Document MM1p3pvYO5JGe4gRj9NpaXGgj

SECURITIES AND EXCHANGE COMMISSION WASHINGTON. D.C. 20549 FORM 10-K AbNUAL REPORT PURSUANT TO SECTION 13 OR I5(di OF THE SECURITIES EXCHANGE ACT OF 1934 Por the fiscal year ended December 31. 1996 Coaaission file number 1-12139 V R. GRACE A 00. Incorporated under the Laws of the State of Delaware I.R.S. Employer Identification No. 65-0654331 ONE TOWN CENTER ROAD. BOCA RATON, FLORIDA 33486-1010 561/ 362-2000 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OP THE ACT: TTTIF. OP EACH C1ASS NAME OP EACH EXCHANGE ON WITCH REG! STTOHD Conton Stock, $.01 par value Preferred Stock Purchase Rights 7-3/4% Notes Due 2002 (issued by V. R Grace k Co -Conn, a wholly owned subsidiary) and related Guarantees } New York Stock bxchange, Inc } } ) New York Stock Exchange, Inc. ) ) SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OP THE ACT' None Indicate by check nark whether the registrant (including its predecessor) (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 nonths and (2) has been subject to such filing requireatents for the past 90 days. Yes X No Indicate by check nark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the beat of registrant's knowledge, in the Proxy Stotenent incorporated by reference in Part III of this Porn 10-K or any anendaent to this Form 10-K. X The aggregate narket value of W. R. Grace A Co. voting atock held by nonafflliatca was approxinately $3.8 billion at January 31, 1997. At February 28, 1997, 74,048,314 shares of W. R. Grace A Co. Common Stock, $.01 par value, were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Docuaent Where Incorporated Proxy Siatenent for Annual Meeting to be held May 9, 1997 (specified portions) Part III i'ABLB 0* CONTENTS PART I Page Item 1. Iten 2. Iten 3. Iten 4. Business .......................................................................................................................... Introduction and Overview ................................................................................ Products and Markets ........................................................................................... Discontinued Operations .................................................................................... Research Activities ............................................................................................. Patents and Other intellectual Property Matters ................................. Environmental, Health and Safeiy Matters ................................................ Properties ...................................................................................................................... Legal Proceedings ....................................................................................................... Submission of Matters to i Vote ofSecurity Holders ............................... L 1 4 II 12 12 13 14 14 22 Executive Officers ....................................................................................................................... 22 PART II Iten 5. Iten 6. Iten 7. Tt.en 8. Iten 9. Market for Registrant's Conmon Equity and Related Stockholder Matters ........................................................................................... Selected Financial Data .......................................................................................... Management's Discussion and Analysis of Financial Condition and Results of Operations ......................................................... Financial Statements and Supplements ry Data ................................................ Changes in and Disagreements vith Accountants on Accounting and Financial Disclosure ........................................................ 23 23 23 23 23 PART III Item 10. Directors and Executive Officers of the Registrant .............................. Item 11. Executive Cumpeusatiuu ........................................................................................... Item 12. Security Ownership of Certain Beneficial Ownera and Management ......................................................................................... Item 13. Certain Relationships and Related Transactions ....................................... 23 26 26 26 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................................................................................................. 26 Signatures ......................................................................................................................................... 