement of a priorperiod is necessary. All significant intercompany accounts and transactionshave been eliminated.

 

The results of operations for the nine-month interim period endedSeptember 30, 2007 are not necessarily indicative of the results ofoperations for the year ending December 31, 2007.

 

***Reclassifications***— Certain amounts in prior years’ Consolidated Financial Statements have beenreclassified to conform to the 2007 presentation. Such reclassifications havenot materially affected previously reported amounts in the ConsolidatedFinancial Statements.

 

I-7

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***Use of Estimates***— The preparation of financial statements in conformity with U.S. generallyaccepted accounting principles requires that management make estimates andassumptions affecting the assets and liabilities reported at the date of theConsolidated Financial Statements, and the revenues and expenses reported forthe periods presented. Actual amounts could differ from those estimates, andthe differences could be material. Changes in estimates are recorded in theperiod identified. Grace’s accounting measurements that are most affected bymanagement’s estimates of future events are:

 

•                  Contingent liabilities which depend on an assessmentof the probability of loss and an estimate of ultimate resolution cost, such asasbestos-related matters (see Notes 2 and 3), environmental remediation (seeNote 12), income taxes (see Note 4), and litigation (seeNote 12);

 

•                  Pension and postretirement liabilities that depend onassumptions regarding participant life spans, future inflation, discount ratesand total returns on invested funds (see Note 13); and

 

•                  Realization values of net deferred tax assets andinsurance receivables, which depend on projections of future income and cashflows and assessments of insurance coverage and insurer solvency.

 

The accuracy of management’s estimates may be materially affected bythe uncertainties arising under Grace’s Chapter 11 proceeding.

 

***Effect of NewAccounting Standards*** — In June 2006, the FASBissued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”(“FIN 48”), which prescribes a recognition threshold and measurement attributefor tax positions taken or expected to be taken in tax returns. FIN 48 alsoprovides guidance on derecognition, classification, interest and penalties,accounting in interim periods, disclosure, and transition. Grace adopted FIN 48effective in the first quarter of 2007. See Note 4 for a discussion of theimpact of the adoption of FIN 48.

 

In February 2007, the FASB issued SFAS No. 159, “The FairValue Option for Financial Assets and Financial 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 fair value.SFAS No. 159 is effective for the first quarter of 2008, and Grace iscurrently evaluating the impact on its financial statements of adopting SFASNo. 159.

 

In September 2006, the FASB Emerging Issues Task Force (“EITF”)promulgated Issue No. 06-4, “Accounting for Deferred Compensation andPostretirement Benefit Aspects of Endorsement Split-Dollar Life InsuranceArrangements.” This Issue specifies that if a company provides a benefit to anemployee under an endorsement split-dollar life insurance arrangement thatextends to postretirement periods, it would have to recognize a liability andrelated compensation costs. In November 2006, the EITF promulgated IssueNo. 06-10, “Accounting for Deferred Compensation and PostretirementBenefit Aspects of Collateral Assignment Split-Dollar Life InsuranceArrangement.” EITF 06-10, among other things, extends the guidance in EITF 06-4to collateral assignment split-dollar life insurance arrangements. Grace willadopt EITF 06-4 and EITF 06-10 effective in the first quarter of 2008, and hasnot yet assessed the impact of these Issues on its Consolidated FinancialStatements.

 

In September 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements.” SFAS No. 157 defines fair value, establishes a frameworkfor measuring fair value, and expands disclosures about fair valuemeasurements. Grace will adopt SFAS No. 157 effective in the first quarterof 2008, and has not yet assessed the estimated impact on its ConsolidatedFinancial Statements.

 

**2.     Chapter11-Related Information**

 

***Official Parties toGrace’s Chapter 11 Proceedings*** — Three creditors’committees, two representing asbestos claimants, the Official Committee ofAsbestos Personal Injury Claimants (the “PI Committee”) and the Official Committeeof Asbestos Property Damage Claimants (the “PD Committee”) and the thirdrepresenting other unsecured creditors, and a committee representing 

 

I-8

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shareholders, have been appointed in the Chapter 11 Cases. Thesecommittees, and a legal representative of future asbestos claimants (the “FCR”),have the right to be heard on all matters that come before the Bankruptcy Courtand have important roles in the Chapter 11 Cases. The Debtors are required tobear certain costs and expenses of the committees and of the FCR, includingthose of their counsel and financial advisors.

 

***Plan ofReorganization*** — On November 13, 2004 Gracefiled a plan of reorganization, as well as several associated documents,including a disclosure statement, with the Bankruptcy Court. OnJanuary 13, 2005, Grace filed an amended plan of reorganization (the “Plan”)and related documents to address certain objections of creditors and otherinterested parties. The Plan is supported by committees representing generalunsecured creditors and equity holders, but is not supported by the PI Committee,the PD Committee or the FCR.

 

Under the terms of the Plan, a trust would be established underSection 524(g) of the Bankruptcy Code to which all pending and futureasbestos-related claims would be channeled for resolution. The Plancontemplates that the Bankruptcy Court will conduct hearings to determine,among other things, the amount that would need to be paid into the trust on theeffective date of the Plan to satisfy Grace’s asbestos-related liabilities andtrust administration 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 will become effective only after a vote of eligible creditorsand with the approval of the Bankruptcy Court and the U.S. District Court forthe District of Delaware. Votes on the Plan may not be solicited until theBankruptcy Court approves the disclosure statement. The Bankruptcy Court hascurrently deferred consideration of the disclosure statement and Plan untilafter completion of hearings on the amount of Grace’s asbestos-relatedliability (see Note 3).

 

Under the terms of the Plan, claims would be satisfied under theChapter 11 Cases as follows:

 

Asbestos-Related Claims and Costs

 

Under the Plan, a trust would be established under Section 524(g)of the Bankruptcy Code to which all pending and future asbestos- related claimswould be channeled for resolution. The trust would utilize specified trustdistribution procedures to satisfy the following allowed asbestos-relatedclaims and costs:

 

*Personal injury claims that meet specifiedexposure and medical criteria (Personal Injury-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.

 

*Personal injury claims that do not meet theexposure and medical criteria necessary to qualify as PI-SE Claims (PersonalInjury-Asymptomatic and Other or “PI-AO” Claims)* —This class would contain all asbestos-related personal injury claims againstGrace that do not meet the specific requirements to be PI-SE Claims, but domeet certain other specified exposure and medical criteria.

 

*Property damage claims, including claimsrelated to ZAI (“PD Claims”)* — In order to qualify forthis class, claimants would have to prove Grace liability for loss of propertyvalue or remediation costs related to products formerly manufactured by Gracethat claimants allege contained asbestos.

 

*Trust administration costs and legal expenses*

 

The pending asbestos-related legal proceedings are described in “Asbestos-RelatedLitigation” (see Note 3). The claims arising from such proceedings wouldbe subject to this classification process as part of the Plan.

 

I-9

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The Bankruptcy Court has entered separate case management orders forestimating liability for pending and future personal injury claims andadjudicating pending property damage claims, excluding ZAI claims. A trial forestimating liability for personal injury claims is currently scheduled to beginin the first quarter of 2008. The Debtors expect that the estimated liabilityfor all asbestos- related claims may provide the basis for determining theamount to be paid into a trust on the effective date of a plan ofreorganization.

 

Under the Plan, asbestos personal injury claimants, including bothPI-SE and PI-AO claims, would have the option either to litigate their claimsagainst the trust in federal court in Delaware or, if they meet specifiedeligibility criteria, accept a settlement amount based on the severity of theircondition. Under the Plan, asbestos property damage claimants would be requiredto present allowed claims to the trust or litigate their claims against thetrust in federal court in Delaware. The Plan provides that, as a conditionprecedent to confirmation, the maximum estimated aggregate funding amount forall asbestos-related liabilities (PI-SE, PI-AO and PD including ZAI) and trustadministration costs and expenses as determined by the Bankruptcy Court cannotexceed $1,613 million, which Grace believes would fund over$2 billion in claims, costs and expenses over time.

 

The PI-SE Claims, the PD Claims and the related trust administrationcosts and expenses would be funded 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 a two-for-one stock split) ofcommon stock of Sealed Air Corporation (“Sealed Air”) to be made directly byCryovac, Inc., a wholly owned subsidiary of Sealed Air (“Cryovac”), to theasbestos trust pursuant to the terms of a settlement agreement resolvingasbestos-related, successor liability and fraudulent transfer claims againstSealed Air and Cryovac and (2) Grace common stock. The number of shares ofGrace common stock required to satisfy these claims will depend on the price ofGrace common stock on the effective date of the Plan, liability measuresapproved by the Bankruptcy Court, and the value of the Sealed Air settlement,which changes daily with the accrual of interest and the trading value of SealedAir common stock. The Sealed Air settlement agreement has been approved by theBankruptcy Court, but remains subject to the fulfillment of specifiedconditions.

 

The PI-AO Claims would be funded with warrants exercisable for thatnumber of shares of Grace common stock which, when added to the shares issueddirectly to the trust on the effective date of the Plan, would represent 50.1%of Grace’s voting securities. If the common stock issuable upon exercise of thewarrants is insufficient to pay all PI-AO Claims (the liability for which isuncapped under the Plan), then Grace would pay any additional liabilities incash.

 

Under the Plan, the amounts to fund PI-SE Claims, PD Claims and theexpense of trust administration would be capped at the amount determined by theBankruptcy Court. Amounts required to fund PI-AO Claims would not be capped, soif the amount funded in respect thereof later proved to be inadequate, Gracewould be responsible for contributing additional funds into the asbestos trustto satisfy PI-AO Claims. Because of the number and nature of the uncertaintiesinvolved, Grace is unable to determine the extent to which, if any, theliability under the Plan for PI-AO claims may exceed the amount funded into thetrust 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 $1,312 million, including interest accrued throughSeptember 30, 2007, would be satisfied in this manner at the effectivedate of the Plan. Grace would finance these payments with cash on hand, cashfrom Fresenius Medical Care Holdings, Inc. (“Fresenius”) paid insettlement of asbestos and other Grace-related claims, new Grace debt, andGrace common stock. Grace would satisfy other 

 

I-10

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non-asbestos related liabilities and claims (primarily certainenvironmental, tax, pension and retirement medical obligations) as they becomedue and payable over time using cash flow from operations, insurance proceedsfrom policies and settlement agreements covering asbestos-related liabilities,and new credit facilities. Proceeds from available product liability insuranceapplicable to asbestos-related claims would supplement operating cash flow toservice new debt and liabilities not paid on the effective date of the Plan.

 

Effect on Grace Common Stock

 

The Plan provides that Grace common stock will remain outstanding atthe effective date of the Plan, but that the interests of existing shareholderswould be subject to dilution by additional shares of common stock issued underthe Plan. In addition, in order to preserve significant tax benefits from netoperating loss carryforwards (“NOLs”) and certain future deductions, which aresubject to elimination or limitation in the event of a change in control (asdefined by the Internal Revenue Code) of Grace, the Plan places restrictions onthe purchase of Grace common stock. The restrictions would prohibit (withoutthe consent of Grace), for a period of three years after the effective date ofthe Plan, a person or entity from acquiring more than 4.75% of the outstandingGrace common stock or, for those persons already holding more than 4.75%,prohibit them from increasing or decreasing their holdings. The BankruptcyCourt has approved the trading restrictions described above, excluding therestriction on sales, until the effective date of the Plan.

 

Grace intends to address all pending and future asbestos-related claimsand all other pre-petition claims as outlined in the Plan. However, the Planmay not be ultimately approved by the Bankruptcy Court and other interestedparties. For example, the PI and PD Committees and the FCR have challenged theconfirmability of the Plan, arguing that the Plan impairs the rights ofasbestos creditors and impermissibly denies them voting rights, and haveasserted that Grace’s asbestos-related liabilities exceed the fair value ofGrace’s assets. As a result of these challenges and other Bankruptcy Courtrulings, a materially different plan of reorganization may ultimately beapproved. Under the ultimate plan of reorganization, the interests of theCompany’s shareholders could be substantially diluted or cancelled and thevalue of non-abestos claims could be materially different from that reflectedin Grace's balance sheet. The value of Grace common stock and the extent of anyrecovery by non-asbestos-related creditors, will depend principally on theamount of Grace’s asbestos-related liability under a confirmed plan ofreorganization.

 

On July 26, 2007, the Bankruptcy Court terminated Grace’s exclusiverights to propose a plan of reorganization and solicit votes thereon. Thetermination of such rights will permit any party-in-interest to propose acompeting plan of reorganization. 

 

***Claims Filings***— The Bankruptcy Court established a bar date of March 31, 2003 for claimsof general unsecured creditors, asbestos-related property damage claims (otherthan ZAI claims) and medical monitoring claims related to asbestos. The bardate did not apply to asbestos-related personal injury claims or claims relatedto ZAI.

 

Approximately 14,900 proofs of claim were filed by the March 31,2003 bar date. Of these claims, approximately 9,400 were non-asbestos related,approximately 4,300 were for asbestos-related property damage, andapproximately 1,000 were for medical monitoring. The medical monitoring claimswere made by individuals who allege exposure to asbestos through Grace’sproducts or operations. These claims, if sustained, would require Grace to fundongoing health monitoring costs for qualified claimants. In addition,approximately 800 proofs of claim were filed after the bar date.

 

Approximately 7,000 of the non-asbestos related claims involve claimsby employees or former employees for future retirement benefits such as pensionand retiree medical coverage. Grace views most of these claims as contingentand has proposed a plan of reorganization that would retain such benefits.These claims include claims for payment of goods and services, taxes, productwarranties, 

 

I-11

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principal and interest under pre-petition credit facilities, amountsdue under leases and other contracts, leases and other executory contractsrejected in the Bankruptcy Court, environmental remediation, pendingnon-asbestos-related litigation, and non-asbestos-related personal injury.Claims for indemnification or contribution to actual or potential codefendantsin asbestos-related and other litigation were also filed.

 

The Debtors have analyzed the claims filed pursuant to theMarch 31, 2003 bar date and have found that many are duplicates, representthe same claim filed against more than one of the Debtors, lack any supportingdocumentation, or provide insufficient supporting documentation. As ofSeptember 30, 2007, of the approximately 4,035 asbestos property damageclaims filed, five claims have been resolved (four of these agreements arevoidable depending on the terms of a confirmed plan of reorganization),approximately 3,570 claims have been expunged or withdrawn by claimants,leaving approximately 460 claims to be addressed through the property damagecase management order approved by the Bankruptcy Court. As ofSeptember 30, 2007, of the approximately 3,260 non-asbestos claims filed,approximately 1,830 have been expunged or withdrawn by claimants, approximately1,140 have been resolved, and an additional approximately 290 claims are to beaddressed through the claim objection process and the dispute resolutionprocedures approved by the Bankruptcy Court.

 

Grace believes that its recorded liabilities for claims subject to theMarch 31, 2003 bar date represent a reasonable estimate of the ultimateallowable amount for claims that are not in dispute or have been submitted withsufficient information to both evaluate the merit and estimate the value of theclaim. The asbestos-related claims are considered as part of Grace’s overallasbestos liability and are being accounted for in accordance with theconditions precedent under the Plan, as described in “Accounting Impact” below.Grace will adjust its recorded asbestos-related liability, as necessary, toreflect rulings by the Bankruptcy Court. Any such adjustments could be materialto its consolidated financial position and results of operations.

 

***LitigationProceedings in Bankruptcy Court*** — InSeptember 2000, Grace was named in a purported class action lawsuit filedin California Superior Court for the County of San Francisco, alleging that the1996 reorganization involving a predecessor of Grace and Fresenius AG and the1998 reorganization involving a predecessor of Grace and Sealed Air werefraudulent transfers *(Abner, et al., v. W.R.Grace & Co., et al.)*. The Bankruptcy Court authorized thePI and PD Committees to proceed with claims against Fresenius and Sealed Airand Cryovac on behalf of the Debtors’ bankruptcy estate.

 

On November 29, 2002, Sealed Air (and Cryovac) and Fresenius eachannounced that they had reached agreements in principle with the PI and PDCommittees to settle asbestos, successor liability and fraudulent transferclaims related to such transactions (the “litigation settlement agreements”).Under the terms of the Fresenius settlement, subject to the fulfillment ofcertain conditions, Fresenius would pay $115.0 million to the Debtors’estate as directed by the Bankruptcy Court upon confirmation of the Debtors’plan of reorganization. In July 2003, the Fresenius settlement wasapproved by the Bankruptcy Court. Under the terms of the Sealed Air settlement,subject to the fulfillment of certain conditions, Cryovac would make a paymentof $512.5 million (plus interest at 5.5% compounded annually, commencingon December 21, 2002) and nine million shares (now 18 million sharesto reflect a two-for-one stock split) of Sealed Air common stock (collectivelyvalued at $1,122.0 million as of September 30, 2007), as directed bythe Bankruptcy Court upon confirmation of the Debtors’ plan of reorganization.In June 2005, the Sealed Air settlement was approved by the BankruptcyCourt.

 

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

 

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The Debtors have entered into a debtor-in-possession post-petition loanand security agreement with Bank of America, N.A. (the “DIP facility”) in theaggregate amount of $250 million. The term of the DIP facility expires onApril 1, 2008.

 

***Accounting Impact***– The accompanying Consolidated Financial Statements have been prepared inaccordance with Statement of Position 90-7 (“SOP 90-7”), “Financial Reportingby Entities in Reorganization Under the Bankruptcy Code,” promulgated by theAmerican Institute of Certified Public Accountants. SOP 90-7 requires thatfinancial statements of debtors-in-possession be prepared on a going concernbasis, which contemplates continuity of operations, realization of assets andliquidation of liabilities in the ordinary course of business. However, as aresult of the Filing, the realization of certain of the Debtors’ assets and theliquidation of certain of the Debtors’ liabilities are subject to significantuncertainty. While operating as debtors-in-possession, the Debtors may sell orotherwise dispose of assets and liquidate or settle liabilities for amountsother than those reflected in the Consolidated Financial Statements. Further,the ultimate plan of reorganization could materially change the amounts andclassifications reported in the Consolidated Financial Statements.

 

Pursuant to SOP 90-7, Grace’s pre-petition and future liabilities thatare subject to compromise are required to be reported separately on the balancesheet at an estimate of the amount that will ultimately be allowed by the BankruptcyCourt. As of September 30, 2007, such pre-petition liabilities includefixed obligations (such as debt and contractual commitments), as well asestimates of costs related to contingent liabilities (such as asbestos-relatedlitigation, environmental remediation, and other claims). Obligations of Gracesubsidiaries not covered by the Filing continue to be classified on theConsolidated Balance Sheets based upon maturity dates or the expected dates ofpayment. SOP 90-7 also requires separate reporting of certain expenses,realized gains and losses, and provisions for losses related to the Filing asreorganization items. Grace presents reorganization items as “Chapter 11expenses, net of interest income,” a separate caption in its ConsolidatedStatements of Operations.

 

Grace has not recorded the benefit of any assets that may be availableto fund asbestos-related and other liabilities under the litigation settlementswith Sealed Air and Fresenius, as such agreements are subject to conditions,which, although expected to be met, have not been satisfied and confirmed bythe Bankruptcy Court. The value available under these litigation settlementagreements as measured at September 30, 2007, was $1,237.0 millioncomprised of $115.0 million in cash from Fresenius and$1,122.0 million in cash and stock from Cryovac. Payments under the SealedAir settlement will be made directly to the asbestos trust by Cryovac, and willbe accounted for as a satisfaction of a portion of Grace’s recorded asbestos-relatedliability and a credit to shareholders’ equity.

 

Grace’s Consolidated Balance Sheets separately identify the liabilitiesthat are “subject to compromise” as a result of the Chapter 11 proceedings. InGrace’s case, “liabilities subject to compromise” represent both pre-petitionand future liabilities as determined under U.S. generally accepted accountingprinciples. The bases for the asbestos-related liability component of “liabilitiessubject to compromise” are described in Note 3. Changes to the recordedamount of such liabilities will be based on developments in the Chapter 11Cases and management’s assessment of the claim amounts that will ultimately beallowed by the Bankruptcy Court. Changes to pre-petition liabilities subsequentto the Filing Date reflect: 1) cash payments under approved court orders;2) the terms of Grace’s proposed plan of reorganization, as discussedabove, including the accrual of interest on pre-petition debt and other fixedobligations; 3) accruals for employee-related programs; and 4) changesin estimates related to other pre-petition contingent liabilities.

 

I-13

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Components of liabilities subject to compromise are as follows:

 
| ** **                                     | ** ** | **September 30,   2007** | ** **  | **December 31,  2006** | ** ** |
|------------------------------------------------|------------|------------------------------------|-------------|-----------------------------|------------|
| *(In  millions)*                               | ** ** | ** **                         | ** **  | ** **                  | ** ** |
| Debt, pre-petition plus accrued interest       |       | **$**                              | **787.2**   | ** **                  | $          | 739.5 |   |
| Asbestos-related contingencies                 |       | **1,700.0**                        | ** **  | 1,700.0                     |       |
| Income taxes(1)                                |       | **99.1**                           | ** **  | 141.2                       |       |
| Environmental contingencies                    |       | **366.0**                          | ** **  | 361.1                       |       |
| Postretirement benefits other than pension     |       | **78.2**                           | ** **  | 72.7                        |       |
| Unfunded special pension arrangements          |       | **99.3**                           | ** **  | 95.6                        |       |
| Retained obligations of divested businesses(2) |       | **31.4**                           | ** **  | 18.0                        |       |
| Accounts payable                               |       | **31.7**                           | ** **  | 31.7                        |       |
| Other accrued liabilities                      |       | **82.0**                           | ** **  | 71.2                        |       |
| Reclassification to current liabilities(3)     |       | **(11.1**                          | **)**       | (9.4                        | )          |
| **Total Liabilities Subject to Compromise**    | * *   | **$**                              | **3,263.8** | ** **                  | $          | 3,221.6 | * * |

 

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| (1)    |   | Amounts as of September 30, 2007 and December 31, 2006 are  net of expected refunds of $75.0 million and $15.0 million,  respectively.                                                                                                                                                                                    |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                          |
| (2)    |   | Increased $13.4 million from December 31, 2006 due to  reclass from tax reserves.                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                          |
| (3)    |   | As of September 30, 2007 and December 31, 2006,  approximately $11.1 million and $9.4 million, respectively, of  certain pension and postretirement benefit obligations subject to compromise  have been presented in other current liabilities in the Consolidated Balance  Sheets in accordance with SFAS No. 158. |

 

Note that the unfunded special pension arrangements reflected aboveexclude non-U.S. pension plans and qualified U.S. pension plans that becameunderfunded subsequent to the Filing. Contributions to qualified U.S. pensionplans are subject to Bankruptcy Court approval.

 

I-14

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***Change inLiabilities Subject to Compromise***

 

Set forth below is a reconciliation of the changes in pre-filing dateliability balances for the period from the Filing Date throughSeptember 30, 2007.

 
| ** **                                                                                          | ** ** | **Cumulative  Since Filing** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| *(In  millions)*                                                                                    |       |                              |       |
| Balance, Filing Date April 2, 2001                                                                  |       | $                                 | 2,366.0    |   |
| Cash disbursements and/or reclassifications  under Bankruptcy Court orders:                         |       |                              |       |
| Freight and distribution order                                                                      |       | (5.7                              | )          |
| Trade accounts payable order                                                                        |       | (9.1                              | )          |
| Resolution of contingencies subject to  Chapter 11                                                  |       | (130.0                            | )          |
| Other court orders including employee wages  and benefits, sales and use tax, and customer programs |       | (346.4                            | )          |
| Expense/(income) items:                                                                             |       |                              |       |
| Interest on pre-petition liabilities                                                                |       | 331.1                             |       |
| Employee-related accruals                                                                           |       | 51.7                              |       |
| Provision for asbestos-related  contingencies                                                       |       | 744.8                             |       |
| Provision for estimate of environmental  contingencies                                              |       | 307.6                             |       |
| Provision for estimate of income tax  contingencies                                                 |       | (9.4                              | )          |
| Balance sheet reclassifications                                                                     |       | (36.8                             | )          |
| Balance, end of period                                                                              |       | $                                 | 3,263.8    |   |

 

Additional liabilities subject to compromise may arise due to therejection of executory contracts or unexpired leases, or as a result of theBankruptcy Court’s allowance of contingent or disputed claims.

 

For the holders of pre-petition bank credit facilities, beginningJanuary 1, 2006, Grace agreed to pay interest on pre-petition bank debt atthe prime rate, adjusted for periodic changes, and compounded quarterly. Theeffective rates for the nine months ended September 30, 2007 and 2006 were8.23% and 7.86%, 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 of claims who, but for the Chapter 11 filing, would beentitled under a contract or otherwise to accrue or be paid interest on suchclaim in a non-default (or non-overdue payment) situation under applicablenon-bankruptcy law, Grace accrues interest at the rate provided in the contractbetween the Grace entity and the claimant or such rate as may otherwise applyunder applicable non-bankruptcy law.

 

For all other holders of allowed general unsecured claims, Graceaccrues interest at a rate of 4.19% per annum, compounded annually, unlessotherwise negotiated during the claim settlement process.

 

I-15

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***Chapter 11 Expenses***

 
| ** **                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                        | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| *(In  millions)*                  | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Legal and financial advisory fees |       | **$**                                                | **24.3**   | ** **                                          | $          | 13.9 |   | **$** | **70.5** | ** ** | $ | 38.1 |   |
| Interest income                   |       | **(3.0**                                             | **)**      | (1.9                                                | )          | **(7.8** | **)** | (5.9 | ) |
| Chapter 11 expenses, net          |       | **$**                                                | **21.3**   | ** **                                          | $          | 12.0 |   | **$** | **62.7** | ** ** | $ | 32.2 |   |

 

Pursuant to SOP 90-7, interest income earned on the Debtors’ cashbalances must be offset against Chapter 11 expenses.

 

***Condensed FinancialInformation of the Debtors***

 

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

**Debtor-in-Possession**

**Statements of Operations**

 
| ** **                                                                                                                                | ** ** | **Nine Months Ended  September 30,** | ** **  |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|-------------|
| ** **                                                                                                                                | ** ** | **2007**                                            | ** **  | **2006** | ** ** |
| *(In  millions)*                                                                                                                          | ** ** | ** **                                          | ** **  | ** ** | ** ** |
| Net sales, including intercompany                                                                                                         |       | **$**                                               | **1,129.1** |   | $ | 1,096.7 |   |
| Cost of goods sold, including intercompany,  exclusive of depreciation and amortization shown separately below                            |       | **792.5**                                           |        | 809.5 |   |
| Selling, general and administrative  expenses, exclusive of net pension expense and depreciation and amortization  shown separately below |       | **234.4**                                           |        | 267.4 |   |
| Research and development expenses                                                                                                         |       | **32.2**                                            |        | 28.5 |   |
| Depreciation and amortization                                                                                                             |       | **40.9**                                            |        | 44.6 |   |
| Net pension expense                                                                                                                       |       | **28.8**                                            |        | 34.8 |   |
| Interest expense and related financing  costs                                                                                             |       | **56.5**                                            |        | 54.2 |   |
| Provision for environmental remediation                                                                                                   |       | **12.0**                                            |        | 30.0 |   |
| Other (income) expense, net                                                                                                               |       | **(40.1**                                           | **)**       | (48.7 | ) |
| Chapter 11 expenses, net of interest income                                                                                               |       | **62.8**                                            |        | 32.1 |   |
|                                                                                                                                      |       | **1,220.0**                                         |        | 1,252.4 |   |
|                                                                                                                                      |       | ** **                                          |        |   |   |
| Income (loss) before income taxes and  equity in net income of non-filing entities                                                        |       | **(90.9**                                           | **)**       | (155.7 | ) |
| Benefit from (provision for) income taxes                                                                                                 |       | **14.4**                                            |        | 35.2 |   |
| Income (loss) before equity in net income  of non-filing entities                                                                         |       | **(76.5**                                           | **)**       | (120.5 | ) |
| Equity in net income of non-filing entities                                                                                               |       | **118.5**                                           |        | 133.8 |   |
| **Net income (loss)**                                                                                                                     |       | **$**                                               | **42.0**    |   | $ | 13.3 |   |

 

I-16

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

**Debtor-in-Possession**

**Condensed Statements of Cash Flows**

 
| ** **                                                                                     | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| *(In  millions)*                                                                               | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| **Operating Activities**                                                                       |       |                                                |       |   |   |
| Net income (loss)                                                                              | ** ** | **$**                                               | **42.0**   | ** ** | $ | 13.3 |   |
| Reconciliation to net cash provided by  (used for) operating activities:                       | ** ** | ** **                                          | ** ** |   |   |
| Chapter 11 expenses, net of interest income                                                    | ** ** | **62.8**                                            | ** ** | 32.1 |   |
| (Benefit from) provision for income taxes                                                      | ** ** | **(14.4**                                           | **)**      | (35.2 | ) |
| Equity in net income of non-filing entities                                                    | ** ** | **(118.5**                                          | **)**      | (133.8 | ) |
| Depreciation and amortization                                                                  | ** ** | **40.9**                                            | ** ** | 44.6 |   |
| Interest on pre-petition liabilities  subject to compromise                                    | ** ** | **56.2**                                            | ** ** | 53.1 |   |
| Provision for environmental remediation                                                        | ** ** | **12.0**                                            | ** ** | 30.0 |   |
| Other non-cash items, net                                                                      | ** ** | **(5.8**                                            | **)**      | 0.4 |   |
| Contributions to defined benefit pension  plans                                                | ** ** | **(65.0**                                           | **)**      | (99.2 | ) |
| Cash paid to resolve contingencies subject  to Chapter 11                                      | ** ** | **(10.3**                                           | **)**      | — |   |
| Chapter 11 expenses paid                                                                       | ** ** | **(55.9**                                           | **)**      | (31.8 | ) |
| Changes in other assets and liabilities,  excluding the effect of businesses acquired/divested | ** ** | **(22.8**                                           | **)**      | 35.3 |   |
| **Net cash provided by (used for) operating activities**                                       | ** ** | **(78.8**                                           | **)**      | (91.2 | ) |
| ** **                                                                                     | ** ** | ** **                                          | ** ** |   |   |
| **Investing Activities**                                                                       | ** ** | ** **                                          | ** ** |   |   |
| Capital expenditures                                                                           | ** ** | **(55.2**                                           | **)**      | (60.2 | ) |
| Loan repayments and other                                                                      | ** ** | **126.7**                                           | ** ** | 60.9 |   |
| **Net cash provided by (used for) investing  activities**                                      | ** ** | **71.5**                                            | ** ** | 0.7 |   |
| **Net cash provided by (used for) financing activities**                                       | ** ** | **18.2**                                            | ** ** | (1.8 | ) |
| **Net increase (decrease) in cash and cash  equivalents**                                      | ** ** | **10.9**                                            | ** ** | (92.3 | ) |
| Cash and cash equivalents, beginning of  period                                                | ** ** | **233.8**                                           | ** ** | 269.2 |   |
| Cash and cash equivalents, end of period                                                       | ** ** | **$**                                               | **244.7**  | ** ** | $ | 176.9 |   |

 

I-17

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

**Debtor-in-Possession**

**Balance Sheets**

 
| ** **                                                     | ** ** | **September 30,  2007** | ** **  | **December 31,  2006** | ** ** |
|----------------------------------------------------------------|------------|------------------------------|-------------|-----------------------------|------------|
| *(In  millions)*                                               |       |                         |        |                        |       |
| **ASSETS**                                                     |       |                         |        |                        |       |
| **Current Assets**                                             |       |                         |        |                        |       |
| Cash and cash equivalents                                      |       | **$**                        | **244.7**   | ** **                  | $          | 233.8 |   |
| Marketable securities                                          |       | **26.0**                     | ** **  | 1.0                         |       |
| Trade accounts receivable, net                                 |       | **116.9**                    | ** **  | 117.9                       |       |
| Receivables from non-filing entities, net                      |       | **99.3**                     | ** **  | 53.2                        |       |
| Inventories                                                    |       | **73.6**                     | ** **  | 72.9                        |       |
| Other current assets                                           |       | **47.6**                     | ** **  | 59.9                        |       |
| **Total Current Assets**                                       |       | **608.1**                    | ** **  | 538.7                       |       |
| Properties and equipment, net                                  |       | **388.9**                    | ** **  | 394.5                       |       |
| Cash value of life insurance policies, net  of policy loans    |       | **93.5**                     | ** **  | 89.2                        |       |
| Deferred income taxes                                          |       | **680.1**                    | ** **  | 687.1                       |       |
| Asbestos-related insurance                                     |       | **500.0**                    | ** **  | 500.0                       |       |
| Loans receivable from non-filing entities,  net                |       | **166.8**                    | ** **  | 237.7                       |       |
| Investment in non-filing entities                              |       | **776.4**                    | ** **  | 660.3                       |       |
| Other assets                                                   |       | **87.6**                     | ** **  | 90.8                        |       |
| **Total Assets**                                               |       | **$**                        | **3,301.4** | ** **                  | $          | 3,198.3 |   |
| ** **                                                     |       | ** **                   | ** **  |                        |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY  (DEFICIT)**       |       | ** **                   | ** **  |                        |       |
| **Liabilities Not Subject to Compromise**                      |       | ** **                   | ** **  |                        |       |
| Current liabilities                                            |       | **$**                        | **239.5**   | ** **                  | $          | 212.0 |   |
| Minority interest in consolidated entities                     |       | **54.4**                     | ** **  | 58.4                        |       |
| Pension liabilities                                            |       | **115.8**                    | ** **  | 218.7                       |       |
| Other liabilities                                              |       | **33.7**                     | ** **  | 37.4                        |       |
| **Total Liabilities Not Subject to Compromise**                | ** ** | **443.4**                    | ** **  | 526.5                       |       |
| **Liabilities Subject to Compromise**                          | ** ** | **3,263.8**                  | ** **  | 3,221.6                     |       |
| **Total Liabilities**                                          | ** ** | **3,707.2**                  | ** **  | 3,748.1                     |       |
| **Shareholders’ Equity (Deficit)**                        |       | **(405.8**                   | **)**       | (549.8                      | )          |
| **Total Liabilities and Shareholders’ Equity  (Deficit)** |       | **$**                        | **3,301.4** | ** **                  | $          | 3,198.3 |   |

 

In addition to Grace’s financial reporting obligations as prescribed bythe U.S. Securities and Exchange Commission (“SEC”), the Debtors are alsorequired, under the rules and regulations of the Bankruptcy Code, toperiodically file certain statements and schedules and a monthly operatingreport with the Bankruptcy Court. This information is available to the publicthrough the Bankruptcy Court. This information is prepared in a format that maynot be comparable to information in Grace’s quarterly and annual financialstatements as filed with the SEC. The monthly operating reports are notaudited, do not purport to represent the financial position or results ofoperations of Grace on a consolidated basis, and should not be relied on forsuch purposes.

 

**3.     Asbestos-RelatedLitigation**

 

Grace is a defendant in property damage and personal injury lawsuitsrelating to previously sold asbestos-containing products. As of the FilingDate, Grace was a defendant in 65,656 asbestos-related 

 

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lawsuits, 17 involving claims for property damage (one of which hassince been dismissed), and the remainder involving 129,191 claims for personalinjury. Due to the Filing, holders of asbestos-related claims are stayed fromcontinuing to prosecute pending litigation and from commencing new lawsuitsagainst the Debtors. The PI and PD Committees, representing the interests ofproperty damage and personal injury claimants, respectively, and the FCR,representing the interests of future personal injury claimants, have beenappointed in the Chapter 11 Cases. Grace’s obligations with respect to presentand future claims will be determined through the Chapter 11 process.

 

***Property DamageLitigation*** — The plaintiffs in asbestos propertydamage lawsuits generally seek to have the defendants pay for the cost ofremoving, containing or repairing the asbestos-containing materials in theaffected buildings. Various factors can affect the merit and value of propertydamage claims, including legal defenses, product identification, the amount andtype of product involved, the age, type, size and use of the building, thelegal status of the claimant, the jurisdictional history of prior cases, thecourt in which the case is pending, and the difficulty of asbestos abatement,if necessary.

 

Out of 380 asbestos property damage cases (which involved thousands ofbuildings) filed prior to the Filing Date, 140 were dismissed without paymentof any damages or settlement amounts; judgments after trial were entered infavor of Grace in nine cases (excluding cases settled following appeals ofjudgments in favor of Grace); judgments after trial were entered in favor ofthe plaintiffs in eight cases (one of which is on appeal) for a total of$86.1 million; 207 property damage cases were settled for a total of$696.8 million; and 16 cases remain outstanding (including the one onappeal). Of the 16 remaining cases, eight relate to ZAI and eight relate to anumber of former asbestos-containing products (two of which also are alleged toinvolve ZAI).

 

Approximately 4,035 additional property damage claims were filed priorto the March 31, 2003 claims bar date established by the Bankruptcy Court.(The bar date did not apply to ZAI claims.) Such claims were reviewed in detailby Grace, categorized into claims with sufficient information to be evaluatedor claims that require additional information and, where sufficient informationexisted, the estimated cost of resolution was considered as part of Grace’srecorded asbestos-related liability. (Approximately 200 claims did not containsufficient information to permit an evaluation.) Grace has objected tovirtually all property damage claims on a number of different bases, including:no authorization to file a claim; the claim was previously settled oradjudicated; no or insufficient documentation; failure to identify a Graceproduct; the expiration of the applicable statute of limitations and/or statuteof repose, and/or laches; and a defense that the product in place is nothazardous. As of September 30, 2007, following the reclassification, withdrawalor expungement of claims, approximately 460 property damage claims remainoutstanding. In October 2007, the Bankruptcy Court approved settlementagreements covering 255 property damage claims for an aggregate allowed amountof $64 million.

 

Eight of the ZAI cases were filed as purported class action lawsuits in2000 and 2001. In addition, ten lawsuits were filed as purported class actionsin 2004 and 2005 with respect to persons and homes in Canada. These cases seekdamages and equitable relief, including the removal, replacement and/ordisposal of all such insulation. The plaintiffs assert that this product is inmillions of homes and that the cost of removal could be several thousanddollars per home. As a result of the Filing, the eight U.S. cases have beenstayed.

 

Based on Grace’s investigation of the claims described in theselawsuits, and testing and analysis of this product by Grace and others, Gracebelieves that the product was and continues to be safe for its intended purposeand poses little or no threat to human health. The plaintiffs in the ZAIlawsuits (and the U.S. government in the Montana criminal proceeding describedin Note 12) dispute Grace’s position on the safety of ZAI. OnOctober 18, 2004, the Bankruptcy Court held a hearing on motions filed bythe parties to address a number of important legal and factual issues regardingthe ZAI claims. On December 14, 2006, the Bankruptcy Court issued anopinion and order holding that, although ZAI is contaminated with asbestos andcan release asbestos fibers when disturbed, there is no unreasonable 

 

I-19

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risk of harm from ZAI. The ZAI claimants intend to appeal such opinionand order. The Bankruptcy Court has scheduled a conference in November 2007to consider whether any of the claimant’s theories of liability still need tobe addressed and what claims, if any, may still remain. Grace’s recordedasbestos-related liability at September 30, 2007 assumes the risk of lossfrom ZAI litigation is not probable. If Grace’s view as to risk of loss is notsustained, management believes the cost to resolve the matter would bematerial.

 

***Personal InjuryLitigation*** — Asbestos personal injury claimantsallege adverse health effects from exposure to asbestos-containing productsformerly manufactured by Grace. Historically, Grace’s cost to resolve suchclaims has been influenced by numerous variables, including the nature of thedisease alleged, product identification, proof of exposure to a Grace product,negotiation factors, the solvency of other former producers of asbestoscontaining products, cross-claims by co-defendants, the rate at which newclaims are filed, the jurisdiction in which the claims are filed, and thedefense and disposition costs associated with these claims.

 

Cumulatively through the Filing Date, 16,354 asbestos personal injurylawsuits involving approximately 35,720 claims were dismissed without paymentof any damages or settlement amounts (primarily on the basis that Graceproducts were not involved) and approximately 55,489 lawsuits involvingapproximately 163,698 claims were disposed of (through settlements andjudgments) for a total of $645.6 million. As of the Filing Date, 129,191claims for personal injury were pending against Grace. Grace believes that asubstantial number of additional personal injury claims would have beenreceived between the Filing Date and September 30, 2007 had such claimsnot been stayed by the Bankruptcy Court.

 

***Asbestos-RelatedLiability*** — The total recorded asbestos-relatedliability as of September 30, 2007 and December 31, 2006 was$1,700.0 million and is included in “liabilities subject to compromise” inthe accompanying Consolidated Balance Sheets. Grace adjusted its asbestos-relatedliability in the fourth quarter of 2004 based on its proposed plan ofreorganization as discussed in Note 2. The amount recorded atSeptember 30, 2007 and December 31, 2006 includes the$1,613 million maximum amount reflected as a condition precedent to thePlan and $87 million related to pre-Chapter 11 contractual settlements andjudgments included in general unsecured claims.

 

Under the Plan, Grace is requesting that the Bankruptcy Court determinethe aggregate dollar amount, on a net present value basis, that must be fundedon the effective date of the Plan into an asbestos trust (established underSection 524(g) of the Bankruptcy Code) to pay all asbestos-relatedpersonal injury and property damage claims (including ZAI) entitled to paymentunder the Plan and related trust administration costs and expenses on the laterof the effective date of the Plan or when allowed (the “Funding Amount”). It isa condition to confirmation of the Plan that the Bankruptcy Court shallconclude that the Funding Amount is not greater than $1,613 million. Thisamount, which should be sufficient to fund over $2 billion in pending andfuture claims, was based in part on Grace’s 2004 evaluation of(1) existing but unresolved personal injury and property damage claims,(2) actuarially-based estimates of future personal injury claims,(3) the risk of loss from ZAI litigation, (4) proposed claim paymentsreflected in the Plan, and (5) the cost of the trust administration andlitigation. Based upon these and other factors, Grace was prepared to settleits asbestos-related claims at this amount as part of a consensual plan ofreorganization. As part of the estimation and litigation process, the amountsproposed to or adopted by the Bankruptcy Court may be materially different thanthis amount.

 

The Bankruptcy Court has entered separate case management orders forestimating liability for pending and future personal injury claims andadjudicating pending property damage claims, excluding ZAI claims. A trial forestimating liability for personal injury claims is currently scheduled to beginin January 2008. The Debtors expect that the estimated liability willprovide the basis for determining the Funding Amount to be paid into the truston the effective date of the Plan.

 

I-20

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For personal injury claims, the Bankruptcy Court ordered that allclaimants with claims pending as of the Filing Date (other than settled butunpaid claims) must complete detailed questionnaires providing information on,among other things, their medical condition, including diagnostic support,exposure to Grace and non-Grace asbestos-containing products, employmenthistory, and pending lawsuits against other companies. The Bankruptcy Courtrequired questionnaires to be completed on or before July 12, 2006 andsupplemental questionnaires to be completed on or before January 12, 2007.

 

The Bankruptcy Court also established procedures and 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 are not subject to such settlementagreements were required to file proofs of claim by November 15, 2006.

 

Grace has catalogued and analyzed the information furnished with theproofs of claim and questionnaires. This information and other information,including Grace’s claims and settlement history, the experience of otherdefendants in asbestos-related litigation, and post-petition developments inasbestos-related litigation generally, have been analyzed and reviewed byexperts; and Grace, the PI Committee and the FCR have submitted expert reportsthat each party will rely upon to support its respective estimate of Grace’sasbestos personal injury liability. The estimate of such liability is expectedto provide the basis for determining the appropriate funding amount to resolvecurrent and future asbestos personal injury claims in a plan of reorganization.Copies of Grace’s and the PI Committee’s expert reports and portions of the FCR’sexpert report are available through the Bankruptcy Court. These expert reports(since supplemented, rebutted and made the subject of discovery) are based ondata, methodologies and assumptions that may or may not be accepted by theBankruptcy Court. Grace expects the estimation litigation process to concludewith hearings currently scheduled to begin in January 2008. Grace expectsto adjust its recorded asbestos-related liability as necessary to reflectrulings made by the Bankruptcy Court following these hearings afterconsideration of all evidence presented by Grace, the official committees andthe FCR such adjustments may be material.

 

For property damage claims, the case management order provides thatestimation will be preceded by litigation on certain common threshold issuesaffecting a substantial majority of claims. Such litigation will consist ofdetermining, among other things, (1) whether asbestos-containing productsformerly manufactured by Grace are hazardous in place, and (2) compliancewith the applicable statute of limitations. Grace will also ask the BankruptcyCourt to rule on Grace’s specific objections to individual claims and groups ofclaims.

 

The Funding Amount will primarily be a function of the number ofproperty damage and personal injury claims entitled to be paid under the Plan,and the amount payable per claim. Through the estimation process, Grace willseek to demonstrate that most claims have no value because they fail toestablish any material property damage, health impairment or significantoccupational exposure to asbestos from Grace’s operations or products. If theBankruptcy Court agrees with Grace’s position on the number of, and the amountsto be paid in respect of, allowed personal injury and property damage claims,then Grace believes that the Funding Amount could be less than$1,613 million. However, this outcome is highly uncertain and will dependon a number of Bankruptcy Court rulings favorable to Grace’s position.

 

Conversely, the PI and PD Committees and the FCR continue to assertthat Grace’s asbestos-related liabilities are substantially higher than$1,613 million, and in fact are in excess of Grace’s business value. Ifthe Court accepts the position of the PI and PD Committees and the FCR, thenany plan of reorganization likely would result in the loss of all orsubstantially all equity value by current shareholders. Therefore, due to thesignificant uncertainties of this process and 

 

I-21

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asbestos litigation generally, Grace is not able to estimate a probableFunding Amount that would be accepted by the Bankruptcy Court.

 

However, as Grace is willing to proceed with confirmation of the Planwith a Funding Amount of up to $1,613 million (assuming that otherconditions precedent to confirmation of the Plan are satisfied, including theavailability of the payment from Cryovac directly to the asbestos trust underthe settlement agreement described in Note 2), Grace’s recorded asbestos-relatedliability reflects the maximum amount allowed as a condition precedent underthe Plan. This amount, plus $87.0 million for pre-Chapter 11 contractualsettlements and judgments, brings the total recorded asbestos-related liabilityas of September 30, 2007 and December 31, 2006 to$1,700 million. Any differences between the Plan as filed and as approvedfor confirmation could fundamentally change the accounting measurement of Grace’sasbestos-related liability and that change could be material.

 

***Insurance Rights***— Grace holds insurance policies that provide coverage for 1962 to 1984 withrespect to asbestos-related lawsuits and claims. Eligible claims would have toexceed $4 billion to access total coverage. For the most part, coveragefor years 1962 through 1972 has been exhausted, leaving coverage for years 1973through 1985 available for pending and future asbestos claims. Since 1985,insurance coverage for asbestos-related liabilities has not been commerciallyavailable to Grace.

 

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

 

Grace has entered into settlement agreements with various excessinsurance carriers. These settlements involve amounts paid and to be paid toGrace. The unpaid maximum aggregate amount for settled insurers available underthese settlement agreements is approximately $487 million. With respect toasbestos-related personal injury claims, the settlement agreements generallyrequire that the claims be spread over the claimant’s exposure period and thateach insurer pay a pro rata portion of each claim based on the amount ofcoverage provided during each year of the total exposure period.

 

Presently, Grace has no agreements in place with insurers with respectto approximately $430 million of excess coverage, which is at layers ofcoverage that have not yet been triggered, but certain layers would betriggered if the Plan were approved at the recorded asbestos-related liabilityof $1,700 million. In estimating its ultimate insurance recovery, Gracehas assumed that its unsettled excess coverage will be settled on terms thatare substantially similar to the existing settlement agreements describedabove. Grace believes that any allowed ZAI claims also would be covered underthe settlement agreements and unsettled policies discussed above to the extentthey relate to installations of ZAI occurring after July 1, 1973.

 

In November 2006, Grace entered into a settlement agreement withan underwriter of a portion of its excess insurance coverage. The insurer paida settlement amount of $90.0 million directly to an escrow account for thebenefit of the holders of claims for which Grace was provided coverage underthe affected policies. The escrow account balance at September 30, 2007approximated $93.7 million, including interest earned on the account.Funds will be distributed from this account directly to claimants at the directionof the escrow agent pursuant to the terms of a confirmed plan of reorganizationor as otherwise ordered by the Bankruptcy Court. The settlement agreementprovides that unless Grace confirms a plan of reorganization byDecember 31, 2008, at the option of the insurer, exercisable at any timeprior to April 30, 2009, the escrow amount with interest must be returnedto 

 

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the insurer. Grace will record the amount in the escrow account as anasset and reduce its asbestos insurance receivable balance if and when allcontingencies for the release of such amount are satisfied.

 

As of September 30, 2007, including the settlement discussed aboveand after subtracting previous reimbursements by insurers and allowing fordiscounts pursuant to certain settlement agreements, there remainsapproximately $917 million of excess coverage from 54 presently solventinsurers. Grace estimates that eligible claims would have to exceed$4 billion to access total coverage. Grace further estimates that,assuming the resolution value of asbestos-related claims is equal to therecorded liability of $1,700 million (which should fund claim payments inexcess of $2 billion), it should be entitled to approximately$500 million of insurance recovery. This amount was determined byestimating the aggregate and per year payout for claims over time and applyingthe expected insurance recovery factor to such claims. However, the ultimateamount of insurance recovered on such claims will depend on a number of factorsthat will only be determined at the time claims are paid including: the natureof the claim (PI, PD or ZAI), the relevant exposure years, the timing ofpayment, the solvency of insurers and the legal status of policy rights. Accordingly,Grace’s recorded estimate of insurance recovery may differ materially fromactual amounts received.

 

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.

 

**4.     IncomeTaxes**

 

As disclosed in Note 1, Grace adopted FIN 48 as of January 1,2007. Under FIN 48, Grace may recognize the tax benefit from an uncertain taxposition only if it is more likely than not that the tax position will besustained upon examination by the taxing authorities, based on the technicalmerits of the position. The tax benefits recognized in the financial statementsfrom such a position should be measured based on the largest benefit that has agreater than fifty percent likelihood of being realized upon ultimatesettlement.

 

The effect of the implementation of FIN 48 was to reduce Grace’saccumulated deficit as of January 1, 2007 by $2.2 million. Thisamount primarily reflected recognition of U.S. federal tax benefits relating tocertain expenses incurred in defense of creditor claims and various alternativeminimum tax benefits arising from prior year audits, offset by certainincreases to reserves on foreign income and undistributed foreign earnings. Theamount of unrecognized tax benefits at January 1, 2007 was$200.2 million. If this amount were recognized, it would affect Grace’seffective tax rate. However, to the extent that such recognition involves anincrease in U.S. net operating losses, the accounting benefit would be reduced.The $200.2 million of unrecognized tax benefits includes$45.0 million related to the deduction of certain capital losses in Grace’s1999 U.S. tax return, as further described below, the benefit of which has notbeen recorded by Grace for financial reporting purposes.

 

During the three months ended June 30, 2007, Grace became entitledto and recorded interest receivable (net of federal tax) of $14.7 millionrelated to certain refund claims resulting from losses arising in the 1997-2002period eligible for carryback. In addition, Grace recorded an increase in itsliability for uncertain tax positions of $3.1 million related primarily toan ongoing income tax examination in Germany.