33 Financial Supplement P-L 3 PART I ITEM 1. BUSINESS. INTRCOUCTION AND OVERVIEW W. R. Grace JfcCo., through its subsidiaries, is one of the world's leading packaging and specialty chenicals companies. Siace's core bnsinesses are packaging, catalysts and other silica-hased products, and construction products. It began operating these core businesses in 1954, when it acquired both the Dewey and May Chemical Company and the Davison Chemical Company. Grace believes that each of its core bnainesaes is an indnztry leader, offera high valne-added products, employs leading technology, and has a global presence. Grace's products and systems serve highly specialized maxket segments; accordingly, competition tends to be baaed primarily on technological capability, customer service, product quality, and, lu a lesser eileul, price. These products and systems also generally represent an important component (bat a relatively small portion of the cost) of the end products or processes in which they are used. Grace believes that it provides highly differentiated, superior products and services through investments in research and development, facilities that enable Grace to Lake advantage of expanding global opportunities, and technology platforms capable of providing multiple products to anticipate and satisfy easterner needs. As used in this Report, the term "Company" refers toW. R. Grace & Co., a Delaware corporation, and t.he tern "Grace" refers t.o t.he Conpany and/or one or more of its subsidiaries and, in certain cases, their respective predecessors. Grace's principal executive offices are located at One Town Center Road, Boca Raton, Florida 33486-1010, and its telephone number is 561/362-2000. At year-end 1996, Grace had approximaielv 17,400 full-time employees worldwide in its continuing operations. Grace's Cousulida Led Financial Sualemeuls fur Lhe three years in Lhe period ended December 31, 1996 ("Consolidated Financial Statements"), and certain ocher financial information included in the Company'a 1996 Annual Report to Shareholders, are set forth in the Financial Supplement tothis Report and incorporated by reference in this Report. Information concerning the sales and revenues, pretax operating income and identifiable assets of Grace's continuing operations by geographic area for 1996, 1995 and 1994 is contained in Note 17 to the Consolidated Financial Statements. STRATEGIC OBJECTIVES AND ACTIONS. Grace's principal strategic obiective has been, and will continue to be, to increase shareholder value, in recent years. Grace has sought to achieve this objective by (a) focusing on core businesses to accelerate profitable growth; (b) upgrading financial performance, principally by disposing of noncore businesses, strengthening the balance sheet and reducing overhead; and (c) integrating 4 corporate and operating nnit inactions through global product line management. In particular, since aid-iy95, Grace has: disposed ol uuucure businesses, including National Medical Care, Inc. i"NIC"), its principal health care business (in a transaction valued at S4.5 billion), at well at Grace's water treataem and process chemical; business for $636 aillion, its cocoa business lor approximately S470 million. the transgenic plant business of its Agracetns subsidiary for S150 aillion, and its Amicon separations science business for $125 aillion, in each cate consisting ol cash pins debt assumed by the bnye r; used the proceeds Iroa these and other transactions to repurchase stock, reduce indebtedness, and, to a lesser extent, invest m core businesses; streamlined processes and thereby reduced expenses by approximately S100 million annually (with further actions being taken to improve margins); strengthened controls on working capital and capital spending; and focused its research and development spending on core businesses. In addition, in the early 1990s, the uauugeaenl itrucLure ol Grace was reorganized on the basis of global pxodnet lines (as distinguished from regional prodnet management). At a result of this reorganization, Grace believea that it is better able to serve its multinational cuttomers in all global regions, as well as to tailor its prodnet offerings to ajet local preferences. Grace is completing the disposition of its remaining noncore businesses. In February 1997, Grace entered into an agreement to sell its specialty polymers business for $147 aillion in cash, and it expects to dispose of its thermal and emission control systems business (see "Discontinued Operations" below) in L997. To foens on core hnsiness growth. Grace Has made strategic acquisitions, totaling $103 million in the 1994-1996 period, directly related to its core businesses, and has entered into a number of strategic alliances intended to farther expand these butinettes inteinitionally. In 1994, Graee acquired construction chemicals businesses with operations in North America, Enrope and Asia Pacific. In 1995, Grace formed a 684-owned joint venture with a Chinese ptektging company, primarily to manufacture shrink films for saustge casings in China, as well as a 514-uwued loiut venture with a Russian company to produce container and closure sealants for sale throughout the Commonwealth of Independent States. In 1996, Grace forned a joint venture to market coatings and sealants in India and forned another joint venture to manufacture and market cement additive; and concrete adnixtnres in Turkey. Also in 1996, Grace acquired a U.S. manufacturer of flexible plastic ptektging materials for the retail pre-cat produce narket segment, a Mexican producer of can coatings and closure sealants for the rigid container industry, and a construction cheaicals business in Anstralia. From 1994 throngh 1996, Grace's capital expenditures for its core packaging and specialty chemicals businesses totaled $1.15 billion (including $389.5 million in 1996). These expenditures were directed towards the expansion of existing facilities as well as -2- 