 

During the three months ended September 30, 2007, Grace recognizeda credit to its deferred tax provision of $3.4 million to record theeffect on deferred tax balances of income tax rate changes in Germany and theUnited Kingdom.

 

I-23

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Grace accrues potential interest and any associated penalties relatedto uncertain tax positions in “benefit from (provision for) income taxes” inthe Consolidated Statements of Operations. The total amount of interest andpenalties (on a gross basis) accrued on uncertain tax positions as ofJanuary 1, 2007 was $59.1 million. During the three months and ninemonths ended September 30, 2007, Grace accrued additional interest expense(net of applicable federal benefit) and penalties of $0.4 million and$3.3 million, respectively.

 

Grace files U.S. federal income tax returns as well as income taxreturns in various states and foreign jurisdictions. In many cases, Grace’suncertain tax positions are related to tax years that remain subject toexamination by the relevant taxing authorities. The following table summarizesthese open tax years by major jurisdiction:

 
| **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                                    |       |

 

----

(1)             Includesfederal as well as state, provincial or local jurisdictions, as applicable.

 

(2)                                      In the U.S., theIRS is currently examining tax years 2002-2004. Tax years 1993-1996 and1997-2001 have been examined and partially resolved and there are still pendingissues in appeals or pending legal proceedings as described below.

 

Based upon the outcome of these examinations, or as a result of theexpiration of statute of limitations for specific jurisdictions, Grace believesthere may be a material change to Grace’s aggregate recorded liabilities foruncertain tax positions in the next twelve months with respect to the followingmatters:

 

1.                                       With respect tothe 1993-1996 federal income tax audit there is one issue outstanding relatedto $7.0 million of research and experimentation (“R&E”) credits. Graceis currently engaged in settlement discussions with the Internal RevenueService (“IRS”) regarding this matter.

 

2.                                       With respect tothe IRS examination of the 1997-2001 tax years, Grace has received revisedexamination reports from the IRS, which include the review of losses carriedback to 1988-1989 (collectively, the “Examination Reports”) asserting, in theaggregate, approximately $32.5 million of net additional tax plus accruedinterest. The most significant issue addressed in the Examination Reportsconcerns the carryback of a specified liability loss from the 1998 tax periodto 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. On June 19, 2007, Grace filed a petition in theUnited States Tax Court to resolve the issues relating to the Notice ofDeficiency. Another unresolved issue relates to the 1999 recognition of acapital loss on the disposal of shares of an affiliated entity formed to assistGrace with its environmental remediation needs. The amount at issue is$45 million and Grace is defending its position administratively throughthe IRS appeals process.

 

Other Tax Matters

In January 2007, Grace settled with the IRS on the matter relatedto federal income tax withholding and Federal Insurance Contributions Act taxesfor calendar years 1993 through 1998 of a Grace subsidiary that formerlyoperated a temporary staffing business for health care personnel. Grace paid a 

 

I-24

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$13.0 million settlement and received an indemnification paymentof approximately $2.7 million from its former partner in the business.

 

As of September 30, 2007, Grace had $269.0 million in U.S.net operating loss (“NOL”) carryforwards. As reflected in Grace’s accrualrelated to future foreign earnings repatriations, Grace anticipates theutilization of these NOLs to reduce the tax cost of future dividends from itsnon-U.S. affiliates. Grace anticipates generating additional NOLs uponemergence from bankruptcy as contemplated in the Plan. Because Grace did notpay a significant amount of U.S. taxes in prior years and/or has alreadyreceived or applied for tax refunds from available NOL carryback years, itexpects to carryforward most of its NOLs after emergence from bankruptcy. Underfederal income tax law, a corporation is generally permitted to carryforwardNOLs for a 20-year period for deduction against future taxable income. Grace’sability to deduct NOL carryforwards could be significantly limited if it wereto undergo an ownership change during or as a result of the Chapter 11proceeding. During the course of the bankruptcy proceeding, the BankruptcyCourt entered an order that places certain limitations on trading in Gracecommon stock or options convertible into Grace common 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 that these limitations will prevent an ownershipchange or that its ability to utilize net operating loss carryforwards will notbe significantly limited as a result of Grace’s reorganization.

 

I-25

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**5.      Other (Income) Expense**

** **

Components of other (income) expense are as follows:

 
| ** **                                                       | ** ** | **Three Months  Ended  September 30,** | ** ** | **Nine Months  Ended  September 30,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| **Other (Income) Expense**                             | ** ** | **2007**                                         | ** ** | **2006**                                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| *(In  millions)*                                                 | ** ** | ** **                                       | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income from insurance settlements                                |       | **$**                                            | **(0.1**   | **)**                                           | $          | (0.9 | ) | **$** | **(0.1** | **)** | $ | (7.8 | ) |
| COLI income, net                                                 |       | **(0.5**                                         | **)**      | (0.5                                            | )          | **(3.0** | **)** | (2.2 | ) |
| Interest income                                                  |       | **(1.6**                                         | **)**      | (1.7                                            | )          | **(5.3** | **)** | (4.7 | ) |
| Net (gain) loss on sales of investments and  disposals of assets |       | **0.8**                                          | ** ** | 0.2                                             |       | **(2.8** | **)** | (2.6 | ) |
| Currency translation — intercompany loan                    |       | **(6.8**                                         | **)**      | (2.4                                            | )          | **(10.6** | **)** | (16.1 | ) |
| Value of currency contracts                                      |       | **6.0**                                          | ** ** | 1.6                                             |       | **8.4** | ** ** | 15.1 |   |
| Other currency transaction effects                               |       | **0.9**                                          | ** ** | (0.2                                            | )          | **2.9** | ** ** | 2.5 |   |
| Interest income on joint venture cash  balances                  |       | **(0.7**                                         | **)**      | (0.3                                            | )          | **(2.0** | **)** | (0.5 | ) |
| Other miscellaneous income                                       |       | **(2.9**                                         | **)**      | (2.1                                            | )          | **(8.1** | **)** | (5.8 | ) |
| Total other (income) expense                                     |       | **$**                                            | **(4.9**   | **)**                                           | $          | (6.3 | ) | **$** | **(20.6** | **)** | $ | (22.1 | ) |

 

**6.      BalanceSheet Accounts**

 

*Marketable Securities*

 

In April 2007, Grace invested $25.0 million in a six-month5.25% note offered by the Federal Home Loan Bank. Principal and interest on thenote matures on November 1, 2007. Grace is accounting for this investmentas held-to-maturity, and carrying the note at amortized cost, whichapproximates fair value. Grace has accrued $0.3 million and $0.6 million,respectively, of interest income on this note in the three months and ninemonths ended September 30, 2007, which is recorded in “Chapter 11expenses, net of interest income” in the Consolidated Statement of Operations.

 

I-26

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*Other Balance Sheet Accounts*

 

The following table provides details of Grace’s other significantbalance sheet accounts as of September 30, 2007 and December 31,2006:

 
| ** **                                                                   | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| *(In millions)*                                                         | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| **Inventories**                                                              |       |                         |       |                        |       |
| Raw materials                                                                |       | **$**                        | **74.9**   | ** **                  | $          | 59.6 |   |
| In process                                                                   |       | **40.7**                     | ** ** | 41.4                        |       |
| Finished products                                                            |       | **212.1**                    | ** ** | 189.8                       |       |
| General merchandise                                                          |       | **38.3**                     | ** ** | 35.6                        |       |
| Less: Adjustment of certain inventories to  a last-in/first-out (LIFO) basis |       | **(67.3**                    | **)**      | (41.8                       | )          |
|                                                                         |       | **$**                        | **298.7**  | ** **                  | $          | 284.6 |   |
| **Other Assets**                                                             |       | ** **                   | ** ** |                        |       |
| Deferred charges                                                             |       | **$**                        | **38.9**   | ** **                  | $          | 38.1 |   |
| Long-term receivables, less allowances of  $0.0 (2006 — $0.5)           |       | **7.9**                      | ** ** | 7.9                         |       |
| Patents, licenses and other intangible  assets, net                          |       | **83.2**                     | ** ** | 84.9                        |       |
| Investments in unconsolidated affiliates and  other                          |       | **10.2**                     | ** ** | 0.6                         |       |
|                                                                         |       | **$**                        | **140.2**  | ** **                  | $          | 131.5 |   |
| **Other Current Liabilities**                                                |       | ** **                   | ** ** |                        |       |
| Accrued compensation                                                         |       | **$**                        | **87.1**   | ** **                  | $          | 90.4 |   |
| Deferred tax liability                                                       |       | **7.6**                      | ** ** | 6.7                         |       |
| Customer volume rebates                                                      |       | **37.4**                     | ** ** | 41.8                        |       |
| Accrued commissions                                                          |       | **11.4**                     | ** ** | 13.5                        |       |
| Accrued reorganization fees                                                  |       | **39.1**                     | ** ** | 24.9                        |       |
| Income taxes payable                                                         |       | **34.8**                     | ** ** | 13.9                        |       |
| Other accrued liabilities                                                    |       | **107.0**                    | ** ** | 81.4                        |       |
|                                                                         |       | **$**                        | **324.4**  | ** **                  | $          | 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                                             |       | **7.2**                      | ** ** | 12.2                        |       |
| Other accrued liabilities                                                    |       | **19.7**                     | ** ** | 17.8                        |       |
|                                                                         |       | **$**                        | **40.2**   | ** **                  | $          | 43.3 |   |

 

During 2007, a reduction in U.S. LIFO inventory levels resulted incosts pertaining to prior years being reflected in cost of sales for the ninemonths ended September 30, 2007. This had the effect of increasing pre-taxincome by $0.9 million compared to current cost.

 

Accrued compensation in the table above includes salaries and wages aswell as estimated current amounts due under the annual and long-term incentiveprograms.

 

**7.      LifeInsurance**

 

Grace is the beneficiary of corporate-owned life insurance (“COLI”)policies on certain current and former employees with a net cash surrendervalue of $93.5 million and $89.2 million at September 30, 2007and December 31, 2006, respectively. The policies were acquired to fundvarious employee benefit 

 

I-27

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programs and other long-term liabilities and are structured to providecash flow (primarily tax-free) over an extended number of years.

 

The following tables summarize activity in these policies for the ninemonths ended September 30, 2007 and 2006, and the components of net cashvalue at September 30, 2007 and December 31, 2006:

 
| ** **                                            | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **Life Insurance — Activity Summary**            | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| *(In  millions)*                                      | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Earnings on policy assets                             |       | **$**                                               | **3.6**    | ** ** | $ | 3.2 |   |
| Interest on policy loans                              |       | **(0.6**                                            | **)**      | (1.0 | ) |
| Premiums                                              |       | **1.7**                                             | ** ** | — |   |
| Policy loan repayments                                |       | **0.1**                                             | ** ** | 0.1 |   |
| Proceeds from termination of life insurance  policies |       | **—**                                          | ** ** | — |   |
| Net investing activity                                |       | **(0.5**                                            | **)**      | (0.2 | ) |
| Change in net cash value                              |       | **$**                                               | **4.3**    | ** ** | $ | 2.1 |   |
| Tax-free proceeds received                            |       | **$**                                               | **0.3**    | ** ** | $ | 0.4 |   |

 
| **Components of Net Cash Value** | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| *(In  millions)*                                     | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Gross cash value                                     |       | **$**                        | **119.5**  | ** **                  | $          | 114.7 |   |
| Principal — policy loans                        |       | **(25.6**                    | **)**      | (25.0                       | )          |
| Accrued interest — policy loans                 |       | **(0.4**                     | **)**      | (0.5                        | )          |
| Net cash value                                       |       | **$**                        | **93.5**   | ** **                  | $          | 89.2 |   |
| Insurance benefits in force                          |       | **$**                        | **198.8**  | ** **                  | $          | 197.9 |   |

 

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

 

I-28

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**8. Debt**

 
| **Components of Debt**                          | ** ** | **September 30,  2007** | ** **       | **December 31,**

**2006** | ** ** |
|-----------------------------------------------------------|------------|------------------------------|------------------|---------------------------------|------------|
| *(In  millions)*                                          | ** ** | ** **                   | ** **       | ** **                      | ** ** |
| **Debt payable within one year**                          |       | ** **                   | ** **       |                            |       |
| Other short-term borrowings                               |       | **$**                        | ** 4.1**    | ** **                      | $          |  3.3 |   |
| **Debt payable after one year**                           |       | ** **                   | ** **       |                            |       |
| DIP facility                                              |       | **$**                        | ** —** | ** **                      | $          |  — |   |
| Other long-term borrowings                                |       | **0.3**                      | ** **       | 0.2                             |       |
|                                                      |       | **$**                        | ** 0.3**    | ** **                      | $          | 0.2 |   |
| **Debt Subject to Compromise**                            |       | ** **                   | ** **       |                            |       |
| Bank borrowings                                           |       | **$**                        | ** 500.0**  | ** **                      | $          |  500.0 |   |
| Other borrowings                                          |       | **15.7**                     | ** **       | 13.8                            |       |
| Accrued interest                                          |       | **271.5**                    | ** **       | 225.7                           |       |
|                                                      |       | **$**                        | **787.2**        | ** **                      | $          | 739.5 |   |
| Annualized weighted average interest rates  on total debt |       | **8.2**                      | **%**            | 7.9                             | %          |

 

In April 2001, the Debtors entered into the DIP facility for atwo-year term in the aggregate amount of $250 million. The DIP facility issecured by a priority lien on substantially all assets of the Debtors with theexclusion of the capital stock of non-U.S. subsidiaries, and bears interestbased on the London Interbank Offered Rate (LIBOR). The Debtors have extendedthe term of the DIP facility through April 1, 2008. Grace had nooutstanding borrowings under the DIP facility as of September 30, 2007 andDecember 31, 2006; however, $52.4 million and $55.4 million ofstandby letters of credit were issued and outstanding under the facility as ofSeptember 30, 2007 and December 31, 2006, respectively. The lettersof 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 subsidiary entered intoa line of credit arrangement with a German financing company in the maximumaggregate amount of €50.0 million (equivalent to $70.6 million atSeptember 30, 2007) secured by the accounts receivable of the Germansubsidiary. The financing arrangement will terminate on December 31, 2009,and includes financing costs based on the EURIBOR rate of interest, plus aminimum annual fee.

 

As of September 30, 2007, Grace had access to the equivalent ofapproximately $89.3 million (including the $70.6 million discusseddirectly above) in available credit under various non-U.S. credit facilities.

 

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

 

Under its Certificate of Incorporation, the Company is authorized toissue 300,000,000 shares of common stock, $0.01 par value. Of the common stockunissued at September 30, 2007, approximately 3,269,139 shares werereserved for issuance pursuant to stock options and other stock incentives.Since the Filing Date, Grace has not granted any stock options. During the ninemonths ended September 30, 2007, 1,312,703 stock options were exercisedfor aggregate proceeds of $20.2 million.

 

For additional information, see Notes 15 and 17 to the ConsolidatedFinancial Statements in Grace’s 2006 Form 10-K.

 

I-29

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**10.    Earnings(Loss) Per Share**

 

The following table shows a reconciliation of the numerators anddenominators used in calculating basic and diluted earnings (loss) per share.

 
| ** **                                                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **Earnings (Loss) Per Share**               | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| *(In  millions, except per share amounts)*                 | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Numerators**                                             |       | ** **                                           |       |                                                |       | ** ** |   |   |   |
| Net income (loss)                                          |       | **$**                                                | **16.7**   |                                                | $          | 18.4 |   | **$** | **42.0** |   | $ | 13.3 |   |
| **Denominators**                                           |       | ** **                                           |       |                                                |       | ** ** |   |   |   |
| Weighted average common shares — basic  calculation   |       | **70.2**                                             |       | 68.3                                                |       | **69.9** |   | 67.7 |   |
| Dilutive effect of employee stock options                  |       | **1.3**                                              |       | 0.2                                                 |       | **1.6** |   | 0.4 |   |
| Weighted average common shares — diluted  calculation |       | **71.5**                                             |       | 68.5                                                |       | **71.5** |   | 68.1 |   |
| **Basic earnings (loss) per share**                        |       | **$**                                                | **0.24**   |                                                | $          | 0.27 |   | **$** | **0.60** |   | $ | 0.20 |   |
| **Diluted earnings (loss) per share**                      |       | **$**                                                | **0.23**   |                                                | $          | 0.27 |   | **$** | **0.59** |   | $ | 0.20 |   |

 

The average market price of Grace’s common stock exceeded the exerciseprice of all outstanding stock options for the three months and nine monthsended September 30, 2007. Therefore, there were no antidilutive optionsoutstanding during these periods.

 

Stock options that could potentially dilute basic earnings (loss) pershare (that were excluded from the computation of diluted earnings (loss) pershare because their exercise prices were greater than the average market priceof the common shares) averaged approximately 4.7 million in each of thethree-month and nine-month periods ended September 30, 2006, respectively.

 

I-30

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**11.    ComprehensiveIncome (Loss)**

 

The tables below present the pre-tax, tax and after-tax components ofGrace’s other comprehensive income (loss) for the three months and nine monthsended September 30, 2007 and 2006:

 
| **Three Months Ended September 30, 2007**                 | ** ** | **Pre-Tax  Amount** | ** ** | **Tax  Benefit/  (Expense)** | ** ** | **After-  Tax  Amount** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------|------------|
| *(In  millions)*                                                                   | ** ** | ** **          | ** ** | ** **                   | ** ** | ** **              | ** ** |
| Gain (loss) from hedging activities                                                |       | $                   | (0.8       | )                            | $          | 0.6                     |       | **$** | **(0.2** | **)** |
| 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 |       | 7.0                 |       | (2.4                         | )          | **4.6**                 | ** ** |
| Other changes in funded status                                                     |       | 4.0                 |       | (1.0                         | )          | **3.0**                 | ** ** |
| Benefit plans, net                                                                 |       | 9.3                 |       | (2.8                         | )          | **6.5**                 | ** ** |
| Foreign currency translation adjustments                                           |       | 19.8                |       | —                       |       | **19.8**                | ** ** |
| Other comprehensive income (loss)                                                  |       | $                   | 28.3       |                         | $          | (2.2                    | )          | **$** | **26.1** | ** ** |

 
| **Nine Months Ended September 30, 2007**                  | ** ** | **Pre-Tax  Amount** | ** ** | **Tax  Benefit/  (Expense)** | ** ** | **After-  Tax  Amount** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------|------------|
| *(In  millions)*                                                                   | ** ** | ** **          | ** ** | ** **                   | ** ** | ** **              | ** ** |
| Gain (loss) from hedging activities                                                |       | $                   | (0.9       | )                            | $          | 0.6                     |       | **$** | **(0.3** | **)** |
| Defined benefit pension and other postretirement  plans:                           |       |                |       |                         |       | ** **              | ** ** |
| Amortization of net prior service credit  included in net periodic benefit cost    |       | (5.2                | )          | 1.8                          |       | **(3.4**                | **)**      |
| Amortization of net deferred actuarial loss  included in net periodic benefit cost |       | 21.1                |       | (7.2                         | )          | **13.9**                | ** ** |
| Other changes in funded status                                                     |       | 53.0                |       | (18.0                        | )          | **35.0**                | ** ** |
| Benefit plans, net                                                                 |       | 68.9                |       | (23.4                        | )          | **45.5**                | ** ** |
| Foreign currency translation adjustments                                           |       | 34.4                |       | —                       |       | **34.4**                | ** ** |
| Other comprehensive income (loss)                                                  |       | $                   | 102.4      |                         | $          | (22.8                   | )          | **$** | **79.6** | ** ** |

 
| **Three Months Ended September 30, 2006** | ** ** | **Pre-Tax  Amount** | ** ** | **Tax  Benefit** | ** ** | **After-  Tax  Amount** | ** ** |
|--------------------------------------------------------------------|------------|---------------------|------------|------------------|------------|-------------------------|------------|
| *(In  millions)*                                                   | ** ** | ** **          | ** ** | ** **       | ** ** | ** **              | ** ** |
| Gain (loss) from hedging activities                                |       | $                   | (0.6       | )                | $          | 0.2                     |       | **$** | **(0.4** | **)** |
| Foreign currency translation adjustments                           |       | 8.3                 |       | —           |       | **8.3**                 | ** ** |
| Other comprehensive income (loss)                                  |       | $                   | 7.7        |             | $          | 0.2                     |       | **$** | **7.9** | ** ** |

 

I-31

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| **Nine Months Ended September 30, 2006** | ** ** | **Pre-Tax**

**Amount** | ** ** | **Tax  Benefit** | ** ** | **After-  Tax  Amount** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------|------------|------------------|------------|-------------------------|------------|
| *(In  millions)*                                                  | ** ** | ** **              | ** ** | ** **       | ** ** | ** **              | ** ** |
| Gain (loss) from hedging activities                               |       | $                       | (1.0       | )                | $          | 0.3                     |       | **$** | **(0.7** | **)** |
| Foreign currency translation adjustments                          |       | 22.9                    |       | —           |       | **22.9**                | ** ** |
| Other comprehensive income (loss)                                 |       | $                       | 21.9       |             | $          | 0.3                     |       | **$** | **22.2** | ** ** |

 

The following table presents the components of Grace’s accumulatedother comprehensive income (loss) at September 30, 2007 andDecember 31, 2006:

 
| **Components of Accumulated Other Comprehensive Income (Loss)** | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| *(In  millions)*                                                                              | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Hedging activities (net of tax)                                                               |       | **$**                        | **(1.6**   | **)**                       | $          | (1.3 | ) |
| Defined benefit pension and other  postretirement plans:                                      |       | ** **                   | ** ** |                        |       |
| Net prior service credit (net of tax)                                                         |       | **5.7**                      | ** ** | 9.1                         |       |
| Net deferred actuarial loss (net of tax)                                                      |       | **(355.3**                   | **)**      | (404.2                      | )          |
| Benefit plans, net                                                                            |       | **(349.6**                   | **)**      | (395.1                      | )          |
| Foreign currency translation                                                                  |       | **40.0**                     | ** ** | 5.6                         |       |
| Accumulated other comprehensive income  (loss)                                                |       | **$**                        | **(311.2** | **)**                       | $          | (390.8 | ) |

 

Accumulated other comprehensive income (loss) related to the definedbenefit pension and other postretirement plans at September 30, 2007represents the accumulation of net actuarial losses of $355.3 million aswell as net prior service credits of $5.7 million. These amounts are netof tax and are amortized as a component of net periodic benefit cost. For thethree months and nine months ended September 30, 2007, the pre-tax benefitrecognized related to prior service credits was $1.7 million and$5.2 million, respectively, and the pre-tax expense recognized foramortization of accumulated actuarial losses was $7.0 million and$21.1 million, respectively. In addition, $4.0 million and$53.0 million of additional pre-tax comprehensive income was recognizedfor changes in funded status during the three months and nine months endedSeptember 30, 2007, respectively (see Note 13 for more information).

 

From time to time, Grace enters into commodity derivatives such asforward contracts or option contracts directly with natural gas suppliers, and fixed-rateswaps with financial institutions to mitigate the risk of volatility of naturalgas prices in the United States. Under fixed-rate swaps, Grace locks in a fixedrate with a financial institution for future natural gas purchases, purchasesits natural gas from a supplier at the prevailing market rate, and settles withthe bank for any difference in the rates, thereby “swapping” a variable ratefor a fixed rate. Grace purchases forward contracts, swaps and/or options for aportion of its expected natural gas requirements. Grace’s forward contracts fornatural gas qualify for the normal purchases and normal sales exception fromSFAS No. 133, as they do not contain net settlement provisions, and resultin physical delivery of natural gas from suppliers. Therefore, the fair valuesof these contracts are not recorded in the Consolidated Balance Sheets. Theoutstanding swaps and options are treated as effective cash flow hedges foraccounting purposes and revalued at the end of each quarter, with correspondingadjustments to other comprehensive income (loss).

 

Grace is a global enterprise operating in over 40 countries with localcurrency generally deemed to be the functional currency for accountingpurposes. The foreign currency translation amount represents 

 

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the adjustments necessary to translate the balance sheets valued inlocal currencies to the U.S. dollar as of the end of each period presented, andto translate revenues and expenses at average exchange rates for each periodpresented. 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. Grace also utilizes foreign currency forwardexchange rate and/or option contracts from time to time to hedge the value ofits net investment in certain foreign entities. 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.    Commitmentsand Contingent Liabilities**

 

***Asbestos-RelatedLiability —***See Note 3

 

***EnvironmentalRemediation —***Grace is subject to losscontingencies resulting from extensive and evolving federal, state, local andforeign environmental laws and regulations relating to the generation, storage,handling, discharge and disposition of hazardous wastes and other materials.Grace accrues for anticipated costs associated with investigative andremediation efforts where an assessment has indicated that a probable liabilityhas been incurred and the cost can be reasonably estimated. These accruals donot take into account any discounting for the time value of money.

 

Grace’s environmental liabilities are reassessed whenever circumstancesbecome better defined or remediation efforts and their costs can be betterestimated. These liabilities are evaluated based on currently availableinformation, including the progress of remedial investigation at each site, thecurrent status of discussions with regulatory authorities regarding the methodand extent of remediation at each site, existing technology, prior experiencein contaminated site remediation and the apportionment of costs amongpotentially responsible parties. Grace expects that the funding ofenvironmental remediation activities will be affected by the Chapter 11proceedings.

 

At September 30, 2007, Grace’s estimated liability forenvironmental investigative and remediation costs totaled $366.0 million,as compared with $361.1 million at December 31, 2006. The amount isbased on funding and/or remediation agreements in place and Grace’s bestestimate of its cost for sites not subject to a formal remediation plan. Grace’sestimated environmental liabilities are included in “liabilities subject tocompromise” in the accompanying Consolidated Balance Sheets.

 

For the nine-month period ended September 30, 2007, Grace recordedpre-tax charges of $12.0 million to adjust its estimate of costs toresolve environmental remediation claims based on information exchanged withthe U.S. Government. Of the pre-tax charges, $9.4 million was inconnection with cost recovery obligations arising out of a lawsuit brought bythe U.S. Government (see below). The remainder of the pre-tax charges wereattributable to the ongoing review of recorded environmental liabilities.

 

Net cash expenditures charged against previously established reservesfor the nine months ended September 30, 2007 and 2006 were$7.1 million and $8.7 million, respectively.

 

*Vermiculite Related Matters*

 

EPA Cost Recovery Claim — As a result of a2002 district court ruling, Grace is required to reimburse the U.S. Governmentfor $54.5 million (plus interest) in costs expended throughDecember 2001, and for all appropriate future costs to complete asbestos-relatedremediation relating to Grace’s former vermiculite mining and processingactivities in the Libby, Montana area. These costs include cleaning 

 

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and/or demolition of contaminated buildings, excavation and removal ofcontaminated soil, health screening of Libby residents and former mine workers,and investigation and monitoring costs.

 

Grace’s total estimated liability for asbestos remediation related toits former vermiculite operations in Libby, including the cost of remediationat vermiculite processing sites outside of Libby, at September 30, 2007and December 31, 2006 was $267.1 million and $255.2 million,respectively. The estimated obligation as of each date includes$164.4 million for asserted reimbursable costs through 2005 (whichincludes the $54.5 million charge discussed above). The estimate as ofeach date does not include the cost to remediate the Grace-owned mine site atLibby or other nearby properties that may require remediation, which costs arenot currently estimable. Grace’s estimate of costs is based on informationexchanged with the EPA. However, the EPA’s cost estimates have increasedregularly and substantially over the course of this remediation. Consequently,as the EPA’s spending on these matters increases, or the expected time frameincreases, Grace’s liability for remediation may increase.

 

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’sformer vermiculite mining and processing activities in Libby, Montana. Theindictment accuses the defendants of (1) conspiracy to violateenvironmental laws and obstruct federal agency proceedings; (2) violationsof the federal Clean Air Act; and (3) obstruction of justice.

 

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

 

In March 2005, the U.S. District Court for the District of Montanaentered a scheduling order setting a trial date of September 11, 2006. InJuly 2006, the District Court dismissed a portion of the conspiracy countof a superseding indictment alleging conspiracy to knowingly endanger residentsof the Libby area and others in violation of the Clean Air Act. InAugust 2006, the District Court granted a motion by the defendants toexclude as evidence sample results that included minerals that do notconstitute asbestos under the Clean Air Act. The Government appealed these andother rulings to the Ninth Circuit Court of Appeals, which heard oral argumentin June 2007. In September 2007, the Ninth Circuit Court of Appealsoverturned the July 2006 and August 2006 District Court rulings. InNovember 2007, Grace filed a petition for rehearing concerning theserulings. A new trial date has not yet been scheduled.

 

The U.S. Bankruptcy Court previously granted Grace’s request to advancelegal and defense costs to the employees, subject to a reimbursement obligationif it is later determined that the employees did not meet the standards forindemnification set forth under the appropriate state corporate law. For thenine months ended September 30, 2007 and 2006, respectively, total expensefor Grace and the employees was $11.2 million and $48.2 million,which is included in selling, general and administrative expenses in theaccompanying Consolidated Statements of Operations. Cumulative expenses toaddress this matter were $83.8 million through September 30, 2007.

 

Grace is unable to assess whether the indictment, or any convictionresulting therefrom, will have a material adverse effect on the results ofoperations or financial condition of Grace or affect Grace’s 

 

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bankruptcy proceedings. While the appeal is pending, Grace expectslegal fees for this matter to be $3 million to $5 million perquarter. Grace intends to expense such costs as they are incurred.

 

New Jersey Lawsuit — On June 1, 2005, theNew Jersey Department of Environmental Protection (“DEP”) filed a lawsuitagainst Grace and two former employees in the Superior Court of New Jersey LawDivision: Mercer County *(N.J. Dept. ofEnvironmental 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. The State of New Jerseyand the U.S. Department of Justice also were conducting criminal investigationsrelated to Grace’s former operations of the Hamilton plant, but Grace is notaware of any recent activity related to such investigations.

 

Grace purchased the Hamilton plant assets in 1963 and ceased operationsin 1994. During the operating period, Grace produced spray-on fire protectionproducts and vermiculite-based products at this plant. The current propertyowners are conducting remediation activities as directed by the EPA. Theproperty owners and the EPA have filed proofs of claim against Grace for thissite and now seek approximately $3.4 million with respect to the Hamiltonplant site.

 

In August 2007, the Bankruptcy Court denied the State of NewJersey’s motion for leave to file a late proof of claim in the amount of$31 million. This ruling, which the State of New Jersey has appealed, doesnot affect the claims against the former employees, for which Grace would havean indemnification obligation.

 

*Non-Vermiculite Related Matters*

 

At September 30, 2007 and December 31, 2006, Grace’sestimated liability for remediation of sites not related to its formervermiculite mining and processing activities was $98.9 million and$105.9 million, respectively. This liability relates to Grace’s currentand former operations, including its share of liability for off-site disposalat facilities where it has been identified as a potentially responsible party.Grace’s estimated liability is based upon an evaluation of claims for whichsufficient information was available. As Grace receives new information andcontinues its claims evaluation process, its estimated liability may changematerially.

 

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***Purchase Commitments***— Grace engages in purchase commitments tominimize the volatility of major components of direct manufacturing costsincluding natural gas, certain metals, asphalt, amines and other materials.Such commitments are for quantities that Grace fully expects to use in itsnormal operations.

 

***Guarantees andIndemnification Obligations***— Grace is a party tomany contracts containing guarantees and indemnification obligations. Thesecontracts primarily consist of:

 

•                  Contracts providing for the sale of a formerbusiness unit or product line in which Grace has agreed to indemnify the buyeragainst liabilities arising prior to the closing of the transaction, includingenvironmental liabilities. These liabilities are included in “liabilitiessubject to compromise” in the accompanying Consolidated Balance Sheets.

 

•                  Guarantees of real property lease obligations ofthird parties, typically arising out of (a) leases entered into by formersubsidiaries of Grace, or (b) the assignment or sublease of a lease byGrace to a third party. These obligations are included in “liabilities subjectto compromise” in the accompanying Consolidated Balance Sheets.

 

•                  Licenses of intellectual property by Grace to thirdparties in which Grace has agreed to indemnify the licensee against third partyinfringement claims.

 

•                  Contracts entered into with third party consultants,independent contractors, and other service providers in which Grace has agreedto indemnify such parties against certain liabilities in connection with theirperformance. Based on historical experience and the likelihood that suchparties will make a claim against Grace, Grace believes that such indemnificationobligations are immaterial.

 

•                  Product warranties with respect to certain productssold to customers in the ordinary course of business. These warrantiestypically provide that product will conform to specifications. Grace generallydoes not establish a liability for product warranty based on a percentage ofsales or other formula. Grace accrues a warranty liability on a transaction-specificbasis depending on the individual facts and circumstances related to each sale.Both the liability and annual expense related to product warranties areimmaterial to the Consolidated Financial Statements.

 

***Financial Assurances***— Financial assurances have been established for avariety of purposes, including insurance and environmental matters, asbestossettlements and appeals, trade-related commitments and other matters. AtSeptember 30, 2007, Grace had gross financial assurances issued andoutstanding of $279.2 million, comprised of $138.7 million of suretybonds issued by various insurance companies, and $140.5 million of standbyletters of credit and other financial assurances issued by various banks. Asdiscussed in Note 8, $52.4 million of these financial assurances havebeen issued under the DIP facility.

 

In connection with a 1994 divestment, Grace obtained a letter of creditin the maximum amount of $25.0 million to secure scheduled payments onbonds issued to fund the transaction. Amounts drawn under this letter of creditaggregated $3.9 million through September 30, 2007. The last of thebonds 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 forContingencies***— Although the outcome of each ofthe matters discussed above cannot be predicted with certainty, Grace hasassessed its risk and has made accounting estimates as required under U.S.generally accepted accounting principles. As a result of the Filing, claimsrelated to certain of the items discussed above will be addressed as part ofGrace’s Chapter 11 proceedings. Accruals recorded for such contingencies havebeen included in “liabilities subject to compromise” in the accompanyingConsolidated Balance Sheets. The amounts of these liabilities as ultimatelydetermined through the Chapter 11 proceedings could be materially differentfrom amounts recorded at September 30, 2007.

 

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**13.    PensionPlans and Other Postretirement Benefit Plans**

 

***Pension Plans***—Grace maintains defined benefit pension plans covering employees of certainunits who meet age and service requirements. Benefits are generally based onfinal average salary and years of service. Grace funds its U.S. qualifiedpension plans (“U.S. qualified pension plans”) in accordance with U.S. federallaws and regulations. Non-U.S. pension plans (“non-U.S. pension plans”) arefunded under a variety of methods, as required under local laws and customs.

 

Grace also provides, through nonqualified plans, supplemental pensionbenefits in excess of U.S. qualified pension plan limits imposed by federal taxlaw. These plans cover officers and higher-level employees and serve toincrease the combined pension amount to the level that they otherwise would havereceived under the U.S. qualified pension plans in the absence of such limits.The nonqualified plans are unfunded and Grace pays the costs of benefits asthey are incurred.

 

At the December 31, 2006 measurement date for Grace’s definedbenefit pension plans (the “Plans”), the projected benefit obligation (“PBO”)was approximately $1,433 million as measured under U.S. generally acceptedaccounting principles. Beginning in 2007, on a quarterly basis, Grace analyzespension assets and pension liabilities along with the resulting funded statusand updates its estimate of these measures. Funded status is adjusted forcontributions, benefit payments, actual return on assets, current discountrates and other identifiable and material actuarial changes.

 

The assumed discount rate for pension plans reflects the market ratesfor high quality corporate bonds currently available and is subject to changebased on changes in the overall market interest rates. For the U.S. qualifiedpension plans, the assumed discount rate of 5.75% as of December 31, 2006and 6.25% as of June 30 and September 30, 2007 was selected by Grace,in consultation with its independent actuaries, based on a yield curveconstructed from a portfolio of high quality bonds for which the timing and amountof cash outflows approximate the estimated payouts of the plan. Based on reviewof an updated yield curve analysis as of September 30, 2007, Grace did notchange the assumed discount rate of 6.25% (used at June 30, 2007) for theU.S. qualified pension plans. Grace also evaluated the current discount ratesfor the United Kingdom pension plan and German pension plans, which combinedrepresented approximately 87% of the benefit obligation of the non-U.S. pensionplans as of December 31, 2006. Based on review of the yield curve analysesfor these plans as of September 30, 2007, Grace increased the discountrate for the United Kingdom by 25 basis points from 5.75% at June 30, 2007to 6.00% at September 30, 2007. No change was made to the discount ratefor Germany as compared to June 30, 2007 (remained at 5.25%). For thethree months ended September 30, 2007, the aggregate adjustment to thefunded status resulting from the change in discount rate for the United Kingdompension plan was an increase to total assets of approximately $6 million.After tax effects, total assets increased by approximately $4 million andshareholders’ equity increased by approximately $4 million. For the ninemonths ended September 30, 2007, the aggregate adjustment to the fundedstatus resulting from the change in discount rates was an increase to totalassets of approximately $19 million, and a decrease to total liabilitiesof approximately $57 million. After tax effects, total assets decreased byapproximately $7 million, total liabilities decreased by approximately$57 million and shareholders’ equity increased by approximately$50 million.

 

At September 30, 2007, Grace’s recorded pension liability forunderfunded and unfunded plans was $364.2 million ($258.3 millionincluded in “underfunded and unfunded defined benefit pension plans”,$12.0 million included in “other current liabilities”, and$93.9 million related to noncurrent supplemental pension benefits,included in “liabilities subject to compromise”). The recorded liability reflects1) the shortfall between dedicated assets and the PBO of underfunded plans($124.9 million); and 2) the PBO of unfunded pay-as-you-go plans($239.3 million).

 

***PostretirementBenefits Other Than Pensions***— Grace providespostretirement health care and life insurance benefits for retired employees ofcertain U.S. business units and certain divested units. The postretirementmedical plan provides various levels of benefits to employees hired before 1991who

 

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retire from Grace after age 55 with at least 10 years of service.These plans are unfunded and Grace pays a portion of the costs of benefitsunder these plans as they are incurred. Grace applies SFAS No. 106, “Employers’Accounting for Postretirement Benefits Other Than Pensions,” which requiresthat the future costs of postretirement health care and life insurance benefitsbe accrued over the employees’ years of service.

 

Retirees and beneficiaries covered by the postretirement medical planare required to contribute a minimum of 40% of the calculated premium for thatcoverage. During 2002, per capita costs under the retiree medical plansexceeded caps on the amount Grace was required to contribute under a 1993amendment to the plan. As a result, for 2003 and future years, retirees willbear 100% of any increase in premium costs.

 

For 2007 measurement purposes, per capita costs, before retireecontributions, were assumed to initially increase at a rate of 10.0%. The rateis assumed to decrease gradually to 5.0% through 2012 and remain at that levelthereafter. A one percentage point increase or decrease in assumed health caremedical cost trend rates would have a negligible impact on Grace’spostretirement benefit obligations.

 

The components of net periodic benefit cost (income) for Grace’spension and postretirement plans for the three months and nine months endedSeptember 30, 2007 and 2006 are as follows:

 
| ** **                                                                         | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                                 | ** ** | **2006** | ** ** |
| ** **                                                                         | ** ** | **Pension**                                              | ** ** | **Post-** | ** ** | **Pension** | ** ** | **Post-** | ** ** |
| **Components of Net Periodic Benefit Cost (Income)** | ** ** | **U.S.**                                                 | ** ** | **Non-U.S.** | ** ** | **retirement** | ** ** | **U.S.** | ** ** | **Non-U.S.** | ** ** | **retirement** | ** ** |
| *(In  millions)*                                                                   | ** ** | ** **                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                                                       |       | **$**                                                    | **3.9**    | ** ** | **$** | **2.1** | ** ** | **$** | **—** | ** ** | $ | 4.1 |   | $ | 2.1 |   | $ | 0.1 |   |
| Interest cost                                                                      |       | **14.5**                                                 | ** ** | **5.3** | ** ** | **1.1** | ** ** | 14.5 |   | 4.6 |   | 1.0 |   |
| Expected return on plan assets                                                     |       | **(14.6**                                                | **)**      | **(5.5** | **)** | **—** | ** ** | (13.3 | ) | (4.5 | ) | — |   |
| Amortization of prior service cost (credit)                                        |       | **0.6**                                                  | ** ** | **0.2** | ** ** | **(2.4** | **)** | 0.7 |   | 0.2 |   | (2.6 | ) |
| Amortization of net deferred actuarial loss                                        |       | **5.3**                                                  | ** ** | **1.3** | ** ** | **0.4** | ** ** | 5.7 |   | 1.8 |   | 0.1 |   |
| **Net periodic benefit cost (income)**                                             |       | **$**                                                    | **9.7**    | ** ** | **$** | **3.4** | ** ** | **$** | **(0.9** | **)** | $ | 11.7 |   | $ | 4.2 |   | $ | (1.4 | ) |

 
| ** **                                                                         | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                                | ** ** | **2006** | ** ** |
| ** **                                                                         | ** ** | **Pension**                                             | ** ** | **Post-** | ** ** | **Pension** | ** ** | **Post-** | ** ** |
| **Components of Net Periodic Benefit Cost (Income)** | ** ** | **U.S.**                                                | ** ** | **Non-U.S.** | ** ** | **retirement** | ** ** | **U.S.** | ** ** | **Non-U.S.** | ** ** | **retirement** | ** ** |
| *(In  millions)*                                                                   | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                                                       |       | **$**                                                   | **11.8**   | ** ** | **$** | **5.9** | ** ** | **$** | **0.2** | ** ** | $ | 12.2 |   | $ | 6.2 |   | $ | 0.3 |   |
| Interest cost                                                                      |       | **43.5**                                                | ** ** | **15.4** | ** ** | **3.4** | ** ** | 43.6 |   | 13.1 |   | 3.0 |   |
| Expected return on plan assets                                                     |       | **(43.8**                                               | **)**      | **(16.0** | **)** | **—** | ** ** | (39.8 | ) | (13.3 | ) | — |   |
| Amortization of prior service cost (credit)                                        |       | **1.8**                                                 | ** ** | **0.6** | ** ** | **(7.5** | **)** | 1.9 |   | 0.5 |   | (7.8 | ) |
| Amortization of net deferred actuarial loss                                        |       | **15.8**                                                | ** ** | **3.9** | ** ** | **1.4** | ** ** | 17.2 |   | 5.9 |   | 0.3 |   |
| **Net periodic benefit cost (income)**                                             |       | **$**                                                   | **29.1**   | ** ** | **$** | **9.8** | ** ** | **$** | **(2.5** | **)** | $ | 35.1 |   | $ | 12.4 |   | $ | (4.2 | ) |

 

***Plan Contributionsand Funding*** — Subject to any required approval ofthe Bankruptcy Court, Grace intends to satisfy its funding obligations underthe Plans and to comply with all of the requirements of the Employee RetirementIncome Security Act of 1974 (“ERISA”). For ERISA purposes, funded status 

 

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is calculated on a different basis than under U.S. generally acceptedaccounting principles. On June 20, 2007, Grace obtained Bankruptcy Courtapproval to fund minimum required payments of approximately $54 millionfor the period from July 2007 through January 2008. In that regard,Grace contributed approximately $9 million in July 2007, andapproximately $15 million in each of September 2007 andOctober 2007 to the trusts that hold assets of the Plans. While Graceintends to continue to fund all minimum required payments under the Plans,there can be no assurance that the Bankruptcy Court will continue to approvethese payments.

 

Contributions to non-U.S. pension plans are not subject to BankruptcyCourt approval and Grace intends to fund such plans based on applicable legalrequirements, and actuarial and trustee recommendations.

 

Grace plans to pay benefits as they become due under virtually allpay-as-you-go plans and to maintain compliance with federal funding laws forits U.S. qualified pension plans.

 

**14.    OperatingSegment Information**

 

Grace is a global producer of specialty chemicals and materials. Itgenerates revenues from two operating segments: Grace Davison, which includessilica- and alumina-based catalysts and materials used in a wide range ofindustrial applications; and Grace Performance Chemicals, which includesspecialty chemicals and materials used in commercial and residentialconstruction and in rigid food and beverage packaging. Intersegment sales,eliminated in consolidation, are not material.

 

The following table presents information related to Grace’s operatingsegments for the three months and nine months ended September 30, 2007 and2006, respectively. Only those corporate expenses directly related to theoperating segments are allocated for reporting purposes. All remainingcorporate items are reported separately and labeled as such.

 
| ** **                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **Operating Segment Data** | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| *(In  millions)*                     | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net Sales**                        |       |                                                 |       |                                                |       |   |   |   |   |
| Grace Davison                        |       | **$**                                                | **403.4**  | ** **                                          | $          | 396.5 |   | **$** | **1,229.8** | ** ** | $ | 1,133.2 |   |
| Grace Performance Chemicals          |       | **379.7**                                            | ** ** | 344.9                                               |       | **1,081.7** | ** ** | 995.9 |   |
| **Total**                            |       | **$**                                                | **783.1**  | ** **                                          | $          | 741.4 |   | **$** | **2,311.5** | ** ** | $ | 2,129.1 |   |
| **Pre-tax Operating Income**         |       | ** **                                           | ** ** |                                                |       | ** ** | ** ** |   |   |
| Grace Davison                        |       | **$**                                                | **47.6**   | ** **                                          | $          | 45.6 |   | **$** | **153.2** | ** ** | $ | 127.9 |   |
| Grace Performance Chemicals          |       | **54.1**                                             | ** ** | 51.9                                                |       | **148.9** | ** ** | 139.2 |   |
| Corporate costs                      |       | **(27.7**                                            | **)**      | (26.4                                               | )          | **(74.4** | **)** | (77.5 | ) |
| **Total**                            |       | **$**                                                | **74.0**   | ** **                                          | $          | 71.1 |   | **$** | **227.7** | ** ** | $ | 189.6 |   |

 

Corporate costs include expenses of corporate headquarters functionsincurred in support of core operations, such as corporate financial and legalservices, human resources management, communications and regulatory affairs.Corporate costs also include certain pension and postretirement benefits,including the amortization of deferred costs that are considered a coreoperating expense but not allocated to operating segments.

 

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The following table presents information related to the geographicareas in which Grace operated for the three months and nine months endedSeptember 30, 2007 and 2006, respectively. Sales are attributed togeographic areas based on customer location.

 
| ** **                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **Geographic Area Data** | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| *(In  millions)*                   | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net Sales**                      |       |                                                 |       |                                                |       |   |   |   |   |
| United States                      |       | **$**                                                | **259.0**  | ** **                                          | $          | 268.7 |   | **$** | **757.4** | ** ** | $ | 775.6 |   |
| Canada and Puerto Rico             |       | **24.5**                                             | ** ** | 39.0                                                |       | **69.7** | ** ** | 105.0 |   |
| Total North America                |       | **$**                                                | **283.5**  | ** **                                          | $          | 307.7 |   | **$** | **827.1** | ** ** | $ | 880.6 |   |
| Germany                            |       | **43.7**                                             | ** ** | 37.7                                                |       | **118.3** | ** ** | 103.1 |   |
| Europe, other than Germany         |       | **280.3**                                            | ** ** | 243.5                                               |       | **835.1** | ** ** | 694.1 |   |
| Total Europe                       |       | **$**                                                | **324.0**  | ** **                                          | $          | 281.2 |   | **$** | **953.4** | ** ** | $ | 797.2 |   |
| Asia Pacific                       |       | **123.3**                                            | ** ** | 113.7                                               |       | **382.4** | ** ** | 340.4 |   |
| Latin America                      |       | **52.3**                                             | ** ** | 38.8                                                |       | **148.6** | ** ** | 110.9 |   |
| **Total**                          |       | **$**                                                | **783.1**  | ** **                                          | $          | 741.4 |   | **$** | **2,311.5** | ** ** | $ | 2,129.1 |   |

 

The pre-tax operating income for Grace’s operating segments for thethree months and nine months ended September 30, 2007 and 2006,respectively, is reconciled below to income (loss) before income taxes andminority interest presented in the accompanying Consolidated Statements ofOperations.

 
| ** **                                                                                              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **Reconciliation of Operating Segment Data to Financial Statements** | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| *(In  millions)*                                                                                        | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Pre-tax operating income — core operations                                                         |       | **$**                                                | **74.0**   | ** **                                          | $          | 71.1 |   | **$** | **227.7** | ** ** | $ | 189.6 |   |
| Minority interest in consolidated entities                                                              |       | **3.3**                                              | ** ** | 7.9                                                 |       | **9.8** | ** ** | 26.2 |   |
| Chapter 11 expenses, net of interest income                                                             |       | **(21.3**                                            | **)**      | (12.0                                               | )          | **(62.7** | **)** | (32.2 | ) |
| Net gain (loss) on sales of investments and  disposals of assets                                        |       | **(0.8**                                             | **)**      | (0.2                                                | )          | **2.8** | ** ** | 2.6 |   |
| Provision for environmental remediation                                                                 |       | **—**                                           | ** ** | —                                              |       | **(12.0** | **)** | (30.0 | ) |
| Interest expense and related financing  costs                                                           |       | **(17.4**                                            | **)**      | (18.8                                               | )          | **(57.1** | **)** | (54.5 | ) |
| Other, net                                                                                              |       | **(10.4**                                            | **)**      | (24.1                                               | )          | **(25.1** | **)** | (56.8 | ) |
| Income (loss) before income taxes and  minority interest                                                |       | **$**                                                | **27.4**   | ** **                                          | $          | 23.9 |   | **$** | **83.4** | ** ** | $ | 44.9 |   |

 

Minority interest primarily pertains to Advanced Refining TechnologiesLLC (“ART”), a joint venture between Grace and Chevron Products Company inwhich Grace has a 55% economic interest.

 

**15.    MinorityInterest in Consolidated Entities**

 

Within both Grace Davison and Grace Performance Chemicals, Graceconducts certain business activities in various countries through jointventures with unaffiliated third parties, the financial results

 

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of which are included in Grace’s consolidated financial statements. Thefollowing tables present summary financial statistics for Grace’s combinedbusinesses subject to profit sharing:

 
| ** **                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                           | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| *(In  millions)*                     | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales                                |       | **$**                                                | **89.9**   | ** **                                          | $          | 107.9 |   | **$** | **305.8** | ** ** | $ | 311.5 |   |
| Income before taxes                  |       | **8.2**                                              | ** ** | 18.7                                                |       | **23.9** | ** ** | 62.1 |   |
| Net income                           |       | **7.3**                                              | ** ** | 17.2                                                |       | **21.9** | ** ** | 58.9 |   |
| Minority interests in net income     |       | **3.3**                                              | ** ** | 7.9                                                 |       | **9.8** | ** ** | 26.2 |   |
| Dividends paid to minority interests |       | **(0.2**                                             | **)**      | (0.1                                                | )          | **(12.0** | **)** | (0.1 | ) |
|                                      |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |

 
| ** **                                      | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|-------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| *(In  millions)*                                | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Cash                                            |       | **$**                        | **66.1**   | ** **                  | $          | 65.5 |   |
| Other current assets                            |       | **126.3**                    | ** ** | 136.7                       |       |
| Total assets                                    |       | **210.1**                    | ** ** | 212.4                       |       |
| Total liabilities                               |       | **69.3**                     | ** ** | 66.9                        |       |
| Shareholders’ equity                       |       | **140.8**                    | ** ** | 145.5                       |       |
| Minority interests in shareholders’ equity |       | **62.7**                     | ** ** | 65.0                        |       |
|                                                 |            |                              |            |                             |            |  |  |

 

**16.    SubsequentEvent—PI Committee and FCR Plan of Reorganization**

** **

On July 26, 2007, theBankruptcy Court terminated Grace’s exclusive rights to propose a plan ofreorganization and solicit votes thereon. As a result of the termination of these rights, any party-in-interestcan propose a competing plan of reorganization.