5 the construction of nev facilities. Grace anticipates that its capital expenditures lor 1997 will approx mate $301) Million, all ol which will be directed toward: its core businesses. In the future, Grace intends to continue its emphasis on internal growth, primarily through new product development and geographic expansion. In addition, it may also effect acquisitions, joint ventures and strategic alliances that afford synergies or other benefits necessary to fulfill strategic objectives of a core business (such as a key technology or an opportunity for geographic expansion) or that provide a combination of a close fit with a core basinets and the potential for exceptional returns. PROJECTIONS AND OTHER FORWARD -LOCKING INFORMATION. This Report contains, and other cnimnni cat. inns hy Grace nay contain, projections or oi.her "forward-looking" information. Like any other basiness, Grace is snbject to risks and other uncertainties that coaid canse its actual remits to differ naterially from any inch projections or that conld canse other forward-looking information to prove incorrect. In addition to general economic conditions and conditions in the industries in which Grace competes and the Markets it serves, Grace is snbject to risks and uncertainties that conld canse its projections and other forward-looking information to prove iucorieul, including the following: technological breakthroughs rendering a product, a class of products or a line of business obsolete; tn inability to adapt to continuing technological improvements by competitors or customers; incidents (including outbreaks snch as those experienced in 1996 with E. coli bacteria and "mad cow disease") that canse declines in the consumption of beef or other foods or prodnots served by Graoc's packaging business; a decline in worldwide oil consnnpt.ion or the development, of new methods of oil refining; increases in prices ol law materials, snch as resins and polyethylene; a reversal of the current trend towards more processing of food products (particularly neats, cheeses and produce) outside of the supe market; an inability to gain customer acceptance, or slower than anticipated acceptance, of new products or product enhancements (particularly iu the construction industry); changes in environmental regulations or societal pressures that nake Grace's bnsinesses more costly or that change the types of products nsed, especially packaging products and oil products; slower than anticipated economic advanoes in leas developed oonntries; a decrease in the nse of strnctnral steel in buildings; underutilization of Grace's Manufacturing and production plants as a rcsnlt of slower than anticipated growth, especially in light of recent significant capital expenditures; and -3- 6 the acquisition (through theft or other means) and nse by others of Grace' 5 proprietary lornnlas and other know-how iparticularly in Grace'i container business). See Notes 1, 3, 4, 6, 7. 11. 12 and 18 to the Consolidated Financial Statements and 'Management's Discussion and Analysis oi Resalts of Operations and Financial Condition" in the Financial Snpplenent for additional information. PRODUCTS AND MARKETS CHEMICAL INDUSTRY OVERVIEW. Specialty chemicals, such as those prodneed by Grace, are high value-added prodnets used as intermediates in a vide variety of products; they are prodneed in relatively small volumes and must, satisfy veil-defined performance requirements and specifications. Specialty chemicals are often critical components of the end prodnets in which they are nsetf consequently, they ire tailored to enstoaer needs, vhich generally results in s close relationship between the specialty chemicals producer and the enstoner. Rapid response to changing customer needs and reliability of product and supply are important competitive factors in the specialty chemicals bnsiness. Grace's management believes that, in the specialty chemicals business, technological leadership (resulting from continuous innovstion through research and development), combined with product differentiation and superior customer service, lead to high operating margins. Grace believes that its core businesses are characterized by market features that reward the higher research and development tod customer service costs associated with its strategy. PACKAGING. Grace's packaging and container business ("Grace Packaging") provides high-performance systems on a worldwide basis, competing principally by providing snperior-qna 1 it.y prodnets and services for speciali7ed enstoner needs. Its principal packaging prodnets and services compete through three product gronps; flexible packaging (marketed extensively nnder the Cryovac(K) registered trademark), Formpac(TM) foam trays and Omicron(TM) rigid plastic containers. Grace Packaging's container bnsiness, operated until 1996 as a separate Grace business unit, competes primarily through three product lines; container sealants, closnre sealants, and coatings for metal packaging. Grace believes lbs l the cuubiuatiou oi ils packaging and container businesses will euable il to capitalize on the complementary technological, marketing and product development strengths of each business. The Cryovac packaging prodnets group developed and introduced