 

On November 5, 2007, the PICommittee and the FCR filed a proposed plan of reorganization (the “PI Plan”)with the Bankruptcy Court.  A copy of thePI Plan is available from the Bankruptcy Court. The filing did not include a disclosure statement, trust distributionprocedures, exhibits or other supporting documents.  Any plan of reorganization will becomeeffective only after a vote of eligible creditors and with the approval of theBankruptcy Court and the U.S. District Court for the District of Delaware.  Votes on any plan of reorganization may notbe solicited until the Bankruptcy Court approves the related disclosurestatement.

 

Under the terms of the PI Plan, a trust would be established underSection 524(g) of the Bankruptcy Code (the “PI Trust”) to which all pending andfuture asbestos-related personal injury claims and demands (“PI Claims”) wouldbe channeled for resolution.  The PI Plancontemplates that the Bankruptcy Court would determine, among other things, anestimate of the value of all PI Claims. The PI Plan assumes that:  cashwould be available from insurers (see Note 3); cash would be available fromFresenius pursuant to the Fresenius settlement (see Note 2); and cash andshares of Sealed Air common stock would be available from Cryovac pursuant tothe Sealed Air settlement (see Note 2). As a condition precedent to the PI Plan, the Bankruptcy Court mustdetermine that the estimated value of all PI Claims, excluding to the extentapplicable post-petition interest, is not less than $4.0 billion.  If the amount available for distributionpursuant to the PI Plan is more than the principal amount of creditors’ claims,creditors entitled to post-petition interest would be paid such interest andany remaining value would be available to current Grace shareholders in theform of new Grace equity securities.

 

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

 

***Asbestos-Related Personal Injury Claims andCosts (PI Claims)*—** All pending and future PIClaims would be channeled to the PI Trust for resolution.  The pending asbestos-related legalproceedings are described in “Asbestos-Related Litigation” (see Note 3).  The PI Plan provides that claims arising fromsuch proceedings would be subject to specified trust distribution proceduresthat were not part of the documents filed with the Bankruptcy Court.

 

In order to satisfy allowed PI Claims and the related trustadministration costs and expenses, on the effective date ofthe PI Plan, the PI Trust would be funded with:  (1) cash; (2) cash and shares of Sealed Aircommon stock pursuant to the Sealed Air settlement (see Note 2); (3) personalinjury liability insurance (see Note 3), unless it is valued at more than $500million, in which case it would remain with Grace; and (4) Grace equitysecurities.  The number of shares and thevalue of Grace equity securities contributed to the PI Trust would depend onthe enterprise value of Grace, the value of Grace’s personal injury liabilityinsurance and the value of the Sealed Air settlement.

 

 

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***Asbestos-Related Property Damage Claimsexcluding ZAI (PD Claims) —***Settled PD Claimswould be paid in a combination of cash and Grace equity securities on the effective date of the PI Plan.  Onthe effective date of the PI Plan, Grace would establish a reserve consistingof cash and Grace equity securities with a value equal to the estimated amountof unresolved PD Claims.  UnresolvedPD Claims would remain in the mediation and litigation process and would be paid in cash and Graceequity securities from the reserve.  If the reserve did not have sufficientassets to pay all unresolved PD Claims once the amounts were determined, Gracewould be liable to pay any amounts not funded from the reserve.

 

# ***ZAI Claims —*** ZAI claims would remain inthe litigation process and would bepaid by Grace, if required.

 

***Certain Environmental Claims*—**Certain allowed environmental claims wouldbe paid in cash and Grace equity securities on the effective date of the PIPlan.  On the effective date of the PI Plan, Grace would establish a reserveconsisting of cash and Grace equity securities with a value equal to theestimated amount of unresolved environmental claims.  Unresolved environmental claims wouldbe determined by the Bankruptcy Court and would be paid in cash and Grace equity securities from thereserve.  If the reserve did not have sufficient assets to pay all unresolved environmentalclaims once the amounts weredetermined, Grace would be liable to pay any amounts not funded from thereserve.

 

***Other Claims*—**All allowed administrative or priorityclaims would be paid in cash (either on the effective date of the PI Plan or asthey become due and payable over time). General unsecured claims, other than those covered by the PI Trust,would be paid in cash (either on the effective date of the PI Plan or as theybecome due and payable over time) and Grace equity securities.  Certain environmental and general unsecuredclaims would be reinstated and the holders of such claims would retain alllegal and other rights to which they are entitled under such claims.  Other non-asbestos-related liabilities andclaims (primarily certain tax claims and employee-related claims such aspension and retirement medical obligations) would be paid in cash as theybecome due and payable over time.

 

***Effect on Grace Common Stock*****— Outstanding Grace common stock would becancelled at the effective date of the PI Plan.

 

The Plan proposed by theDebtors (see Note 2) (referred to in Note 16 as the “Debtors Plan”) and the PIPlan are designed to address all pending and future asbestos-related claims andall other pre-petition claims as outlined respectively, therein.  However, neither plan of reorganization maybe ultimately approved by the Bankruptcy Court and other interestedparties.  Further, the proponents of theDebtors Plan and the PI Plan are free to amend their respective plans ofreorganization at any time.  As a result,a plan of reorganization that is materially different from the Debtors Plan andthe PI Plan may ultimately be approved. Under the ultimate plan ofreorganization, the interests of the holders of Grace common stock could be substantiallydiluted or cancelled and the value of non-asbestos claims could be materiallydifferent from that reflected in Grace’s balance sheet.  The value of Grace common stock and theextent of any recovery by non-asbestos-related creditors, will dependprincipally on the amount of Grace’s asbestos-related liability under aconfirmed plan of reorganization.

 

 

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**Item 2. MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Financial Summary for September 30, 2007**

 

Following is a summary analysis of key financial measures of ourperformance for the three months and nine months ended September 30, 2007compared with the prior year periods.

 

•     Salesincreased 5.6% and 8.6% for the three months and nine months endedSeptember 30, 2007, respectively, primarily as a result of higher sellingprices in response to rising raw material costs and to higher volumes in mostproduct groups, particularly outside the United States.

 

•     Netresults for each period have been primarily affected by: 1) the results ofour businesses — which are categorized as “core operations”; and 2) theimpact of legal contingencies and other nonoperating liabilities — which iscategorized as “noncore activities”.

 

•     Net incomewas $16.7 million for the three months ended September 30, 2007,compared with $18.4 million for the three months ended September 30,2006. Net income was $42.0 million for the nine months endedSeptember 30, 2007, compared with $13.3 million for the nine monthsended September 30, 2006. The current year and prior year periods werenegatively affected by Chapter 11 expenses, litigation and other matters notrelated to core operations.

 

•     Pre-taxincome from core operations increased 4.1% and 20.1% for the three months andnine months ended September 30, 2007, respectively, primarily attributableto higher sales volume in regions other than North America, higher sellingprices to offset cost inflation and lower overall pension costs.

 

•     Pre-taxoperating income of our Grace Davison operating segment increased 4.4% and19.8% for the three months and nine months ended September 30, 2007,respectively, attributable primarily to higher sales in most product groups andin regions other than North America, partially offset by higher raw materialcosts, which have increased approximately 11% year-to-date.

 

•     Pre-taxoperating income of our Grace Performance Chemicals operating segment increased4.2% and 7.0% for the three months and nine months ended September 30,2007, respectively, attributable primarily to higher sales volume in geographicregions other than North America, selling price increases, and positive resultsfrom productivity and cost containment initiatives, which more than offset anapproximate 6% year-to-date increase in raw material costs.

 

•     Operatingcash inflow for the nine months ended September 30, 2007 was $65.8 millioncompared with $49.4 million for the prior year period. The increase incash flow from operating activities was principally attributable to higherpretax operating income offset by higher dividends to joint venture partnersand cash paid to resolve certain tax contingencies.

 

•     Pre-taxloss from noncore activities was $12.8 million in the third quarter of2007 compared with $26.0 million in the prior year quarter. The pre-taxloss from noncore activities was $39.6 million for the nine months endedSeptember 30, 2007 compared with $88.9 million in the prior yearperiod. The losses are principally due to: (1) charges of$12.0 million and $30 million in the nine months endedSeptember 30, 2007 and 2006, respectively, to adjust Grace’s estimate ofcosts to resolve environmental remediation claims; and (2) defense costsof $11.2 million and $48.2 million in the nine months endedSeptember 30, 2007 and 2006, respectively, related to legal proceedingsarising from Grace’s former vermiculite mining operations in Montana.

 

We are attempting to resolve noncore liabilities and contingenciesthrough our Chapter 11 proceeding. Our noncore liabilities include asbestos-relatedlitigation, environmental remediation, tax disputes and business litigation.Our operating statements include periodic adjustments to account for changes in

 

 

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estimates of such liabilities and developments in our Chapter 11proceeding. These liabilities and contingencies may result in continuedvolatility in net income in the future.

 

**Description of Core Business**

 

We are engaged in specialty chemicals and specialty materialsbusinesses on a worldwide basis through 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 polyethylene and polypropyleneresins, and other chemical catalysts used in a variety of industrial,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 our hydroprocessing catalyst business through AdvancedRefining Technologies, LLC (“ART”), our joint venture with Chevron ProductsCompany (“Chevron”). We report 100% of the revenues of the ART joint venture,but only receive 55% of the income after minority interest is allocated toChevron.

 

Key external factors for our FCC catalysts and hydroprocessingcatalysts are the economics of the petroleum refining industry, specificallythe impacts of demand for transportation fuels and petrochemical products, andcrude oil supply. FCC catalysts are consumed at a relatively steady rate andreplaced regularly, while most hydroprocessing catalysts are consumed over aperiod of years and replaced in an irregular pattern.

 

Sales of our other three Grace Davison product groups are affected bygeneral economic conditions including the underlying growth rate of targetedend-use applications.

 

***Grace PerformanceChemicals*** includes:

 

•     Specialty chemicals and materials, includingconcrete admixtures and fibers used to improve the durability and workingproperties of concrete, additives used in cement processing to improve energyefficiency, enhance the characteristics of finished cement and improve ease ofuse, building materials used in commercial and residential construction andrenovation to protect buildings from water,

 

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vapor andair penetration, and fireproofing materials used to protect buildings in theevent of fire; and

 

•     Darexpackaging products and technologies, primarily specialty sealants and coatingsused in rigid food and beverage packages, including can and closure sealantsused to seal and enhance the shelf life of can and bottle contents, andcoatings for cans and closures that prevent metal corrosion, protect packagecontents from the influence of metal and ensure proper adhesion of sealingcompounds.

 

Construction products sales are primarily impacted by globalnon-residential construction activity and U.S. residential constructionactivity.

 

Our packaging technologies sales are affected by regional economicconditions as well as an ongoing shift in demand away from metal containers toplastic packaging for foods and beverages. This shift has caused a decline incan sealant usage over recent years, but provides opportunities for increasedsales of closure sealants, coatings and other products for plastic packaging.

 

In May 2007, we transferred our packaging technologies productgroup to the Grace Davison operating segment. As a result, we are currentlyevaluating the configuration of our reportable operating segments in an effortto more clearly convey business drivers and performance; the evaluation isexpected to be completed during the fourth quarter of 2007. Until such reviewis complete, we will continue to report segment information consistent withprior periods.

 

***Global scope***— We operate our business on a global scale with approximately two-thirds ofour revenue (see table below) and over half of our operating properties outsidethe United States. We conduct business in more than 40 countries and in morethan 20 currencies. We manage our operating segments on a global basis, toserve global markets. Currency fluctuations in relation to the U.S. dollar affectour reported earnings, net assets and cash flows.

 

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

 
| ** **                                              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **Percentage of Total Grace Sales** | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Grace Davison                                      |       | **51.5**                                             | **%**      | 53.5                                                | %          | **53.2** | **%** | 53.2 | % |
| Grace Performance Chemicals                             |       | **48.5**                                             | **%**      | 46.5                                                | %          | **46.8** | **%** | 46.8 | % |
| **Total**                                               |       | **100.0**                                            | **%**      | 100.0                                               | %          | **100.0** | **%** | 100.0 | % |
|                                                    |       | ** **                                           | ** ** |                                                |       | ** ** | ** ** |   |   |
| Grace U.S.                                              |       | **33.1**                                             | **%**      | 36.3                                                | %          | **32.8** | **%** | 36.4 | % |
| Grace non-U.S.                                          |       | **66.9**                                             | **%**      | 63.7                                                | %          | **67.2** | **%** | 63.6 | % |
| **Total**                                               |       | **100.0**                                            | **%**      | 100.0                                               | %          | **100.0** | **%** | 100.0 | % |

 

**Voluntary Bankruptcy Filing**

 

In response to a sharply increasing number of asbestos-related personalinjury claims, on April 2, 2001, Grace and 61 of our United Statessubsidiaries and affiliates, including W. R. Grace & Co.-Conn., filedvoluntary petitions for reorganization under Chapter 11 of the United StatesBankruptcy Code in the United States Bankruptcy Court for the District ofDelaware. Our non-U.S. subsidiaries and certain of our U.S. subsidiaries werenot included in the Chapter 11 filing.

 

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Under Chapter 11, we have continued to operate as debtors-in-possessionunder court protection from creditors and claimants, while using the Chapter 11process to develop and implement a plan for addressing the asbestos-relatedclaims. Since the Chapter 11 filing, the bankruptcy court has approved allmotions necessary to conduct normal business activities.

 

On January 13, 2005, we filed an amended plan of reorganizationand related documents with the bankruptcy court. The plan of reorganization issupported by committees representing general unsecured creditors and equityholders, but is not supported by committees representing asbestos personalinjury claimants and asbestos property damage claimants or the representativeof future asbestos claimants. Under the terms of the plan of reorganization, atrust would be established to which all pending and future asbestos-relatedclaims would be channeled for resolution. The plan of reorganization can becomeeffective only after a vote of eligible creditors and with the approval of thebankruptcy court and the U.S. District Court for the District of Delaware. See “Planof Reorganization” below for more information.

 

**Critical Accounting Estimates**

 

See the “Critical Accounting Estimates” heading in Item 7 of ourForm 10-K for the year ended December 31, 2006 and in Item 2 of ourForm 10-Q for the quarter ended March 31, 2007 for a discussion ofour critical accounting estimates.

 

**Summary Financial Information and Metrics**

 

Set forth below is a chart that lists our key operating statistics, anddollar and percentage changes for the three-month and nine-month periods endedSeptember 30, 2007 and 2006. Please refer to this Analysis of ContinuingOperations chart when reading Management’s Discussion and Analysis of FinancialCondition and Results of Operations.

 

In the Analysis of Continuing Operations chart, as well as in the financialinformation presented throughout Management’s Discussion and Analysis ofFinancial Condition and Results of Operations, we present our financial resultsin the same manner as results are reviewed 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 income from core operations, pre-tax income (loss) from noncoreactivities, pre-tax income from core operations as a percentage of sales, andpre-tax income from core operations before depreciation and amortization do notpurport to represent income or cash flow measures as defined under U.S.generally accepted accounting principles, and you should not consider them analternative to such measures as an indicator of our performance. We providethese measures so you can distinguish the operating results of our currentbusiness base from the income and expenses of our past businesses, discontinuedproducts, and corporate legacies, and the effect of our Chapter 11 proceedings,and to ensure that you understand the key data that management uses to evaluateour results of operations.

 

Pre-tax income from core operations has material limitations as anoperating performance measure because it excludes income and expenses thatcomprise our noncore activities, which include, among other things, provisionsfor asbestos-related litigation and environmental remediation, income from

 

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insurance settlements, and legal defense costs, all of which have beenmaterial components of our net income (loss). Pre-tax income from coreoperations before depreciation and amortization also has material limitationsas an operating performance measure since it excludes the impact ofdepreciation 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 should evaluate pre-tax income from core operationsand pre-tax income from core operations before depreciation and amortization inconjunction with net income (loss) for a more complete analysis of ourfinancial results.

 

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| ** **                                                                             | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **Analysis  of Continuing Operations**                                                 | ** ** | **2007**                                                 | ** ** | **2006**                                                | ** ** | **$   Change  Fav  (Unfav)** | ** ** | **%  Change  Fav  (Unfav)** | ** ** | **2007** | ** ** | **2006** | ** ** | **$   Change  Fav  (Unfav)** | ** ** | **%  Change  Fav  (Unfav)** | ** ** |
| *(In millions)*                                                                   | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net  sales:**                                                                        |       | ** **                                               | ** ** |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Grace Davison                                                                          |       | **$**                                                    | **403.4**  | ** **                                              | $          | 396.5 |   | $ | 6.9 |   | 1.7 | % | **$** | **1,229.8** | ** ** | $ | 1,133.2 |   | $ | 96.6 |   | 8.5 | % |
| Grace Performance  Chemicals                                                           |       | **379.7**                                                | ** ** | 344.9                                                   |       | 34.8 |   | 10.1 | % | **1,081.7** | ** ** | 995.9 |   | 85.8 |   | 8.6 | % |
| **Total  Grace net sales**                                                             |       | **$**                                                    | **783.1**  | ** **                                              | $          | 741.4 |   | $ | 41.7 |   | 5.6 | % | **$** | **2,311.5** | ** ** | $ | 2,129.1 |   | $ | 182.4 |   | 8.6 | % |
| **Pre-tax  operating income:**                                                         |       | ** **                                               | ** ** |                                                    |       |   |   |   |   | ** ** | ** ** |   |   |   |   |   |   |
| Grace Davison(1)                                                                       |       | **$**                                                    | **47.6**   | ** **                                              | $          | 45.6 |   | $ | 2.0 |   | 4.4 | % | **$** | **153.2** | ** ** | $ | 127.9 |   | $ | 25.3 |   | 19.8 | % |
| Grace Performance  Chemicals(2)                                                        |       | **54.1**                                                 | ** ** | 51.9                                                    |       | 2.2 |   | 4.2 | % | **148.9** | ** ** | 139.2 |   | 9.7 |   | 7.0 | % |
| Corporate costs:                                                                       |       | ** **                                               | ** ** |                                                    |       |   |   |   |   | ** ** | ** ** |   |   |   |   |   |   |
| Support functions                                                                      |       | **(12.1**                                                | **)**      | (11.5                                                   | )          | (0.6 | ) | (5.2 | )% | **(35.4** | **)** | (33.5 | ) | (1.9 | ) | (5.7 | )% |
| Pension,  performance-related compensation, and other                                  |       | **(15.6**                                                | **)**      | (14.9                                                   | )          | (0.7 | ) | (4.7 | )% | **(39.0** | **)** | (44.0 | ) | 5.0 |   | 11.4 | % |
| Total Corporate  costs                                                                 |       | **(27.7**                                                | **)**      | (26.4                                                   | )          | (1.3 | ) | (4.9 | )% | **(74.4** | **)** | (77.5 | ) | 3.1 |   | 4.0 | % |
| **Pre-tax  income from core operations**                                               |       | **74.0**                                                 | ** ** | 71.1                                                    |       | 2.9 |   | 4.1 | % | **227.7** | ** ** | 189.6 |   | 38.1 |   | 20.1 | % |
| **Pre-tax  income (loss) from noncore activities**                                     |       | **(12.8**                                                | **)**      | (26.0                                                   | )          | 13.2 |   | 50.8 | % | **(39.6** | **)** | (88.9 | ) | 49.3 |   | 55.5 | % |
| Interest expense                                                                       |       | **(17.4**                                                | **)**      | (18.8                                                   | )          | 1.4 |   | 7.4 | % | **(57.1** | **)** | (54.5 | ) | (2.6 | ) | (4.8 | )% |
| Interest income                                                                        |       | **1.6**                                                  | ** ** | 1.7                                                     |       | (0.1 | ) | (5.9 | )% | **5.3** | ** ** | 4.7 |   | 0.6 |   | 12.8 | % |
| **Income  (loss) before Chapter 11 expenses and income taxes**                         |       | **45.4**                                                 | ** ** | 28.0                                                    |       | 17.4 |   | 62.1 | % | **136.3** | ** ** | 50.9 |   | 85.4 |   | 167.8 | % |
| Chapter 11  expenses, net of interest income                                           |       | **(21.3**                                                | **)**      | (12.0                                                   | )          | (9.3 | ) | (77.5 | )% | **(62.7** | **)** | (32.2 | ) | (30.5 | ) | (94.7 | )% |
| Benefit from  (provision for) income taxes                                             |       | **(7.4**                                                 | **)**      | 2.4                                                     |       | (9.8 | ) | NM |   | **(31.6** | **)** | (5.4 | ) | (26.2 | ) | NM |   |
| **Net  income (loss)**                                                                 |       | **$**                                                    | **16.7**   | ** **                                              | $          | 18.4 |   | $ | (1.7 | ) | (9.2 | )% | **$** | **42.0** | ** ** | $ | 13.3 |   | $ | 28.7 |   | NM |   |
| ** **                                                                             |       | ** **                                               | ** ** |                                                    |       |   |   |   |   | ** ** | ** ** |   |   |   |   |   |   |
| **Key  Financial Measures:**                                                           |       | ** **                                               | ** ** |                                                    |       |   |   |   |   | ** ** | ** ** |   |   |   |   |   |   |
| **Pre-tax  income from core operations as a percentage of sales:**                     |       | ** **                                               | ** ** |                                                    |       |   |   |   |   | ** ** | ** ** |   |   |   |   |   |   |
| Grace Davison                                                                          |       | **11.8**                                                 | **%**      | 11.5                                                    | %          | NM |   | 0.3pts |   | **12.5** | **%** | 11.3 | % | NM |   | 1.2pts |   |
| Grace Performance  Chemicals                                                           |       | **14.2**                                                 | **%**      | 15.0                                                    | %          | NM |   | (0.8pts | ) | **13.8** | **%** | 14.0 | % | NM |   | (0.2pts | ) |
| Total Core  Operations                                                                 |       | **9.4**                                                  | **%**      | 9.6                                                     | %          | NM |   | (0.2pts | ) | **9.9** | **%** | 8.9 | % | NM |   | 1.0pts |   |
| Total Core  Operations adjusted for profit sharing of joint ventures(3)                |       | **9.9**                                                  | **%**      | 10.7                                                    | %          | NM |   | (0.8pts | ) | **10.3** | **%** | 10.1 | % | NM |   | 0.2pts |   |
| **Pre-tax  income from core operations before depreciation and amortization**          |       | **$**                                                    | **102.3**  | ** **                                              | $          | 100.3 |   | $ | 2.0 |   | 2.0 | % | **$** | **311.2** | ** ** | $ | 275.3 |   | $ | 35.9 |   | 13.0 | % |
| **As a  percentage of sales**                                                          |       | **13.1**                                                 | **%**      | 13.5                                                    | %          | NM |   | (0.4pts | ) | **13.5** | **%** | 12.9 | % | NM |   | 0.6pts |   |
| **Depreciation  and amortization**                                                     |       | **$**                                                    | **28.3**   | ** **                                              | $          | 29.2 |   | $ | 0.9 |   | 3.1 | % | **$** | **83.5** | ** ** | $ | 85.7 |   | $ | 2.2 |   | 2.6 | % |
| **Gross  profit percentage (sales less cost of goods sold as a percent of sales)(4):** | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Grace Davison                                                                          |       | **28.6**                                                 | **%**      | 30.0                                                    | %          | NM |   | (1.4pts | ) | **28.7** | **%** | 29.6 | % | NM |   | (0.9pts | ) |
| Grace Performance  Chemicals                                                           |       | **34.9**                                                 | **%**      | 34.9                                                    | %          | NM |   | pts |   | **34.6** | **%** | 34.7 | % | NM |   | (0.1pts | ) |
| Total Grace                                                                            |       | **31.4**                                                 | **%**      | 32.1                                                    | %          | NM |   | (0.7pts | ) | **31.3** | **%** | 31.9 | % | NM |   | (0.6pts | ) |
|                                                                                   |       | ** **                                               | ** ** |                                                    |       |   |   |   |   | ** ** | ** ** |   |   |   |   |   |   |
| **Net  Consolidated Sales by Region:**                                                 |       | ** **                                               | ** ** |                                                    |       |   |   |   |   | ** ** | ** ** |   |   |   |   |   |   |
| North America                                                                          |       | **$**                                                    | **283.5**  | ** **                                              | $          | 307.7 |   | $ | (24.2 | ) | (7.9 | )% | **$** | **827.1** | ** ** | $ | 880.6 |   | $ | (53.5 | ) | (6.1 | )% |
| Europe                                                                                 |       | **324.0**                                                | ** ** | 281.2                                                   |       | 42.8 |   | 15.2 | % | **953.4** | ** ** | 797.2 |   | 156.2 |   | 19.6 | % |
| Asia Pacific                                                                           |       | **123.3**                                                | ** ** | 113.7                                                   |       | 9.6 |   | 8.4 | % | **382.4** | ** ** | 340.4 |   | 42.0 |   | 12.3 | % |
| Latin America                                                                          |       | **52.3**                                                 | ** ** | 38.8                                                    |       | 13.5 |   | 34.8 | % | **148.6** | ** ** | 110.9 |   | 37.7 |   | 34.0 | % |
| **Total**                                                                              |       | **$**                                                    | **783.1**  | ** **                                              | $          | 741.4 |   | $ | 41.7 |   | 5.6 | % | **$** | **2,311.5** | ** ** | $ | 2,129.1 |   | $ | 182.4 |   | 8.6 | % |

 

----

| 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.                                                   |

 

 

I-48

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**Grace Overview**

 

The following is an overview of our financial performance for the threemonths and nine months ended September 30, 2007 compared with the prioryear periods.