flexible plastic vacuum shrink packaging to the food processing industry in the lax.e 1940s, contributing to expanded food distribntion and marketing by providing superior protection against decay-inducing bacteria and moisture loss. The market for Cryovac prodnets has since 7 expanded into the retail food market. Today, Cryovac flexible plastic packaging systems (including natenal, equipment and services) are used tor a broad range of perishable foods snch as fresh, smoked and processed meat products, cheese, fish, poultry, prepared foods (including soups and sauces for restaurants and institutions), baked goods and prodnce. Cryovac packaging technology also is nsed in nonfood applications for consomer merchandising of snch products as housewares, toys and compact discs, as well as for electronic and medical products. Cryovac flexible packaging products include shrink bags, shrink films, laminated films, and films for medical bags and equipment. Shrink bags are mnlti-layered plastio bags that mold themselves to the cxaot shape of the product, forming a clear 'second skin.' Using sophisticated coextrusion technology, Cryovac shrink hags maximize barrier properties, optics, ahnse resistance, shrinkability and seal strength. Cryevsc shrink films are mnlti-layered shrinkable plastic films nsed to package a variety of food and nonfood consumer and industrial prodnets to protect against damage, preserve freshness and enhance marketability. Cryovac laminates are multi-layered, nonshnnkable and normally high-barrier flexible materials nsed for packaging perishable foods, shelf-stable products (nonrefrigerated foods, snch as syrnps, Cuppings tud lumalu paste) and various uunfuod products. The Cryovac liue also includes sterilized medical bags and films for use with medical prodnets. Grace Packaging differentiates its flexible packaging prodnets from competitive prodnets by offering a combination of the following core competencies: (a) proprietary film processing technology, (b) resin technology, permitting the production of materials suited to specific customer needs; (c) packaging and food science expertise, providing better understanding of the interaction between packaging materials and packaged prodoots; (d) complete systems support capability, providing a single source for customer needs; (e) a talented employee base that, strives to anticipate, meet and exceed customer expectations; and (f) effective sales and distribution networks. In addition, Grace Pactaging's systems can be adapted to support customers' changing marketing goals. Technological leadership is a key competitive factor in the packaging bnsiness, and Grace Packaging is recognized as a worldwide leader in flexible packaging lecbuulogy. Management expects thaL technological leadership will continue to spur Grace Packaging's growth in several market segments. For fresh meat, Grace Packaging'a caae-ready program reduces supermarkets' in-store production costs by allowing neat processors to centrally package meat products suitable for display. For bone-in pork, Grace Packaging's TBG(TM) bonegnard packaging prodnets have revolntionized the distribution of large snbprimal cats by adding a film patch to certain sections of a high-abuse barrier bag to prevent bone pnnctnres. For processed meats and ponltry, Cryovac cook-in bags and laminates withstand high cooking temperatures, reducing the potential for contamination while retaining product shape, clarity and weight. For fresh-cut prodnce, Grace Packaging prodnce* film* that, permit, oxygen to pa*a throngh at. various rates, thereby marching the -5- s varying respiration rates of different vegetables and pernitting longer shelf life. Grace Packaging* technological leadership was farther enhanced by the 1996 acquisition of Cypress Packaging, Inc., a leader m the retail fresh-cat produce packaging laarkel. Because technological innovations by coupe Li tors coulJ adversely affect its business, Grace Packaging intends to continue to tocos research and developaent expenditures on naintaining technological leadership in flexible packaging. Grace Packaging has continned to expand its flexible packaging business in growing aarkets around the world. In 1993, Grace foraed a 31t-owned joint venture to produce flexible packaging in the Coanonwealth of Independent States, and in 199S Grace foraed a 68-owned joint ventnre in China, priaarily to nannfactnre shrink lilns for sausage casings. Grace Packaging's container business group consists primarily of three product lines: container sealants, closure sealants, and coatings tor netal packaging. Container sealants are applied to food and beverage cans, as well as to other rigid containers (snch as industrial product containers and aerosol cans), to ensure a hernetic seal between the lid and the body of the container. Closure sealants are nted to seal pry-off and twist-off aetal crowns, as well as lull-on pilfer proof and plastic closures, for the glass and plastic container markets (primarily in beverage and food applications). Coatings are nsed in the mannfactnre of cans and closures to protect metal against corrosion, to protect the contents against the influences of netal, to ensure proper adhesion of sealing compounds to metal