 

***Net Sales***— The following tables identify the period-over-period increase or decrease insales attributable to changes in product volume, product price and/or mix, andthe impact of foreign currency translation.

 
| ** **                       | ** ** | **Three Months Ended September 30, 2007 as a Percentage  Increase (Decrease) from Three Months Ended  September 30, 2006** | ** ** |
|----------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Net  Sales Variance Analysis** | ** ** | **Volume**                                                                                                                                                                                            | ** ** | **Price/Mix** | ** ** | **Currency  Translation** | ** ** | **Total** | ** ** |
| Grace Davison                    |       | (0.7                                                                                                                                                                                                  | )%         | (0.2 | )% | 2.6 | % | 1.7 | % |
| Grace Performance Chemicals      |       | 3.4                                                                                                                                                                                                   | %          | 2.8 | % | 3.9 | % | 10.1 | % |
| Net sales                        |       | 1.2                                                                                                                                                                                                   | %          | 1.2 | % | 3.2 | % | 5.6 | % |
|                             |       |                                                                                                                                                                                                  |       |   |   |   |   |   |   |
| **By Region:**                   |       |                                                                                                                                                                                                  |       |   |   |   |   |   |   |
| North America                    |       | (8.4                                                                                                                                                                                                  | )%         | 0.3 | % | 0.2 | % | (7.9 | )% |
| Europe                           |       | 5.2                                                                                                                                                                                                   | %          | 4.5 | % | 5.5 | % | 15.2 | % |
| Asia Pacific                     |       | 2.8                                                                                                                                                                                                   | %          | 0.4 | % | 5.2 | % | 8.4 | % |
| Latin America                    |       | 36.1                                                                                                                                                                                                  | %          | (5.7 | )% | 4.4 | % | 34.8 | % |

 

Sales for the three months ended September 30, 2007 were favorablyimpacted by foreign currency translation, higher volume (includingacquisitions), and selling price increases that partially offset costinflation. Acquisitions contributed $2.8 million or 0.4 percentagepoints of the sales volume growth.

 
| ** **                                     | ** ** | **Nine Months Ended September 30, 2007 as a Percentage  Increase (Decrease) from Nine Months Ended  September 30, 2006** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Net Sales Variance Analysis** | ** ** | **Volume**                                                                                                                                                                                          | ** ** | **Price/Mix** | ** ** | **Currency  Translation** | ** ** | **Total** | ** ** |
| Grace Davison                                  |       | 3.0                                                                                                                                                                                                 | %          | 2.5 | % | 3.0 | % | 8.5 | % |
| Grace Performance Chemicals                    |       | 2.1                                                                                                                                                                                                 | %          | 3.0 | % | 3.5 | % | 8.6 | % |
| Net sales                                      |       | 2.6                                                                                                                                                                                                 | %          | 2.7 | % | 3.3 | % | 8.6 | % |
|                                           |       |                                                                                                                                                                                                |       |   |   |   |   |   |   |
| **By Region:**                                 |       |                                                                                                                                                                                                |       |   |   |   |   |   |   |
| North America                                  |       | (6.1                                                                                                                                                                                                | )%         | (0.1 | )% | 0.1 | % | (6.1 | )% |
| Europe                                         |       | 8.5                                                                                                                                                                                                 | %          | 4.2 | % | 6.9 | % | 19.6 | % |
| Asia Pacific                                   |       | (0.3                                                                                                                                                                                                | )%         | 9.5 | % | 3.1 | % | 12.3 | % |
| Latin America                                  |       | 28.1                                                                                                                                                                                                | %          | 3.4 | % | 2.5 | % | 34.0 | % |

 

Sales for the nine months ended September 30, 2007 were favorablyimpacted by foreign currency translation, higher volume (includingacquisitions), and selling price increases that partially offset costinflation. Acquisitions contributed $10.0 million or 0.5 percentagepoints of the sales volume growth.

 

***Pre-tax Income fromCore Operations*** — Operating profit for the threemonths and nine months ended September 30, 2007 improved due to salesvolume growth and selling price increases, partially offset by raw materialcost inflation.

 

I-49

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Corporate costs include corporate functional costs (such as financialand legal services, human resources, communications and informationtechnology), the cost of corporate governance (including directors and officersliability insurance) and pension costs related to both corporate employees andto the effects of changes in assets and liabilities for all of our pensionplans. Corporate costs for the three months ended September 30, 2007increased compared with the prior year due primarily to higher long-termincentive plan expense. Corporate costs for the nine months endedSeptember 30, 2007 decreased compared with the prior year primarily due tolower pension costs from the effect of contributions made to defined benefitpension plans in recent years and higher investment returns.

 

We value our U.S. inventories under the last-in/first- out method, orLIFO, and our non-U.S. inventories under the first-in/first-out, or FIFO,method. LIFO was selected in 1974 for U.S. financial reporting and tax purposesbecause it generally results in a better matching of current revenue withcurrent costs during periods of inflation. We have not elected LIFO for ournon-U.S. inventories due to statutory restrictions. However, if we valued ourU.S. inventories using the FIFO method, consistent with our non-U.S.subsidiaries, our pre-tax income from core operations would have beenapproximately 6.4% higher and 8.6% lower for the nine months endedSeptember 30, 2007 and 2006, respectively. The significant change ininventory valuations between FIFO and LIFO relates primarily to the pricevolatility, over the past several quarters, of commodity metals and natural gasused in Grace Davison products and production processes. We attempt to mitigateprice volatility through hedging techniques such as layering our requiredsupply under fixed delivery contracts, entering into commodity option and swapcontracts with suppliers and financial institutions, and by negotiating salescontracts that permit the partial pass-through of market price increases forthese volatile commodity items.

 

We normally attempt to lock in raw material costs through long-termsupply contracts and targeted hedging programs. Arrangements and programs canspan a few months to several years. Major raw materials include natural gas,certain metals, petroleum-based materials and certain industrial chemicals. Theactual cost of these raw materials can differ significantly from spot prices atany point in time. Our reported gross profit for the periods presented has beenfavorably impacted by certain raw material supply arrangements and unfavorablyaffected by others, relative to the then-current market price. We expect thatnew supply agreements and hedging arrangements will result in raw materialcosts that can be significantly favorable or unfavorable compared with priorperiods. We attempt to mitigate period-over-period commodity-driven costchanges through utilization and customer pricing strategies; however, grossprofit margins are still likely to be affected when compared over time.

 

Within both Grace Davison and Grace Performance Chemicals, we conductcertain business activities in various countries through joint ventures withunaffiliated third parties. Minority interest in consolidated entitiesdecreased due to lower earnings of our joint ventures, particularly ART, ourlargest joint venture. ART’s period-over-period net income was adverselyaffected by lower sales volume and higher raw material costs.

 

***Pre-tax Income(Loss) from Noncore Activities*** — Pre-tax income(loss) from noncore activities reflects financial matters unrelated to our coreoperations. This category of costs and income is expected to be volatile aspotentially material items are addressed through our Chapter 11proceedings and/or as the financial implications of our legal contingenciesbecome apparent. Some noncore activities are shown as separate items on theConsolidated Statement of Operations. Those not separately listed are primarilyincluded in selling, general and administrative expenses and in other (income)expense. The table below shows the components of noncore activities, and thecaptions in which each component is presented in the Consolidated Statements ofOperations:

 

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| ** **                                                        | ** ** | **Three Months  Ended September 30,** | ** ** | **Nine Months  Ended September 30,** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                        | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| *(In millions)*                                                   | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Provision for environmental remediation —  vermiculite       |       | **$**                                                | **—** | ** **                                          | $          | — |   | **$** | **(9.4** | **)** | $ | (29.4 | ) |
| Provision for environmental remediation —  other sites       |       | **—**                                           | ** ** | —                                              |       | **(2.6** | **)** | (0.6 | ) |
| **Total provision for environmental  remediation**                |       | **$**                                                | **—** | ** **                                          | $          | — |   | **$** | **(12.0** | **)** | $ | (30.0 | ) |
| ** **                                                        |       | ** **                                           | ** ** |                                                |       | ** ** | ** ** |   |   |
| Insurance settlements — environmental and  asbestos-related  |       | **$**                                                | **0.1**    | ** **                                          | $          | 0.9 |   | **$** | **0.1** | ** ** | $ | 7.8 |   |
| COLI income, net                                                  |       | **0.5**                                              | ** ** | 0.5                                                 |       | **3.0** | ** ** | 2.2 |   |
| Translation effects — intercompany loan                      |       | **6.8**                                              | ** ** | 2.4                                                 |       | **10.6** | ** ** | 16.1 |   |
| Value of currency contracts                                       |       | **(6.0**                                             | **)**      | (1.6                                                | )          | **(8.4** | **)** | (15.1 | ) |
| Gain on sale of real estate                                       |       | **—**                                           | ** ** | —                                              |       | **1.1** | ** ** | 5.0 |   |
| Other                                                             |       | **(0.8**                                             | **)**      | (0.3                                                | )          | **(2.6** | **)** | (3.2 | ) |
| **Total other income (expense), net**                             |       | **$**                                                | **0.6**    | ** **                                          | $          | 1.9 |   | **$** | **3.8** | ** ** | $ | 12.8 |   |
| ** **                                                        |       | ** **                                           | ** ** |                                                |       | ** ** | ** ** |   |   |
| D&O insurance cost — portion related to  Chapter 11 |       | **$**                                                | **(1.5**   | **)**                                               | $          | (1.5 | ) | **$** | **(4.5** | **)** | $ | (4.5 | ) |
| Asbestos administration                                           |       | **(2.1**                                             | **)**      | (2.7                                                | )          | **(6.2** | **)** | (8.1 | ) |
| Postretirement benefit costs — divested  businesses          |       | **(1.9**                                             | **)**      | (2.8                                                | )          | **(5.7** | **)** | (8.6 | ) |
| Equity-indexed compensation                                       |       | **(2.1**                                             | **)**      | (0.4                                                | )          | **(2.1** | **)** | (2.4 | ) |
| Legal defense costs                                               |       | **(5.0**                                             | **)**      | (21.0                                               | )          | **(11.4** | **)** | (48.9 | ) |
| Other                                                             |       | **(1.3**                                             | **)**      | (0.4                                                | )          | **(3.0** | **)** | (1.9 | ) |
| **Total selling, general and administrative  expenses**           |       | **$**                                                | **(13.9**  | **)**                                               | $          | (28.8 | ) | **$** | **(32.9** | **)** | $ | (74.4 | ) |
| ** **                                                        |       | ** **                                           | ** ** |                                                |       | ** ** | ** ** |   |   |
| Net pension costs — divested businesses                      |       | **0.5**                                              | ** ** | 0.9                                                 |       | **1.5** | ** ** | 2.7 |   |
| **Total net pension expense**                                     |       | **$**                                                | **0.5**    | ** **                                          | $          | 0.9 |   | **$** | **1.5** | ** ** | $ | 2.7 |   |
| **Total pre-tax income (loss) from noncore  activities**          |       | **$**                                                | **(12.8**  | **)**                                               | $          | (26.0 | ) | **$** | **(39.6** | **)** | $ | (88.9 | ) |

 

Pre-tax income (loss) from noncore activities in the nine months endedSeptember 30, 2007 was attributable primarily to: (1) a charge of$12.0 million in the second quarter to adjust Grace’s estimate of costs toresolve environmental remediation claims based on recent information exchangedwith the U.S. Government; and (2) legal defense costs of$11.4 million related to the Montana and New Jersey legal proceedings (seeNote 12 to the Consolidated Financial Statements for more information).Pre-tax income (loss) from noncore activities in the nine months endedSeptember 30, 2006 was attributable primarily to: (1) a charge of$30.0 million in estimated costs for environmental remediation, primarilyin Montana; and (2) legal defense costs of $48.9 million related tothe Montana and New Jersey legal proceedings.

 

In March 2004, we began accounting for currency fluctuations on a€ 293 million intercompany loan between our subsidiaries in the UnitedStates and Germany as a component of operating results instead of as acomponent of other comprehensive income. This change was prompted by an analysisof new tax laws in Germany and our cash flow planning in connection with ourChapter 11 reorganization, which together indicated that we should nolonger consider this loan as part of our permanent capital structure inGermany. In May 2004, we entered into a series of foreign currency forwardcontracts with a U.S. bank to mitigate future currency fluctuations on theremaining loan balance. Contract amounts of €200.7 million were extendedin June 2005 at varying rates and have terms that coincide with loanrepayments due periodically through December 2008. As part of the contractextension, we were required to pay a settlement premium of $9.3 million tothe bank. We expect to recover this settlement 

 

I-51

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premium over time as the contracts are settled at rates greater thanthe initial rates in the May 2004 foreign currency forward contracts. Forthe nine months ended September 30, 2007 and 2006, respectively,€54.9 million and € 47.6 million of loan principal was repaid. Forthe nine months ended September 30, 2007 and 2006, we recognized contractlosses of $8.4 million and $15.1 million, respectively, offset byforeign currency gains of $10.6 million and $16.1 million,respectively.

 

***Chapter 11Expenses*** — Although we are unable to preciselymeasure the impact of the Chapter 11 proceedings on our overall financialperformance, we incur significant added costs that are directly attributable tooperating in Chapter 11. Net Chapter 11 expenses consist primarily oflegal, financial and consulting fees that we, the three creditors’ committees,the equity committee and the legal representative of future asbestos claimants,incur, reduced by interest income earned on cash and cash equivalents held byour entities subject to Chapter 11. We pay for the costs of allcommittees, and the committees’ advisors. These costs fluctuate with theactivity in our Chapter 11 proceedings.

 

Chapter 11 expenses increased due to a higher level of activity inour bankruptcy proceeding related to claims adjudication and estimation. Weexpect that we will experience continued high levels of Chapter 11expenses in the fourth quarter of 2007 in preparation for the trial to estimatethe value of our asbestos personal injury claims, which is scheduled to beginin January 2008.

 

We incur numerous other indirect costs to manage the Chapter 11proceedings such as: management time devoted to Chapter 11 matters; addedcost of debt capital; added costs of general business insurance, includingD&O liability insurance premiums; and lost business and acquisitionopportunities due to the complexities and restrictions of operating under Chapter 11.

 

***Interest Expense***— Net interest expense is lower for the three months ended September 30,2007 compared with the prior year period due to reduced interest accruals inthe third quarter of 2007 for certain pre-petition obligations. Net interestexpense is higher for the nine months ended September 30, 2007 comparedwith the prior year period. The year-to-date increase is attributable to theeffects of compounding interest on certain liabilities subject to compromiseover the course of the Chapter 11 proceeding. The plan of reorganizationstates that each holder of an allowed general unsecured claim shall be paid infull, plus post-petition interest. Post-petition interest shall accrue throughthe date of payment as follows:

 

•      For theholders 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 nine months ended September 30, 2007 and2006 were 8.23% and 7.86%, respectively.

 

•      For theholders 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.

 

•      For allother holders of allowed general unsecured claims, at a rate of 4.19% perannum, compounded annually, unless otherwise negotiated during the claimsettlement process.

 

The effective interest rates for the nine months endedSeptember 30, 2007 and 2006 were 6.70% and 6.61%, respectively. Suchinterest, which under the plan of reorganization is payable 85% in cash and 15%in Grace common stock, will not be paid until the plan of reorganization isconfirmed and funded.

 

***Income Taxes***— Income tax provision at the federal corporate rate of 35% for the nine monthsended September 30, 2007 and 2006 was $25.8 million and$6.5 million, respectively. The increase in our income tax provision isprimarily driven by our increased pre-tax income from core operations. In thesecond quarter of 2007, we recorded a net reduction of $10.7 million intax expense primarily because we are entitled to receive interest on taxrefunds resulting from the carry-back of tax losses to prior 

 

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years. In the third quarter of 2007, we recorded a net reduction in taxexpense of $3.4 million related to the effect on deferred tax balances oftax rate reductions in Germany and the United Kingdom. Excluding these discreteitems, the difference between the income tax provision at the federal corporaterate and the overall provision for income taxes is due primarily to interest ontax contingencies and the non-deductibility of certain Chapter 11expenses.

 

**Operating Segment Overview**

 

The following is an overview of financial measures of the performanceof our operating segments for the three months and nine months endedSeptember 30, 2007, as compared with the prior year periods.

 

***Grace Davison***

 

***Three Months EndedSeptember 30, 2007***

 
| ** **                             | ** ** | **Three Months Ended September 30,** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------|------------|
| **Net Sales by Region** | ** ** | **2007**                                                 | ** ** | **2006** | ** ** | **$  Change  Fav  (Unfav)** | ** ** | **% Change  Fav  (Unfav)** | ** ** |
| *(In millions)*                        | ** ** | ** **                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| North America                          |       | **$**                                                    | **125.0**  |   | $ | 147.0 |   | $ | (22.0 | ) | (15.0 | )% |
| Europe                                 |       | **188.2**                                                |       | 168.9 |   | 19.3 |   | 11.4 | % |
| Asia Pacific                           |       | **68.9**                                                 |       | 65.9 |   | 3.0 |   | 4.6 | % |
| Latin America                          |       | **21.3**                                                 |       | 14.7 |   | 6.6 |   | 44.9 | % |
| **Total Grace Davison**                |       | **$**                                                    | **403.4**  |   | $ | 396.5 |   | $ | 6.9 |   | 1.7 | % |

 

*Sales*

 

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

 

•      Sellingprice increases that offset higher raw material costs;

 

•      Highervolume of FCC and specialty catalysts from the success of our strategic growthinitiatives; and

 

•      Favorabletranslation effects from sales denominated in foreign currencies.

 

European sales increased from the prior year period due to growth involume and higher selling prices. North American sales were negatively impactedby re-order patterns for certain hydroprocessing units and the loss of onecustomer in Canada. Asia Pacific and Latin America sales increased with strongvolume growth from new business.

 

*Operating Income and Margin*

 

Grace Davison operating income increased compared with 2006 primarilydue to the success of productivity programs and higher selling pricesimplemented to offset raw material cost increases.

 

We report 100% of sales for the Advanced Refining Technologies LLCjoint venture, but only account for 55% of the income in our measure ofoperating performance. Income of this joint venture decreased from the prioryear due to order patterns in the U.S., lower sales in Canada and higher rawmaterial costs.

 

I-53

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***Nine Months EndedSeptember 30, 2007***

 
| ** **                             | ** ** | **Nine Months Ended September 30,** | ** **  |
|----------------------------------------|------------|---------------------------------------------------------|-------------|
| **Net Sales by Region** | ** ** | **2007**                                                | ** **  | **2006** | ** ** | **$ Change  Fav  (Unfav)** | ** ** | **% Change  Fav  (Unfav)** | ** ** |
| *(In  millions)*                       | ** ** | ** **                                              | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| North America                          |       | **$**                                                   | **371.5**   |   | $ | 409.5 |   | $ | (38.0 | ) | (9.3 | )% |
| Europe                                 |       | **567.0**                                               |        | 476.7 |   | 90.3 |   | 18.9 | % |
| Asia Pacific                           |       | **227.7**                                               |        | 205.8 |   | 21.9 |   | 10.6 | % |
| Latin America                          |       | **63.6**                                                |        | 41.2 |   | 22.4 |   | 54.4 | % |
| **Total Grace Davison**                |       | **$**                                                   | **1,229.8** |   | $ | 1,133.2 |   | $ | 96.6 |   | 8.5 | % |

 

 

*Sales*

 

Sales increases for the nine months ended September 30, 2007reflect similar factors as those experienced in the three months endedSeptember 30, 2007. Favorable currency translation increased sales by3.0 percentage points.

 

*Operating Income and Margin*

 

The increase in operating income for the nine months endedSeptember 30, 2007 was a result of higher sales to both refining andindustrial end markets, and in regions other than North America; partiallyoffset by higher raw material costs, which have increased approximately 11%year-to-date.

 

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***Grace PerformanceChemicals***

 

***Three Months EndedSeptember 30, 2007***

 
| ** **                             | ** ** | **Three Months Ended September 30,** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------|------------|
| **Net Sales by Region** | ** ** | **2007**                                                 | ** ** | **2006** | ** ** | **$ Change  Fav  (Unfav)** | ** ** | **% Change**

**Fav  (Unfav)** | ** ** |
| *(In  millions)*                       | ** ** | ** **                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| North America                          |       | **$**                                                    | **158.5**  | ** ** | $ | 160.7 |   | $ | (2.2 | ) | (1.4 | )% |
| Europe                                 |       | **135.8**                                                | ** ** | 112.3 |   | 23.5 |   | 20.9 | % |
| Asia Pacific                           |       | **54.4**                                                 | ** ** | 47.8 |   | 6.6 |   | 13.8 | % |
| Latin America                          |       | **31.0**                                                 | ** ** | 24.1 |   | 6.9 |   | 28.6 | % |
| **Total Grace Performance Chemicals**  |       | **$**                                                    | **379.7**  | ** ** | $ | 344.9 |   | $ | 34.8 |   | 10.1 | % |

 

*Sales*

 

The key factors contributing to the Grace Performance Chemicals salesincrease were:

 

•      Highervolume of construction products in Europe, Asia Pacific and Latin America,where economic activity was favorable and commercial initiatives weresuccessful;

 

•      Highervolume and selling prices (to offset raw material cost increases) for Darexpackaging technologies worldwide, especially in Latin America and Europe; and

 

•      Favorabletranslation effects from sales denominated in foreign currencies.

 

Sales of construction products in North America were lower in the thirdquarter of 2007 compared with 2006 primarily due to a nearly 22% decline inhousing starts in the United States.

 

*Operating Income and Margin*

 

Grace Performance Chemicals operating income increased primarily due tosales volume growth in geographic regions other than North America, sellingprice increases that partially offset raw material cost inflation, andproductivity gains.

 

***Nine Months EndedSeptember 30, 2007***

 
| ** **                             | ** ** | **Nine Months Ended September 30,** | ** **  |
|----------------------------------------|------------|---------------------------------------------------------|-------------|
| **Net Sales by Region** | ** ** | **2007**                                                | ** **  | **2006** | ** ** | **$ Change  Fav  (Unfav)** | ** ** | **% Change  Fav  (Unfav)** | ** ** |
| *(In  millions)*                       | ** ** | ** **                                              | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| North America                          |       | **$**                                                   | **455.6**   | ** ** | $ | 471.1 |   | $ | (15.5 | ) | (3.3 | )% |
| Europe                                 |       | **386.4**                                               | ** **  | 320.5 |   | 65.9 |   | 20.6 | % |
| Asia Pacific                           |       | **154.7**                                               | ** **  | 134.6 |   | 20.1 |   | 14.9 | % |
| Latin America                          |       | **85.0**                                                | ** **  | 69.7 |   | 15.3 |   | 22.0 | % |
| **Total Grace Performance Chemicals**  |       | **$**                                                   | **1,081.7** | ** ** | $ | 995.9 |   | $ | 85.8 |   | 8.6 | % |

 

*Sales*

 

Sales increases for the nine months ended September 30, 2007reflected similar factors as those experienced in the three months endedSeptember 30, 2007. Favorable currency translation increased sales by3.5 percentage points.

 

 

I-55

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*Operating Income and Margin*

 

The increase in operating income for the nine months endedSeptember 30, 2007 was a result of higher sales volume globally, sellingprice increases, and positive results from productivity and cost containmentinitiatives, which more than offset an approximate 6% increase in raw materialcosts.

 

***Operating Returns onAssets Employed***— The following tables set forththe Grace Davison and Grace Performance Chemicals total asset position andpre-tax return on average total assets as of September 30, 2007 andDecember 31, 2006. We use the measure pre-tax return on average totalassets as an indicator of our efficiency in using our assets and allocating ourresources 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,particularly selling expenses, are significantly higher for Grace PerformanceChemicals than for Grace Davison.

 
| **Grace Davison**                                       | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| *(In  millions)*                                             | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Trade receivables                                            |       | **$**                        | **203.1**  | ** **                  | $          | 180.4 |   |
| Inventory                                                    |       | **186.3**                    | ** ** | 192.3                       |       |
| Other current assets                                         |       | **18.5**                     | ** ** | 15.8                        |       |
| Total current assets                                         |       | **407.9**                    | ** ** | 388.5                       |       |
| Properties and equipment, net                                |       | **402.7**                    | ** ** | 402.3                       |       |
| Goodwill and other intangible assets                         |       | **107.7**                    | ** ** | 108.4                       |       |
| Other assets                                                 |       | **15.2**                     | ** ** | —                      |       |
| Total assets                                                 |       | **$**                        | **933.5**  | ** **                  | $          | 899.2 |   |
| Pre-tax return on average total assets  (trailing 12 months) |       | **21.3**                     | **%**      | 18.7                        | %          |

 

Grace Davison’s total assets increased by $34.3 million primarilydue to higher trade receivables, partially offset by a decrease in inventorylevels, both caused by increased sales.

 
| **Grace Performance Chemicals**                    | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| *(In  millions)*                                             | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Trade receivables                                            |       | **$**                        | **291.4**  | ** **                  | $          | 245.1 |   |
| Inventory                                                    |       | **112.4**                    | ** ** | 92.2                        |       |
| Other current assets                                         |       | **21.2**                     | ** ** | 16.9                        |       |
| Total current assets                                         |       | **425.0**                    | ** ** | 354.2                       |       |
| Properties and equipment, net                                |       | **254.9**                    | ** ** | 242.0                       |       |
| Goodwill and other intangible assets                         |       | **96.5**                     | ** ** | 92.6                        |       |
| Other assets                                                 |       | **4.9**                      | ** ** | 6.0                         |       |
| Total assets                                                 |       | **$**                        | **781.3**  | ** **                  | $          | 694.8 |   |
| Pre-tax return on average total assets  (trailing 12 months) |       | **25.2**                     | **%**      | 25.2                        | %          |

 

Grace Performance Chemicals’ total assets increased by$86.5 million, mainly due to higher trade receivables as a result ofincreased sales, higher inventory, and fixed capital to support sales growth.