surfaces, and to provide base coats for inks and for decorative purposes. These prodacts are sold principally to third parties that mannfactnre containers or perforn canning and bottling for food and beverage companies. Grace Packaging is expanding its container product offering and is seeking to improve sales growth through new technologies snch as its oxygen-scavenging compound, which combines with closure sealants to extend shelf life by el minuting oxygen, ind oxygen's effect, on taste, from sealed beer and other beverage bottles. Grace Packaging also is expanding its container business in developing regions through a 51%-owned ioint ventnre to produce container and closure sealants in the Commonwealth of Independent States and a 5 Lt-owned joint venture to market coatings and sealants in India. Competition is based on providing higb-qnality customer service at customer sites, as well as on price and product quality and reliability. In addition, because of the relative couveutra Lion ul Use canning and buttling market, maintaining relationships with leading container manufacturers, canners and bottlers, and assisting them as they install new production equipment and reengineer processes, are key elements for success. Grace Packaging's Formpac business group manufactures and sells polystyrene foam prepackaging trays nsed by supermarkets and grocery stores, and by poultry and other meat processors, to protect and display fresh meat, poultry and produce. It also mannfactnrcs and sells foam food service items snch as hinged-lid containers nsed in institutional environments, by carry-ont restaurants and by snpermafleets for sale to retail -6- 9 customers. Formpac manufactures foam trays in a two-stage pxocess consisting of the ext rut ion and thermotorming ot polystyrene loan sheets. Although the majority of Foxmpac't customers are located in the eastern two-thirds of the U.S., Fuxupac's proprietary Lechuulogy alto lias been successfully used in certain packaging applications outside of the U.S. Competition is based on service, price and product quality. Grace Packaging's Omicron business group produces rigid plastic packaging products (primarily plaatic tuba for dairy products such as margarine and yogurt) in Australia. Omicron products use proprietary thermoforming technology, involving the controlled thinning and shaping of hot plastic sheets to increase strength and rigidity while minimizing weight. Resins are the principal raw materials used by Grace Packaging. Although prices for ethylene-based resins can be volatile, there is currently an adequate worldwide supply of resins at generally stable prices. Farther, Grace Packaging typically has been able to increase the sales prices of its products in response to increases in the prices of resins and other raw materials. However, to the extent that resin prices increase and Grace Packaging cannot pass on the increases to its customers, such price increases may hive an adverse impact ou Grice's profitability. In must cases, multiple sources ol resins and other raw materials exist, with at least one source located in most global regions. Grace Packaging's sales and revenues were $2.01 billion in 1996, $1.97 billion in 199S and $1.67 billion in 1994. Sales of shrink bags accounted for 24% of the total sales and revenues of Grace s ccntinning operations in 1996, and 22% in each of 1995 and 1994. Approximately 46% of Grace Packaging's 1996 aalcs and revenues were generated in North America, 31% in Europe, 14% in Asia Pacific and the remainder in Latin America. Grace Packaging estimates that approximately 80% of its 1996 sales were to t.he food indnst.ry (particularly meat and ponltry processors) and the beverage industry. Although sales and revenues tend to be slightly higher m the fourth quarter, seasonality is generally not significant to Grace Packaging. At year-end 1996. Grace Packaging employed approximately 11,500 people in 45 production facilities (13 in Europe, 12 in etch of North America and Asia Pacific and 8 iu Laliu America) aud 89 sales offices, serving approximately 28,000 customers, no one of which accounted for more than 3% of Grace Packaging's 1996 sales and revenues. Grace Packaging's principal U. S. manufacturing facilities are located at Simpsonville, Sonth Carolina, Iowa Park, Texas, Seneca, South Carolina, Cedar Rapids. Iowa, Reading, Pennsylvania, and Indianapolis, Indiana. Its prinoipal Enropean manufacturing facilities are located at Epernon, France, St. Neots, United Kingdom, Passirana, Italy, and Hamburg and Flensburg, Germany, and it has major manufacturing facilities located in Australia, Japan, Brazil, Ifcxico, Canada and Argentina. Grace Packaging alto has recently constructed a manufacturing facility in Kuanttn, Malaysia that, has hecone it.