 

I-56

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**Noncore Liabilities**

 

We have a number of financial exposures originating from pastbusinesses, products and events. These obligations arose from transactionsand/or business practices that date to when Grace was a much larger company,when we produced products or operated businesses that are no longer part of ourrevenue base, when government regulation was less stringent and when scientificknowledge with respect to such businesses and products was much less advancedthan today.

 

The following table summarizes our net noncore liabilities atSeptember 30, 2007 and December 31, 2006:

 
| **Net Noncore Liabilities** | ** ** | **September 30,  2007** | ** **   | **December 31,  2006** | ** ** |
|---------------------------------------|------------|------------------------------|--------------|-----------------------------|------------|
| *(In  millions)*                      | ** ** | ** **                   | ** **   | ** **                  | ** ** |
| Asbestos-related contingencies        |       | **$**                        | **(1,700.0** | **)**                       | $          | (1,700.0 | ) |
| Asbestos-related insurance receivable |       | **500.0**                    | ** **   | 500.0                       |       |
| Asbestos-related contingencies, net   |       | **(1,200.0**                 | **)**        | (1,200.0                    | )          |
| Environmental contingencies           |       | **(366.0**                   | **)**        | (361.1                      | )          |
| Postretirement benefits               |       | **(78.2**                    | **)**        | (72.7                       | )          |
| Income taxes                          |       | **(99.1**                    | **)**        | (141.2                      | )          |
| Retained obligations and other        |       | **(36.7**                    | **)**        | (23.3                       | )          |
| **Net noncore liability**             |       | **$**                        | **(1,780.0** | **)**                       | $          | (1,798.3 | ) |

 

The resolution of most of these noncore recorded and contingentliabilities will be determined through the Chapter 11 proceedings. We cannotpredict with any certainty how, and for what amounts, any of thesecontingencies will be resolved. The amounts of these liabilities as ultimatelydetermined through the Chapter 11 proceedings could be materially differentfrom amounts recorded at September 30, 2007.

 

**Plan of Reorganization**

 

As described under “Voluntary Bankruptcy Filing” in Notes 1 and 2 tothe Consolidated Financial Statements, Grace and our principal U.S. operatingsubsidiary are debtors-in-possession under Chapter 11 of the bankruptcy code.Our non-U.S. subsidiaries, although not part of the Chapter 11 filing, are owneddirectly or indirectly by our principal operating subsidiary or other filingentities. Consequently, we expect that any Chapter 11 plan of reorganization,including our proposed plan of reorganization, will involve the combined valueof our global businesses and other assets to fund (with cash and/or securities)our obligations as adjudicated through the bankruptcy process. We have analyzedour cash 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 relateddocuments that amended our original plan of reorganization and disclosurestatement filed on November 13, 2004 to address certain objections ofcreditors and other interested parties. The plan of reorganization is supportedby committees representing general unsecured creditors and shareholders, but isnot supported by committees representing asbestos personal injury claimants andasbestos property damage claimants or the legal representative of futureasbestos claimants.

 

See Note 2 to the Consolidated Financial Statements for moreinformation on the plan of reorganization.

 

I-57

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***Risks of the Plan ofReorganization*** — We intend to address all pendingand future asbestos-related claims and all other pre-petition claims asoutlined in the plan of reorganization. However, we may not be successful inobtaining approval of the plan of reorganization by the bankruptcy court.Instead, a materially different plan of reorganization may ultimately beapproved and, under the ultimate plan of reorganization, the interests of ourshareholders 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 ourasbestos-related liability under a confirmed plan of reorganization.

 

Our proposed plan of reorganization assumesseveral 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 AirCorporation and its subsidiary, Cryovac, Inc., and Fresenius Medical CareHoldings, Inc. will be available to satisfy liabilities under the plan ofreorganization.

 

There can be no guarantee that these two fundamental conditions can bemet. The measure of our asbestos-related liabilities could be settled by thebankruptcy court (in conformity with the plan of reorganization or otherwise),by a negotiation with interested parties, and/or under an alternative plan.

 

Any resolution, other than that reflected in the plan ofreorganization, could have a material adverse effect on the percentage of Gracecommon stock to be retained by our current shareholders beyond that reflectedin the proforma financial information presented below. We will adjust ourfinancial statements and the proforma effects of the plan of reorganization asfacts and circumstances warrant.

 

On July 26, 2007, the Bankruptcy Court terminated our exclusiverights to propose a plan of reorganization and solicit votes thereon. Thetermination of such rights will permit any party-in-interest to propose acompeting plan of reorganization.

 

***Proforma FinancialInformation*** — The unaudited proforma financialinformation presented below reflects the accounting effects of our proposedplan of reorganization (1) as if it were put in effect on the date of ourmost recent consolidated balance sheet — September 30, 2007, and(2) as if it were in effect for (a) the full year endedDecember 31, 2006, and (b) the nine months ended September 30,2007. Proforma adjustments for tax effects have been applied at a 35% tax rate.The proforma financial information included herein, may not be consistent withthe plan of reorganization documents filed on January 13, 2005 due to subsequentchanges in operations and accounting estimates. Such proforma financialstatements reflect how our assets, liabilities, equity and income would beaffected by the plan of reorganization as follows:

 

A.    Borrowings Under New DebtAgreements and Contingencies

 

The plan of reorganization reflects the assumption that$1,000 million in debt financing will be available to fund settled claimspayable at the effective date of the plan of reorganization (approximately$800 million) and to provide working capital (approximately$200 million) for continuing operations. 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. In addition, the proforma financial informationreflects $150 million in contingencies to pay professional and bank fees,other non-operating liabilities and their related tax effects that will notbecome liabilities until the effective date of the plan of reorganization. The$26.3 million adjustment to increase deferred taxes reflects the tax impacton $150 million in contingencies as described above, of which we estimate50% would be deductible for tax purposes. Proforma adjustments related to theborrowings under new debt financing and contingencies have been denoted by thecapital letter **“A”** in the proformabalance sheet presented below.

 

I-58

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B.    Fresenius and Sealed AirSettlements

 

The plan of reorganization reflects the value, in the form of cash andsecurities, expected to be realized under litigation settlement agreements asfollows: $115.0 million of cash from Fresenius; and, $1,122.0 millionof estimated value from Cryovac, Inc., a subsidiary of Sealed Air(calculated as of September 30, 2007) in the form of $512.5 millionof cash plus accrued interest at 5.5% from December 21, 2002 compoundedannually (approximately $149.4 million), and 18 million shares ofSealed Air common stock valued at $25.56 per share (approximately$460.1 million). Tax accounts have been adjusted to reflect the satisfactionof our recorded liabilities by way of these third-party agreements. TheFresenius settlement amount will be payable directly to Grace and will beaccounted for as income; however, we have presented the amount of thesettlement as a proforma balance sheet adjustment only in order to avoiddistorting the predictive value of the proforma statement of operations withthis one-time gain. Payments under the Sealed Air settlement will be paiddirectly to the asbestos trust by Cryovac and will be accounted for assatisfaction of a portion of our recorded asbestos-related liability and acredit to shareholders’ equity. Both the Sealed Air and Fresenius settlementsare subject to the fulfillment of specified conditions. The $(40.3) millionadjustment to deferred income taxes in the proforma balance sheet belowrepresents the tax impact of the $115.0 million Fresenius settlement. The$(392.7) million adjustment to deferred income taxes represents the tax impactof the $1,122.0 million Sealed Air settlement. Proforma adjustmentsrelated to the Fresenius and Sealed Air settlements have been denoted by thecapital letter **“B”** in the proformabalance sheet presented below.

 

C.    Payment of Pre-PetitionLiabilities

 

The plan of reorganization reflects the transfer of funds andsecurities to settle estimated obligations payable under the plan ofreorganization at the effective date. We would be required to issueapproximately 20.3 million shares of Grace common stock, based on theclosing price per share of $26.86 on September 30, 2007, for totalproceeds of $546.1 million, and utilize cash of $1,126.8 million tosettle these estimated obligations (see the adjustments denoted by the capitalletter **“C”** in the proforma balancesheet below). The following table provides a calculation of the proforma shareissuance:

 

I-59

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| **Proforma Issuance of Shares**                                                    | ** ** | **September 30,  2007** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| *($ and shares in millions)*                                                  | ** ** |                         |       |
| Payment of asbestos claims                                                                        |       | $                            | 448.0      |   |
| Less: portion related to general unsecured  claims                                                |       | (87.0                        | )          |
|                                                                                              |       | $                            | 361.0      |   |
| Value of unsecured claims paid with equity  (15%)                                                 |       | 185.1                        |       |
| Equity value distributable at emergence  (20.3 million shares)                                    |       | $                            | 546.1      |   |
| Equity value distributable post-emergence  for PI-AO claims (4.8 million shares)                  |       | 130.0                        |       |
| Total value of equity to satisfy claims                                                           |       | $                            | 676.1      |   |
| Closing price of shares at 9/30/07                                                                |       | $                            | 26.86      |   |
| Proforma shares to satisfy asbestos and  general unsecured claims and post-emergence PI-AO claims |       | 25.1                         |       |
| Add: Shares issuable upon exercise of  in-the-money stock options                                 |       | 3.3                          |       |
| **Proforma issuance of shares**                                                                   |       | 28.4                         |       |

 

In our proforma presentation, we have assumed that our emergence frombankruptcy will give rise to 1) the payment of pre-petition liabilities,2) the Fresenius/Sealed Air payments, and 3) the securing ofemergence financing by non-U.S. subsidiaries and payment of dividends asfurther described below.

 

The payments result in changing the source of our tax assets fromreserves for tax-deductible obligations such as asbestos claims andenvironmental claims to time-limited tax net operating losses (see theadjustments denoted by the capital letter **“D”**in the proforma balance sheet below). We have assumed non-asbestos andpass-through liabilities will be paid in cash when due. A portion of thefunding required to meet our emergence obligations will involve repatriatingmonies through a dividend from certain non-U.S. subsidiaries. We believe thatthe reserve related to repatriation of funds presently recorded will beadequate to absorb the U.S. tax effects of this dividend, assuming that weemploy (as intended) certain tax planning strategies to preserve our netoperating losses.

 

The following table presents a detailed description of the proforma taxeffects of these payments on the balance of both (i) net operating losscarryforwards and (ii) temporary differences, net of valuation allowance.

 

I-60

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| **Summary of Change in Deferred Tax Asset Balances** | ** ** | **Tax Effects of  Net Operating  Loss Carry-   Forwards** | ** ** | **Temporary  Differences, Net  of Valuation  Allowance** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| *(In  millions)*                                                                        | ** ** | ** **                                                                         | ** ** | ** **                                                         | ** ** |
| **September 30, 2007 Balance As Reported**                                              |       | $                                                                                  | 94.2       |                                                               | $          | 622.2 |   |
| ** **                                                                              |       |                                                                               |       |                                                               |       |
| **Proforma Adjustments:**                                                               |       |                                                                               |       |                                                               |       |
| Contingent liabilities                                                                  |       | —                                                                             |       | 26.3                                                               |       |
| Fresenius payment                                                                       |       | (40.3                                                                              | )          | —                                                             |       |
| Sealed Air payment                                                                      |       | —                                                                             |       | (392.7                                                             | )          |
| **Emergence Payments & Other:**                                                     |       |                                                                               |       |                                                               |       |
| Accrued interest                                                                        |       | 68.2                                                                               |       | (68.2                                                              | )          |
| Asbestos claims                                                                         |       | 156.8                                                                              |       | (156.8                                                             | )          |
| Environmental claims                                                                    |       | 90.0                                                                               |       | (90.0                                                              | )          |
| Special pensions                                                                        |       | 5.3                                                                                |       | (5.3                                                               | )          |
| Insurance recovery                                                                      |       | (175.0                                                                             | )          | 175.0                                                              |       |
| Repatriation of foreign earnings                                                        |       | (109.0                                                                             | )          | 109.0                                                              |       |
| Other                                                                                   |       | 13.0                                                                               |       | (13.0                                                              | )          |
| Subtotal                                                                                |       | 49.3                                                                               |       | (49.3                                                              | )          |
| **September 30, 2007 Proforma Balance**                                                 |       | $                                                                                  | 103.2      |                                                               | $          | 206.5 |   |

 

D.            Proforma Consolidated Statement ofOperations and Capital Structure

 

The proforma income adjustments to our September 30, 2007 andDecember 31, 2006 Consolidated Statements of Operations consist of:

 

•                  The elimination of all recorded charges and expensesdirectly related to Chapter 11, as these costs would not continue aftereffectiveness 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, General andAdministrative Expenses and Other Income to eliminate noncore legal expenses,and noncore insurance income related to asbestos litigation, as the liabilitiesto which these noncore activities relate would be resolved as part of the Plan(these adjustments are denoted by the letter **“F”**in the proforma statements of operations below);

 

•                  The elimination of interest expense associated withpre-petition bank debt, and the addition of interest expense associated withthe new $1,000.0 million in financing as discussed above, which results inthe net decrease in interest expense denoted by the adjustments marked by theletter **“G”** in the proforma statementsof operations below;

 

•                  The tax effects of the proforma statements ofoperations adjustments at our effective tax rate (see the adjustments denotedby the capital letter **“H”** in theproforma statements of operations below); and

 

•                  The addition of new shares of Grace common stockrelated to the assumed financing of the plan of reorganization (see theadjustments denoted by the capital letter **“I”**in the proforma statements of operations below).

 

Proforma expenses for bothperiods presented reflect an assumed 7.4% average interest rate on outstandingborrowings, based on market conditions as of September 30, 2007 andDecember 31, 2006.

 

 

I-61

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A hypothetical  1/8  percent variance in interest rates wouldincrease or decrease our proforma net income (loss) by approximately$0.5 million for the nine months ended September 30, 2007 and byapproximately $0.7 million for the year ended December 31, 2006.

 

For purposes of proforma earnings per share and proforma share capital,we used the trading price of $26.86 per share as of September 30, 2007 and$19.80 per share as of December 31, 2006 for calculating issued andoutstanding shares. At the per share valuation of $26.86 as ofSeptember 30, 2007, we assume that 20.3 million shares will be issuedat the effective date of the plan of reorganization to fund asbestos andgeneral unsecured claims, 4.8 million shares would be issuable uponexercise of warrants to satisfy our estimate of PI-AO claims, and3.3 million shares would be issued upon exercise of in-the-money stockoptions. We present the trading value solely to show proforma ConsolidatedStatements of Operations. This trading value may not be indicative of theactual trading value of Grace common stock following the effective date of theplan of reorganization. If our distributable value per share at the effectivedate of the plan of reorganization is below approximately $7.40 per share, wewould be required to revalue our balance sheet for a change in control. (Thetrading value of Grace common stock over the twelve-month period endedSeptember 30, 2007 was between $12.19 and $29.92 per share.) Theseproforma financial statements reflect no change in assets or income related tothis potential accounting outcome.

 

E.              Non-asbestos Contingencies

 

The accompanying proforma financial information assumes allnon-asbestos related contingencies (including environmental, tax and civil andcriminal litigation) are settled for recorded amounts as of September 30,2007. Certain liabilities are assumed to be paid at the effective date of theplan of reorganization based on our estimate of amounts that will bedeterminable and payable. The remainder, which would also be subject to theplan of reorganization, if approved, is assumed to be paid subsequent to theeffective date of the plan of reorganization as amounts are either not dueuntil a later date or will be determined through post-effective-datelitigation. The ultimate value of such claims may change materially as Chapter11 and other legal proceedings further define our non-asbestos relatedobligations.

 

I-62

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

**ProformaCondensed Consolidated Balance Sheet**

*(Inmillions)*
| ** **                                                                      | ** ** | ** **                                           | ** ** | **Proforma Adjustments**                                        | ** ** | ** **                             | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                      | ** ** | **September 30,   2007  As Reported** | ** ** | **Borrowings  Under  New Debt  Agreements  and  Contingencies** | ** ** | **Sealed  Air/Fresenius  Settlements** | ** ** | **Payment of  Pre-Petition  Liabilities** | ** ** | **September 30,  2007  Proforma** | ** ** |
| **ASSETS**                                                                      |       |                                                 |       |                                                                 |       |                                   |       |   |   |   |   |
| **Current Assets**                                                              |       |                                                 |       |                                                                 |       |                                   |       |   |   |   |   |
| Cash and cash equivalents                                                       |       | $                                                    | 535.0      | ** **                                                           | **$**      | 800.0                                  | **A**      | $ | 115.0 | **B**** ** | $ | (1,126.8 | )**C** | $ | 323.2 |   |
| Other current assets                                                            |       | 936.0                                                |       | —                                                               |       | —                                 |       | — |   | 936.0 |   |
| **Total Current Assets**                                                        |       | 1,471.0                                              |       | 800.0                                                                |       | 115.0                                  |       | (1,126.8 | ) | 1,259.2 |   |
| Non-current operating assets                                                    |       | 1,013.5                                              |       | —                                                               |       | —                                 |       | — |   | 1,013.5 |   |
| Cash value of life insurance                                                    |       | 93.5                                                 |       | —                                                               |       | —                                 |       | — |   | 93.5 |   |
| Deferred income taxes:                                                          |       |                                                 |       |                                                                 |       |                                   |       |   |   |   |   |
| Net operating loss carryforwards                                                |       | 94.2                                                 |       | —                                                               | ** ** | (40.3                                  | )**B**     | 49.3 | **  D** | 103.2 |   |
| Temporary differences, net of valuation  allowance                              |       | 622.2                                                | ** ** | 26.3                                                                 | **A**      | (392.7                                 | )**B**     | (49.3 | )**D** | 206.5 |   |
| Asbestos-related insurance                                                      |       | 500.0                                                |       | —                                                               |       | —                                 |       | — |   | 500.0 |   |
| **Total Assets**                                                                |       | $                                                    | 3,794.4    |                                                                 | $          | 826.3                                  |       | $ | (318.0 | ) | $ | (1,126.8 | ) | $ | 3,175.9 |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY  (DEFICIT)**                        |       |                                                 |       |                                                                 |       |                                   |       |   |   |   |   |
| Total current liabilities                                                       |       | $                                                    | 520.3      |                                                                 | $          | —                                 |       | $ | — | ** ** | $ | (1.0 | )**C** | $ | 519.3 |   |
| Long-term debt                                                                  |       | 0.3                                                  | ** ** | 800.0                                                                | **A**      | —                                 |       | — |   | 800.3 |   |
| Other noncurrent liabilities                                                    |       | 415.8                                                |       | —                                                               |       | —                                 |       | — |   | 415.8 |   |
| **Total Liabilities Not Subject to Compromise**                                 |       | 936.4                                                |       | 800.0                                                                |       | —                                 | ** ** | (1.0 | )**C** | 1,735.4 |   |
| Bank debt/letters of credit/capital leases                                      |       | 787.2                                                |       | —                                                               |       | —                                 | ** ** | (787.2 | )**C** | — |   |
| Liability for asbestos-related litigation  and claims                           |       | 1,700.0                                              |       | —                                                               | ** ** | (1,122.0                               | )**B**     | (448.0 C | ) | 130.0 |   |
| Liability for environmental remediation                                         |       | 366.0                                                |       | —                                                               |       | —                                 | ** ** | (257.2 C | ) | 108.8 |   |
| Liability for postretirement health and  special pensions                       |       | 166.4                                                |       | —                                                               |       | —                                 | ** ** | (14.2 | )**C** | 152.2 |   |
| Liability for accounts payable and  litigation                                  |       | 145.1                                                |       | —                                                               |       | —                                 | ** ** | (108.4 | )**C** | 36.7 |   |
| Liability for tax claims and contingencies                                      |       | 99.1                                                 |       | —                                                               |       | —                                 | ** ** | (6.9 | )**C** | 92.2 |   |
| Other nonoperating liabilities, including  plan of reorganization contingencies |       | —                                               | ** ** | 150.0                                                                | **A**      | —                                 | ** ** | (50.0 | )**C** | 100.0 |   |
| **Total Liabilities Subject to Compromise**                                     |       | 3,263.8                                              |       | 150.0                                                                |       | (1,122.0                               | )          | (1,671.9 | ) | 619.9 |   |
| **Total Liabilities**                                                           |       | 4,200.2                                              |       | 950.0                                                                |       | (1,122.0                               | )          | (1,672.9 | ) | 2,355.3 |   |
| **Shareholders’ Equity (Deficit)**                                         |       |                                                 |       |                                                                 |       |                                   |       |   |   |   |   |
| Share capital                                                                   |       | 429.2                                                |       | —                                                               |       | —                                 | ** ** | 546.1 | ** C**  | 975.3 |   |
| Retained earnings and other equity items                                        |       | (835.0                                               | )          | (123.7                                                               | )**A**     | 804.0                                  | **B**      | — |   | (154.7 | ) |
| **Total Shareholders’ Equity (Deficit)**                                   |       | (405.8                                               | )          | (123.7                                                               | )          | 804.0                                  |       | 546.1 |   | 820.6 |   |
| **Total Liabilities and Shareholders’ Equity  (Deficit)**                  |       | $                                                    | 3,794.4    |                                                                 | $          | 826.3                                  |       | $ | (318.0 | ) | $ | (1,126.8 | ) | $ | 3,175.9 |   |

----

Note:  Proformaamounts in liabilities subject to compromise will be reclassed to liabilitiesnot subject to compromise after the proposed plan is in effect.

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

**ProformaConsolidated Statements of Operations**

*(Inmillions, except per share amounts)*
| ** **                                                                                             | ** ** | **Year Ended December 31, 2006** | ** **    | **Nine Months Ended September 30, 2007** | ** **  |
|--------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|---------------|-------------------------------------------------------------------|-------------|
| ** **                                                                                             | ** ** | **As Reported**                                 | ** **    | **Proforma  Adjustments**                                         | ** **  | **Proforma** | ** ** | **As Reported** | ** ** | **Proforma  Adjustments** | ** ** | **Proforma** | ** ** |
| **Net Sales**                                                                                          |       | $                                                    |  2,826.5 |                                                              | $           |  — |   | $ | 2,826.5 |   | $ |  2,311.5 |   | $ |  — |   | $ |  2,311.5 |   |
| Cost of goods sold, exclusive of  depreciation and amortization shown separately below                 |       | 1,845.0                                              |          | —                                                            |        | 1,845.0 |   | 1,531.0 |   | — |   | 1,531.0 |   |
| Selling, general and administrative  expenses, exclusive of net pension expense shown separately below |       | 560.9                                                | ** **    | (74.4                                                             | )**F**      | 486.5 |   | 408.5 | ** ** | (22.0 | )**F** | 386.5 |   |
| Depreciation and amortization                                                                          |       | 113.5                                                |          | —                                                            |        | 113.5 |   | 83.5 |   | — | ** ** | 83.5 |   |
| Research and development expenses                                                                      |       | 63.8                                                 |          | —                                                            |        | 63.8 |   | 55.0 |   | — | ** ** | 55.0 |   |
| Net pension expense                                                                                    |       | 63.7                                                 |          | —                                                            |        | 63.7 |   | 38.9 |   | — | ** ** | 38.9 |   |
| Interest expense and related financing  costs                                                          |       | 73.2                                                 | ** **    | (12.9                                                             | )**G**      | 60.3 |   | 57.1 | ** ** | (11.6 | )**G** | 45.5 |   |
| Provision for environmental remediation                                                                |       | 30.0                                                 | ** **    | (30.0                                                             | )**E**      | — |   | 12.0 | ** ** | (12.0 | )**E** | — |   |
| Chapter 11 expenses, net of interest income                                                            |       | 49.9                                                 | ** **    | (49.9                                                             | )**E**      | — |   | 62.7 | ** ** | (62.7 | )**E** | — |   |
| Other (income) expense, net                                                                            |       | (34.3                                                | )             | 12.5                                                              | ** F** | (21.8 | ) | (20.6 | ) | — | ** F** | (20.6 | ) |
| **Total costs and expenses**                                                                           |       | 2,765.7                                              |          | (154.7                                                            | )           | 2,611.0 |   | 2,228.1 |   | (108.3 | ) | 2,119.8 |   |
| **Income (loss) before income taxes and  minority interest**                                           |       | 60.8                                                 |          | 154.7                                                             |        | 215.5 |   | 83.4 |   | 108.3 |   | 191.7 |   |
| Benefit from (provision for) income taxes                                                              |       | (8.1                                                 | )             | (37.3                                                             | )**H**      | (45.4 | ) | (31.6 | ) | (23.2 | )**H** | (54.8 | ) |
| Minority interest in consolidated entities                                                             |       | (34.4                                                | )             | —                                                            |        | (34.4 | ) | (9.8 | ) | — |   | (9.8 | ) |
| **Net income (loss)**                                                                                  |       | $                                                    | 18.3          |                                                              | $           | 117.4 |   | $ | 135.7 |   | $ | 42.0 |   | $ | 85.1 |   | $ | 127.1 |   |
| **Basic earnings (loss) per common share**                                                             |       | $                                                    | 0.27          |                                                              | $           | — |   | $ | 1.37 |   | $ | 0.60 |   | $ | — |   | $ | 1.36 |   |
| Weighted average number of basic shares                                                                |       | 67.9                                                 |          | 31.4                                                              | ** I** | 99.3 |   | 69.9 |   | 23.6 | ** I** | 93.5 |   |
| **Diluted earnings (loss) per common share**                                                           |       | $                                                    | 0.27          |                                                              | $           | — |   | 1.30 |   | $ | 0.59 |   | $ | — |   | $ | 1.27 |   |
| Weighted average number of diluted shares                                                              |       | 68.3                                                 |          | 36.3                                                              | ** I** | 104.6 |   | 71.5 |   | 28.4 | ** I** | 99.9 |   |
|                                                                                                        |            |                                                      |               |                                                                   |             |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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**Financial Condition, Liquidity and Capital Resources**

 

***Chapter 11-Related Information***— See Note 2 to the Consolidated Financial Statements.

 

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

 

***Environmental Matters***— See Note 12 to the Consolidated Financial Statements.

 

***Defined Contribution Retirement Plans***— We sponsor a defined contribution retirement plan for our employees in theUnited States. This plan qualifies under section 401(k) of the U.S. tax code.At the present time, we contribute an amount equal to 100% of employeecontributions, up to 6% of an individual employee's salary or wages. Our costsrelated to this benefit plan were $3.2 million and $3.0 million for the threemonths ended September 30, 2007 and 2006, respectively, and $9.5 million and$10.9 million for the nine months ended September 30, 2007 and 2006,respectively.

 

***Defined Benefit Pension Plans***— We sponsor defined benefit pension plans for our employees in the UnitedStates, Canada, the United Kingdom, Australia, Germany, Italy, France, Spain,Netherlands, Japan, Philippines, South Korea, Taiwan, South Africa, Brazil andMexico and fund government sponsored programs in other countries where weoperate. Certain of our sponsored plans are advance funded and others arepay-as-you-go. The advance funded plans are administered by trustees who directthe management of plan assets and arrange to have obligations paid when due outof a trust. The most significant advance funded plans cover our salariedemployees in the U.S. and U.K. and employees covered by collective bargainingagreements at certain of our U.S. facilities.

The following tables present the components of net pension expense andcash contributions for the advance funded and pay-as-you-go plans:

 
| ** **                                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended   September 30,** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------------|------------|
| **Components  of Net Pension Expense**                             | ** ** | **2007**                                        | ** ** | **2006**                                             | ** ** | **2007** | ** ** | **2006** | ** ** |
| *(In  millions)*                                                   | ** ** | ** **                                      | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Annual pension benefits earned                                     |       | **$**                                           | **6.0**    | ** **                                           | $          | 6.2 |   | **$** | **17.7** | ** ** | $ | 18.4 |   |
| Interest on opening liability — advance-funded  plans         |       | **16.9**                                        | ** ** | 16.3                                                 |       | **49.9** | ** ** | 48.6 |   |
| Expected return on funded assets                                   |       | **(20.1**                                       | **)**      | (17.8                                                | )          | **(59.8** | **)** | (53.1 | ) |
| Net financing cost (benefit) of advance-funded  plans              |       | **(3.2**                                        | **)**      | (1.5                                                 | )          | **(9.9** | **)** | (4.5 | ) |
| Interest on opening liability — pay-as-you-go  plans          |       | **2.9**                                         | ** ** | 2.8                                                  |       | **9.0** | ** ** | 8.1 |   |
| Net pension financing cost (benefit)                               |       | **(0.3**                                        | **)**      | 1.3                                                  |       | **(0.9** | **)** | 3.6 |   |
| Amortization of:                                                   |       | ** **                                      | ** ** |                                                 |       | ** ** | ** ** |   |   |
| Plan changes related to prior service                              |       | **0.9**                                         | ** ** | 0.9                                                  |       | **2.4** | ** ** | 2.4 |   |
| Accumulated differences between actual and  assumed performance(1) |       | **6.6**                                         | ** ** | 7.5                                                  |       | **19.7** | ** ** | 23.1 |   |
| Net pension catch-up expense                                       |       | **7.4**                                         | ** ** | 8.4                                                  |       | **22.1** | ** ** | 25.5 |   |
| **Total Net Pension Expense**                                      |       | **$**                                           | **13.1**   | ** **                                           | $          | 15.9 |   | **$** | **38.9** | ** ** | $ | 47.5 |   |
|                                                                    |            |                                                 |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)             Primarily related to return onassets, termination and mortality.

 

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| ** **                                               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **Cash  Contributions to Defined Benefit Pension Plans** | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| *(In  millions)*                                         | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S. advance-funded plans                                |       | **$**                                                | **24.3**   |                                                | $          | 65.1 |   | **$** | **61.2** |   | $ | 95.3 |   |
| U.S. pay-as-you-go plans                                 |       | **1.3**                                              |       | 1.3                                                 |       | **3.8** |   | 3.9 |   |
| Foreign advance-funded plans                             |       | **1.3**                                              |       | 2.2                                                 |       | **15.8** |   | 6.4 |   |
| Foreign pay-as-you-go plans                              |       | **1.6**                                              |       | 1.3                                                 |       | **4.7** |   | 3.9 |   |
| **Total Cash Contributions**                             |       | **$**                                                | **28.5**   |                                                | $          | 69.9 |   | **$** | **85.5** |   | $ | 109.5 |   |

 

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

 
| ** **                                                | ** ** | **Fully-Funded(1)  Pension Plans** | ** ** | **Underfunded(1)  Pension Plans** | ** ** | **Unfunded(2)  Pension Plans** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|-------------------------------------|------------|
| **Funded Status of Pension Plans(3)** | ** ** | **September 30,   2007**           | ** ** | **December 31,   2006**           | ** ** | **September 30,  2007**        | ** ** | **December 31,   2006** | ** ** | **September 30,   2007** | ** ** | **December 31,   2006** | ** ** |
| *(In  millions)*                                          | ** ** | ** **                              | ** ** | ** **                             | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Projected benefit obligation                              |       | **$**                                   | **236.6**  | ** **                             | $          | 243.8                               |       | **$** | **922.5** | ** ** | $ | 961.4 |   | **$** | **239.3** | ** ** | $ | 227.8 |   |
| Fair value of plan assets                                 |       | **307.9**                               | ** ** | 282.2                                  |       | **797.6**                           | ** ** | 738.5 |   | **—** | ** ** | — |   |
| Funded status (PBO basis)                                 |       | **$**                                   | **71.3**   | ** **                             | $          | 38.4                                |       | **$** | **(124.9** | **)** | $ | (222.9 | ) | **$** | **(239.3** | **)** | $ | (227.8 | ) |

 

----

(1)     Plans intended 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 plans include several defined benefit pension plans wherethe fair value of the plan assets exceeds the projected benefit obligation, orPBO. This group of plans was overfunded by $71.3 million as ofSeptember 30, 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 $124.9 million as of September 30, 2007.Additionally, we have several plans that are funded on a pay-as-you-go basis,and therefore, the entire PBO of $239.3 million at September 30, 2007is unfunded. The combined balance of the underfunded and unfunded plans was$364.2 million as of September 30, 2007 and is presented as aliability on the Consolidated Balance Sheet asfollows — $12.0 million in “other current liabilities,”$258.3 million in “underfunded and unfunded defined benefit pension plans”and $93.9 million in “liabilities subject to compromise.”

 

Beginning in 2007, on a quarterly basis, we analyze pension assets andpension liabilities along with the resulting funded status and update ourestimate of these measures. Funded status is adjusted for contributions,benefit payments, actual return on assets, current discount rates and otheridentifiable and material actuarial changes.

 

The assumed discount rate for pension plans reflects the market ratesfor high quality corporate bonds currently available and is subject to changebased on changes in the overall market interest rates. For the U.S. qualifiedpension plans, the assumed discount rate of 5.75% as of December 31, 2006and 6.25% as of June 30 and September 30, 2007 was selected inconsultation with our independent actuaries, based on a yield curve constructedfrom a portfolio of high quality bonds for which the

 

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timing and amount of cash outflows approximate the estimated payouts ofthe plan. Based on review of an updated yield curve analysis as ofSeptember 30, 2007, we did not change the assumed discount rate of 6.25%for the U.S. qualified pension plans. In addition, we evaluated the currentdiscount rates for the United Kingdom pension plan and German pension plans,which combined represented approximately 87% of the benefit obligation of thenon-U.S. pension plans as of December 31, 2006. Based on review of theyield curve analyses for these plans as of September 30, 2007, weincreased the discount rate for the United Kingdom by 25 basis points from5.75% at June 30, 2007 to 6.00% at September 30, 2007. No change wasmade to the discount rate for Germany as compared to June 30, 2007(remained at 5.25%). For the three months ended September 30, 2007, theaggregate adjustment to the funded status resulting from the change in discountrate for the United Kingdom pension plan was an increase to total assets ofapproximately $6 million. After tax effects, total assets increased byapproximately $4 million and shareholders’ equity increased byapproximately $4 million. For the nine months ended September 30,2007, the aggregate adjustment to the funded status resulting from the changein discount rates was an increase to total assets of approximately$19 million, and a decrease to total liabilities of approximately$57 million. After tax effects, total assets decreased by approximately$7 million, total liabilities decreased by approximately $57 millionand shareholders’ equity increased by approximately $50 million.

 

At the December 31, 2006 measurement date for the U.S. advance-fundeddefined benefit pension plans, the PBO was approximately $949 million asmeasured under U.S. generally accepted accounting principles. The PBO ismeasured as the present value (using a 5.75% discount rate as ofDecember 31, 2006) of vested and non-vested benefits earned from employeeservice to date, based upon current services and estimated future pay increasesfor active employees. Of the participants in the pension plans, approximately82% are current retirees or employees of our former businesses, which skews thepayout pattern to the nearer term. Assets available to fund the PBO atDecember 31, 2006 were approximately $737 million, or approximately$212 million less than the measured obligation.

 

Assets available at September 30, 2007 to fund the PBO of the U.S.advance-funded defined benefit pension plans totaled approximately$796 million, up $59 million from December 31, 2006, primarilyas a result of current year contributions and investment returns on pensionplan assets. It is our intention to satisfy obligations under the pension plansand to comply with the requirements of the Employee Retirement Income SecurityAct of 1974. On June 20, 2007, we obtained bankruptcy court approval tofund minimum required payments of approximately $54 million for the periodfrom July 2007 through January 2008. In that regard, we contributedapproximately $9 million in July 2007, and approximately$15 million in each of September 2007 and October 2007 to thetrusts 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 not subject to bankruptcy court approvaland we intend to fund such plans based on applicable legal requirements, andactuarial and trustee recommendations; $20.5 million was funded during thenine months ended September 30, 2007.

 

We expect total pension expense for 2007 to be approximately$52 million, and benefit payments to retirees to aggregate approximately$123 million for all pension programs in 2007.

 

***PostretirementBenefits Other Than Pensions***— We provide certainhealth care and life insurance benefits for retired employees, a large majorityof whom are retirees of divested businesses. These plans are unfunded, and wepay the costs of benefits under these plans as they are incurred. Our share ofbenefits under this program was $2.4 million and $8.2 million duringthe three months and nine months ended September 30, 2007, respectively,compared with $4.2 million and $10.7 million during the three monthsand nine months ended September 30, 2006, respectively. In addition, wereceived Medicare subsidy payments of $3.7 million during the nine monthsended September 30, 2007. Our recorded liability for postretirementbenefits is $78.2 million at September 30, 2007. Our proposed plan ofreorganization provides for the continuation of these benefits.

 

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***Cash Resources andAvailable Credit Facilities***— AtSeptember 30, 2007, we had $535.0 million in cash and cashequivalents, $28.5 million in marketable securities and $93.5 millionin net cash value of life insurance. In addition, we had access to committedcredit facilities in the U.S., Germany, France, Brazil, Singapore, India andChina. In the U.S., under the $250.0 million DIP facility,$173.7 million was available at September 30, 2007, net of letters ofcredit and holdback provisions. The term of the DIP facility expiresApril 1, 2008. The following table summarizes our non-U.S. creditfacilities as of September 30, 2007:

 
| **Non-U.S.  Credit Facilities** | ** ** | **Maximum  Borrowing  Amount** | ** ** | **Amount  Available** | ** ** | **Expiration  Date** | ** ** |
|---------------------------------|------------|--------------------------------|------------|-----------------------|------------|----------------------|------------|
| *(In  millions)*                | ** ** | ** **                     | ** ** | ** **            | ** ** | ** **           | ** ** |
| **Country**                     |       |                           |       |                  |       |                 |       |
| Germany                         |       | $                              | 70.6       |                  | $          | 70.6                 |       | 12/31/09 |   |
| Germany                         |       | 17.0                           |       | 6.5                   |       | 09/26/08             |       |
| France                          |       | 5.1                            |       | 5.1                   |       | 06/30/08             |       |
| Brazil                          |       | 1.1                            |       | 1.1                   |       | 12/31/07             |       |
| Singapore                       |       | 5.0                            |       | 2.7                   |       | 03/31/08             |       |
| India                           |       | 3.0                            |       | 2.4                   |       | 03/31/08             |       |
| China                           |       | 4.5                            |       | 0.9                   |       | 03/31/08             |       |
| **Total**                       |       | $                              | 106.3      |                  | $          | 89.3                 |       |   |   |

 

In January 2007, our German subsidiary entered into a line ofcredit arrangement with a German financing company in the maximum aggregateamount of €50.0 million (equivalent to $70.6 million as ofSeptember 30, 2007) secured by the accounts receivable of the Germansubsidiary. The financing arrangement will terminate on December 31, 2009,and includes financing costs based on the EURIBOR rate of interest, plus aminimum annual fee. The line was secured to provide liquidity for either ourplan of reorganization or to fund growth in that region.

 

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

 

***Debt and OtherContractual Obligations***— Total debt outstandingat September 30, 2007 was $791.5 million, including$271.5 million of accrued interest on pre-petition debt. As a result ofthe Chapter 11 filing, we are now in default on $515.7 million ofpre-petition debt, which, together with accrued interest thereon, has beenincluded in “liabilities subject to compromise” as of September 30, 2007.The automatic 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 the Consolidated Financial Statements for adiscussion of financial assurances.

 

**Analysis of Cash Flows**

 

Our net cash inflow from operating activities for the nine months endedSeptember 30, 2007 was $65.8 million, compared with$49.4 million for the prior year period. We attribute the higher net cashflow in 2007 to higher pre-tax operating income partially offset by dividendsto joint venture partners and cash paid to resolve certain tax contingencies.Cash used for investing activities was $100.5 million, compared with$95.0 million for the prior year period. The increased investingactivities are primarily due to an investment of $25.0 million in asix-month 5.25% note offered by the Federal Home Loan 

 

 

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Bank, partially offset by the sale of one of our Grace Davison productlines in August, which resulted in net proceeds of $21.8 million. Net cashinflow from financing activities was $18.8 million, compared with$14.4 million for the prior year period. We attribute the increased inflowprimarily to cash received from stock options exercised.

 

***Cash Flow From CoreOperations***— The following table presents thecomponents of net cash flow from core operations for the nine months endedSeptember 30, 2007 and 2006.

 
| ** **                                               | ** ** | **Nine Months Ended   September 30,** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| **Core  Operations**                                     | ** ** | **2007**                                                  | ** ** | **2006** | ** ** |
| *(In  millions)*                                         | ** ** | ** **                                                | ** ** | ** ** | ** ** |
| **Cash flows:**                                          |       |                                                      |       |   |   |
| Pre-tax operating income                                 |       | **$**                                                     | **227.7**  | ** ** | $ | 189.6 |   |
| Depreciation and amortization                            |       | **83.5**                                                  | ** ** | 85.7 |   |
| **Pre-tax income before depreciation and  amortization** |       | **311.2**                                                 | ** ** | 275.3 |   |
| Working capital and other changes                        |       | **(176.1**                                                | **)**      | (102.7 | ) |
| **Cash flow before investing**                           |       | **135.1**                                                 | ** ** | 172.6 |   |
| Proceeds from sale of product line                       |       | **21.8**                                                  | ** ** | — |   |
| Capital expenditures                                     |       | **(89.8**                                                 | **)**      | (82.5 | ) |
| Purchase of equity investment                            |       | **(6.3**                                                  | **)**      | — |   |
| Businesses acquired                                      |       | **(5.5**                                                  | **)**      | (20.0 | ) |
| **Net cash flow from core operations**                   |       | **$**                                                     | **55.3**   | ** ** | $ | 70.1 |   |

 

We expect to continue to invest excess cash flow and/or other availablecapital resources in our core business base. These investments are likely to bein the form of additional plant capacity, product line extensions andgeographic market expansions, and/or acquisitions in existing product lines.Investments that are outside the ordinary course of business may be subject tobankruptcy court approval and review by the Chapter 11 creditor committees.

 

***Cash Flow FromNoncore Activities***— The cash flow from ournoncore activities can be volatile. Expenditures are generally governed bybankruptcy court rulings and receipts are generally nonrecurring. Historically,much of our noncore spending has been under Chapter 11 first-day motions thatallow us to fund postretirement benefits and required environmental remediationon Grace-owned sites. Cash inflows have been from asbestos-related insurancerecovery on pre-Chapter 11 liability payments, and unusual events. Thefollowing table presents the components of net cash flow from noncoreactivities for the nine months ended September 30, 2007 and 2006.

 

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| ** **                                     | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------|------------|
| **Noncore  Activities**                        | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| *(In  millions)*                               | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| **Cash flows:**                                |       |                                                |       |   |   |
| Pre-tax income (loss) from noncore  activities |       | **$**                                               | **(39.6**  | **)** | $ | (88.9 | ) |
| Non-cash charges                               |       | **23.7**                                            | ** ** | 46.2 |   |
| Cash spending for:                             |       | ** **                                          | ** ** |   |   |
| Tax settlement                                 |       | **(10.3**                                           | **)**      | — |   |
| Environmental remediation                      |       | **(7.1**                                            | **)**      | (8.7 | ) |
| Postretirement benefits                        |       | **(4.6**                                            | **)**      | (10.7 | ) |
| Retained obligations and other                 |       | **(0.8**                                            | **)**      | (2.7 | ) |
| **Net cash flow from noncore activities**      |       | **$**                                               | **(38.7**  | **)** | $ | (64.8 | ) |

 

Net cash flow from core operations and net cash flow from noncoreactivities do not represent income or cash flow as defined under generallyaccepted accounting principles, and you should not consider them to be an alternativeto such measures as an indicator of our performance. We provide these measuresto permit you to distinguish operating results of our current business basefrom results and related assets and liabilities of past businesses,discontinued products, and corporate legacies and the effect of our Chapter 11proceedings.

 

See the “Consolidated Statements of Cash Flows” included in theConsolidated Financial Statements for more information.

 

**SubsequentEvent — PI Committee and FCR Plan of Reorganization**

 

On November 5, 2007, thecommittee representing asbestos personal injury claimants and the legalrepresentative of future asbestos claimants filed a proposed plan ofreorganization with the bankruptcy court. See Note 16 to the Consolidated Financial Statements for a descriptionof the proposed plan. Proforma financial information is not available withrespect to this plan.  A copy of the planis available from the bankruptcy court.

 

 

 

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**Forward-Looking Statements**

 

This document contains, and our other public communications maycontain, forward-looking information, that is, information related to future,not past, events. Such information generally includes the words “believes,”“plans,” “intends,” “targets,” “will,” “expects,” “anticipates,” or similarexpressions. Forward-looking information includes all statements regarding ourChapter 11 proceeding (including the proforma financial statements included in“Management’s Discussion and Analysis of Financial Condition and Results ofOperations”); expected financial position; results of operations; cash flows;financing plans; business strategy; budgets; capital and other expenditures;competitive positions; growth opportunities for existing products; benefitsfrom new technology and cost reduction initiatives, plans and objectives; andmarkets for securities. For these statements, we claim the protection of thesafe harbor for forward-looking statements contained in the Private SecuritiesLitigation Reform Act of 1995. Factors that could cause actual results tomaterially differ from those contained in the forward-looking statementsinclude: our bankruptcy and proposed plan of reorganization, any plan ofreorganization that may be proposed by another party to our bankruptcyproceeding, our legal proceedings, especially the Montana criminal proceedingand the environmental proceedings, the cost and availability of raw materialsand energy, our unfunded pension obligations, risks related to foreignoperations, especially, security, regulation and currency risks, costs ofcompliance with environmental regulation and those factors set forth in ourmost recent Annual Report on Form 10-K, this quarterly report onForm 10-Q and current reports on Form 8-K, which have been filed withthe Securities and Exchange Commission. Like other businesses, we are subjectto risks and uncertainties that could cause our actual results to differmaterially from our projections or that could cause other forward-lookinginformation to prove incorrect. Further, our reported results should not beconsidered as an indication of our future performance. Readers are cautionednot to place undue reliance on our projections and forward-looking information,which speak only as of the date thereof. We undertake no obligation to publiclyrelease any revisions to the projections and forward-looking informationcontained in this document, or to update them to reflect events orcircumstances occurring after the date of this document.

 

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

 

See the “Market Risk” heading in Item 7 of our Form 10-K for theyear ended December 31, 2006 and Item 3 of our Form 10-Q for thequarter ended March 31, 2007 for disclosures required by this item.

 

**Item 4.  CONTROLSAND PROCEDURES**

 

*EVALUATION OF DISCLOSURE CONTROLS ANDPROCEDURES*

 

As of September 30, 2007, Grace carried out an evaluation of theeffectiveness of the design and operation of its disclosure controls andprocedures pursuant to Rule 13a-15 under the Securities Exchange Act of1934, as amended (the “Exchange Act”). Based upon that evaluation, Grace’sChief Executive Officer and Chief Financial Officer concluded that Grace’sdisclosure controls and procedures are effective to ensure that informationrequired to be disclosed in Grace’s Exchange Act reports is recorded,processed, summarized and reported within the time periods specified in theSEC’s rules and forms, and that material information relating to Grace is madeknown to management, including Grace’s Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure.

 

*CHANGES IN INTERNAL CONTROL OVER FINANCIALREPORTING*

 

There were no changes in Grace’s internal control over financialreporting during the quarter ended September 30, 2007 that have materiallyaffected, or are reasonably likely to materially affect, Grace’s internalcontrol over financial reporting.

 

 

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**PARTII. OTHER INFORMATION**

 

**Item 1.  LEGALPROCEEDINGS**

 

Notes 2, 3 and 12 to the interim consolidated financial statements inPart 1 of this Report are incorporated herein by reference.

 

**Item 1A.  RISKFACTORS**

 

With respect to certain risk factors disclosed in the “Risk Factors”section of our Annual Report on Form 10-K for the year endedDecember 31, 2006, more recent numerical measures and other informationare available in the “Financial Statements,” and “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” sections of thisReport. These more recent measures and information are incorporated herein byreference.

 

****Ourproposed plan of reorganization provides for substantial dilution of theownership interests of holders of currently outstanding Grace common stock. Analternative plan that has been filed with the bankruptcy court provides forcancellation of these ownership interests with the result that outstandingGrace common stock would likely become worthless.****

 

Our proposed planof reorganization provides that the interests of current holders of Gracecommon stock would be subject to substantial dilution by additional Gracesecurities that may be issued under the plan. The proforma financial information included under the caption“Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Proforma Financial Information” reflects the accounting effects ofour proposed plan as if it were in effect on the dates and for the periods setforth therein.  If our plan is notconfirmed or, if confirmed, if its provisions are materially different fromthose proposed, the proforma financial information will change.  Our plan is subject to the fulfillment ofnumerous conditions, including a determination by the bankruptcy court that themaximum amount that we and other parties would be required to contribute to atrust for the benefit of asbestos personal injury and property damage claimantsdoes not exceed $1,613 million, and that assets from settlement agreements withCryovac, Inc. and Fresenius Medical Care Holdings, Inc. would be available tofund our liabilities.

 

On November 5, 2007, thecommittee representing asbestos personal injury claimants and the legal representativeof future asbestos claimants filed an alternative plan of reorganization withthe bankruptcy court that provides for the cancellation of **the ownership interestsof holders of currently outstanding Grace common stock**.  This plan is subject to the fulfillment ofnumerous conditions, including a determination by the bankruptcy court that thevalue of all pending and future asbestos-related personal injury claims is atleast $4.0 billion, and assumes that assets from settlement agreements withCryovac, Inc. and Fresenius Medical Care Holdings, Inc. would be available tofund our liabilities.  Proforma financialinformation is not available with respect to this plan.

 

Neither plan of reorganization may beultimately approved by the bankruptcy court and other interested parties.  No party currently has exclusive rights topropose a plan of reorganization and solicit votes thereon, so anyparty-in-interest can propose a competing plan of reorganization at anytime.  Further, the proponents of thefiled plans of reorganization are free to amend their respective plans at anytime.  As a result, a plan ofreorganization that is materially different from the two that have been filedmay ultimately be approved and, under the ultimate plan of reorganization, theinterests of the holders of Grace common stock may be substantially diluted orcancelled.  As a result, the value ofGrace common stock is highly speculative and any investment in Grace commonstock poses a high degree of risk.

 

 

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**Item 6.  EXHIBITS**

 

The following is a list of Exhibits filed as part of this QuarterlyReport on Form 10-Q:

 
| 10.1     | Form of 2007-2009 Long-Term Incentive Program Award                                                                                          |
|----------|----------------------------------------------------------------------------------------------------------------------------------------------|
|     |                                                                                                                                         |
| 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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**SIGNATURES**

 

In accordance with the requirements of the Securities Exchange Act of1934, the Registrant caused this Report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                   |   | W. R. GRACE & CO.                             |   |
|------------------------|--------|---------------------------------------------------|--------|
|                   |   | (Registrant)                                      |   |
|                   |   |                                              |
| Date: November 8, 2007 | By:    | /s/  A. E. FESTA                        |   |
|                   |   | A. E. Festa                                       |
|                   |   | President and Chief Executive Officer             |
|                   |   |                                              |
| Date: November 8, 2007 | By:    | /s/  ROBERT M. TAROLA                   |   |
|                   |   | Robert M. Tarola                                  |
|                   |   | Senior Vice President and Chief Financial Officer |
|                   |   | (Principal Accounting Officer)                    |

 

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** **

**EXHIBIT INDEX**

 
| **Exhibit  No.** | ** ** | **Description  of Exhibit**                                                                                                                  |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|
| ** **       | ** ** | ** **                                                                                                                                   |
| 10.1             |       | Form of 2007-2009 Long-Term Incentive Program Award                                                                                          |
|             |       |                                                                                                                                         |
| 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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