* principal shrink film* mannfactnring facility in Asia. Grace Packaging distributes its products in over -7- iO 100 countries through direct sales organizations and distributors, using a network ol distribution facilities located near its manufacturing facilities and najor enstoner concentrations. In Grace Packaging's business, the failure to have capacity sufficient to neet custoner needs, or the inability to manufacture in geographic narketc in which customers expand, conld damage custoner relationships and'or result in a loss of business. As a remit of prodnct introductions, marketing pxogians and improvements in global economic conditions, worldwide demand for Grace Packaging products grew at a rapid pace in 1994 and 1993, placing pressure on existing capacity. To addiess this matter, Grace Packaging has added capacity in all regions (including the plant in Knantan, Malaysia, referred to above). As a result, capacity is generally sufficient to meet market demand currently and, taking planned capacity expansion into accnnnt, for t.he foreseeable fntnre. CATALYSTS AND U1HLR SILICA-RASH) PRODUCTS. Grace's Davison unit ("Grace Davison"), founded in 1832, is composed of two primary product gronps: (a) catalysts and (b) silica products and adsorbents. These products principally apply silica, alnmina and zeolite technology and are designed and manufactured to neet the varying specifications of such diverse customers as najor oil refiners, plastics and chemical manufacturers and consumer products companies. Grace Davison believes that its technological expertise provides a competitive edge, allowing it to quickly design products that meet changing customer specifications, and to develop new products that expand its existing technology. For example, Grace Davison estimates that a substantial portion of its 1996 fluid cracking catalyat sales was attributable to products introduced in the last five years. Grace Davison prodnocs refinery catalysts, including (a) fluid cracking catalysts nsed by petroleum refiners to convert erode oil into more valuable transportation fuels (snch as gasoline and jet and diesel fuels), as well as ether petroleum-based products, and (b) hydroprocessing catalysts that renove certain inpnrities (snch as nitrogen, snilnr and heavy metals) from crude oil prior to the nse of fluid cricking catalysts. Oil refining is a highly specialized discipline, demanding that products be tailored to meet local variations in crude oil and the refinery's changing operational needs. Grace Davison works regularly with most of the approximately 360 refineries m the world, helping Lu find Lhe most appropriate catalyst formula Lions for the refiners' changing needs. Grace Davison's business has benefited in recent years, in part, fron the use by refiners of heavier crude oils, and could be adversely affected by an increase in the availability of lighter crude oil, which generally requires less fluid cracking catalysts to refine. Competition in the refinery catalyst basinets is based on technology, prodnct performance, enstomer service and price. Grace Davison believes it is one of the world leaders in refinery catalysts and the largest supplier of flnid cracking catalysts in the world. Grace Davison's polyolefin catalysts snd catalyst, snpport.s are essential components nsed in manufacturing nearly half of all high density and linear low density -8- u polyethylene resins produced worldwide; these resins are used m products such as plastic film, high-performance pipe and household containers. The polyolefin catalyst business is technology-intensive and focused ou providing produces specifically fornnlated to aeet end-nser applications. Manufacturers generally compete on a worldwide basis, and competition has recently intensified dae to evolving technologies, particalarly the use of metallocenes. Grace believes that metallocenes represent a revolutionary development in the making of plastics, allowing plastics manufacturers to design polymers with exact performance characteristics. Grace Davison is continuing its work on the development and commercialization of metallocene catalysts. Silica prodnets and zeolite adsorbents produced by Grace Davison are nsed in a wide variety of industrial and con untie r applications, for example, silicas are nsed in coatings as flatting agents (i.e., to reduce gloss), in plastics to improve handling, in toothpastes as thickeners and cleaners, in foods to carry flavors and prevent caking, and in the purification of edible oils. Zeolite adsorbents are used between the two panes of insulated glass to adsorb moisture and are nsed in process applications to separate certain chemicals from mixtures. Competition is based on product performance, customer service and price. Grace Davison'a sales and revenues were $732 million in 1996, $647 million in 1995 and $610 million in 1994; approximately 504 of Grace Davison's 1996 sales and revenues were genersted in North America. 364 in Europe, 124 in Asia Pacific and 24 in Latin America. Sales of flnid craoking catalysts accounted for 114 of the total sales and revennes of Grace's continuing operations is 1996, and 104 in each of 1995 and 1994. At year-end 1996, Grace Davison employed approximately 2,700 people worldwide in 10 facilities (6 in the U.S. and l each in Canada. Germany, Brazil and Malaysia). Grace Davison's principal II.S. manufacturing facilities are located in Baltimore, Maryland and Lake Charles, Louisiana; its principal European manufacturing facility is located m Worms, Germany. Grace Davison has a direct selling force and distributes its products directly to over 19,000 customers, the largest of which accounted for approximately 64 of Grace Davison's 1996 sales and revennes. Most raw materials nsed in the manufacture of Grace Davison prodnets are available from multiple sources, and, in some instances, are produced or supplied by Grace Davison. Because of the diverse applications of prodnets using Grace Davison technology and the geographic areas in which snch prodnets are used, seasonality does not have a significant effect on Grace Davison's businesses. CONSTRUCTION PRODUCTS. Grace's construction prodnets business ("Grace Construction") is a leading supplier of specialty materials to the nonrcsidcntial (commercial and government) construction industry and, to a lesser extent, the residential construction industry. Grace Construction's products fall into three main groups: (a) concrete admixtures, cement, additives and masonry prodnets (principally chemicals that add -9- 12 strength, control corrosion, reduce the amount of water required or modify setting tine); (b) products that prevent water damage to strictures (such as water- and ice-proofing products for residential nse and waterproofing systems lor commercial structures), md (o) substances that protect structural steel against collapse dne to fire. In North America, Grace Constrnction also nannfactnres and distributes vermiculite products used in construction and other industrial applications. In recent years, Grace Construction ha3 introduced new products and product enhancements. These new products and enhancements include an admixture that rednces concrete shrinkage and prevents cracking: a product that enables contractors to poor and "work" concrete in colder temperatures; an admixture that inhibits corrosion and prolongs the life of concrete strnctnres; new roof nnrierlaynent.s that provide added protection from ice and wind-driver rain; and enhancements to fireproofing products that make Grace Constrnction's lireprooling systems more price-competitive lor smaller jobs. In addition to customer acceptance of these and other product introductions, Grace Constrnction`s growth strategy ia dependent on the advancement of less developed economies (since, as economies develop, they typically nse more ready-nix concrete, which allows for the application of more concrete admixtures). Grace Constrnction's products are sold to an extremely broad range of customers, including cement manufacturers, ready-mix and pre-stressed concrete producers, local contractors, specialty subcontractors and applicators, masonry block manufacturers, building materials distributors and other indnstrial manufacturers, as well as construction specifiers, such aa architects and strnctnral engineers. For some of these customer groups (such as contractors), cost and ease of application are the key factors in making pnrehasing decisions; for others (suoh as architects and strnctnral engineers), produot performance and adaptability are the critical factors. In view of this diversity, and because Grace Construction'a hnsiness requires intensive sales and enstnner service efforts, Grace Construction maintains a separate sales and technical support force fox each of its prodnet groups. These sales and support forces sell prodnets under global contracts, under U.S. or regional contracts and on a job-by-job basis. Consequently, Grace Constrnction competes globally with several large construction materials suppliers and regionally and locally with numerous smaller competitors. In recent years, the cement mannfactnring business and the contracting business have experienced substantial cuusulidalion, particularly in narkets ontside the U.S. Competition is based largely on technical support and service, prodnet performance, adaptability of the product and price. Grace Construction's 1996 sales and revenues totaled $435 million (64% in North America, 19% in Asia Pacific, 17% in Europe and less than 1% in Latin America), versus $397 million in 1995 and $387 million in 1994. At year-end 1996, Grace Construction employed approximately 1,900 people at 56 production facilities (26 in North America, 11 in Southeast Asia, 7 in each of Anstra 1 ia/New Zealand and Europe, 4 in Turin America, and 1 in Japan) and 76 sales offices worldwide. Grace Construction's capital expenditures -10- 13 tend to be relatively lower, and sales and marketing expenditures tend to be relatively higher, than those of Grace's other core businesses. The construction business is cyclical, in response to economic conditions and construction demand. The construction market has experienced slow but steady growth through 1996 from a cyclical low in 1991. During this time, the management of Grace Construction has focnsed its efforts on streamlining its range of products and reducing coats. For example, dnnng this period, Grace Construction implemented a lower cost structure by consolidating manufacturing plants for its North American fireproofing operations and streamlining its management strnctnrc and conaolidating research efforts in its Enropcan waterproofing operations. The construction business is also seasonal due to weather conditions. Grace ronst.rnct.ion seeks to increase profitability and minimize the impact of cyclical and seasonal downturns in regional economies by introducing technically advanced, valne-added products, expanding geographically, and developing business opportunities in renovation construction markets. However, there is no assurance that these initiatives will succeed, and the cyclicality and seasonality of the construction business could affect Grace Construction's business and results of operations. The raw materials used for mannfactnring Grace Construction products are primarily commoditiea that can be obtained from mnltiple sources, including commodity chemical producers, petroleum companies and paper manufacturers. In most instances, there are at least two alternative suppliers for each of the principal raw materials used by Grace Construction. The worldwide aupply of calcinn lignin, a wood pulping by-product nsed as a raw material in the prodnetion of concrete admixtures, had been decreasing as paper mills converted to new manufacturing processes. In 1996, additional supplies of calcium lignin became available, alleviating the shortage. However, there is no assurance that the additional supplies will remain available in sufficient, quantities or at. satisfactory prices. DISCONTINUED OPERATIONS Grace's thermal and emitsion control systems basinets ("Grace TEC Systems") is Grace's principal discontinued operation that has uot yet been divested. Grace TEC Systems aanniactnies air flotation dryers and volatile organic compound control systems. These products are aold principally to the graphic arts, web coating and paper converting markets. Competition for Grace TEC Systems' products is based primarily on system design, materials, technology, easterner service, prodnot performance and price. Grace TEC Systems employed approximately 700 people at year-end 1996 and had sales of $103 million in 1996, S113 million m 199S and $90 million in 1994. Grace is actively pnrsning the disposition of this business and ita other remaining discontinued operations. See "Strategic Objectives and Actions" above, "Management's Discussion and Analysis of Results of Operations and Financial Condition" and Note 6 to Grace' a -11- 14 Consolidated financial Statements tor additional information concerning Grace's discontinued operations. RESEARCH ACTIVITIES Grace engages in research and development prograas for its core businesses. These prograas are directed toward the developoent of new prodncts and processes, and the improvement of, and develcpaent of new uses for, existing products and processes. Research is carried out by product line laboratories in North America, Enropc, Asia and Latin America and includes research in catalysis, constrnction Materials, specialty packaging and process engineering, principally involving the development, of technologies to nannfact.nre chemical specialties. Grace's research and development strategy is to develop technology plattoins on which new prodncts will be based, while focusing development efforts in each basinets nnit on the improvement of existing products and/or the adaptation of existing prodncts to customer needs. Research and development expenses relating to continuing operations amounted to $94 million in 1990, $112 million in 1995 and $100 milliou in 1994 (including expenses incurred in funding external research projects). The amount of research and development expenses relating to government' and enstomer-sponsored projects (as opposed to projects sponsored by Grace) is not naterial. See "Management* s Discussion and Analysis of Results of Operations and Financial Condition' in the Financial Supplement for additional information. PATENTS AND OTHER TNTEI.THTTTIAT. PROPERTY MATTERS Grace relies on numerous patents and patent applications, as well as know-how and other proprietary information. As competition in the markets in which Grace does business is often based on technological superiority and innovation, with new prodncts being introduced frequently. the ability to achieve technological innovations and obtain patent or other intellectual properly protection is important. There can be uo assurance lbsl Grace's patents, patent applications or other intellectual property will provide sufficient proprietary protection. Other companies nay independently develop similar systems or processes that circnmvent patents issued to Grace, or nay acquire patent rights within the fields of Grace's businesses. Grace's competitors may also develop technologies, systems or processes that are more effective than those developed by Grace, or that render Grace's technology, systems or processes less competitive or obsolete. Any such events coaid have an adverse effect on Giaoc. -12- 15 EN'v'IRONKENIAL, HEALTH AW SAFETY MATTERS Manufacturers of specialty chemical products, including Grice, are subject Lu slriugeul regulaLiens uuder numerous federal, stale and local environmental, health and safety lav's and regulations relating to the generation, storage, handling, discharge and disposition of hazardons wastes and other materials. Grace has expended substantial funds in order to comply vith such laws and regulations and expects to continue to do so in the futare. The following table sets forth Grace's expenditures in the past three years, and its estimated expenditures in 1997 and 1998, lor (a) the operation and maintenance of environmental facilities and the disposal of wastes with respect to continuing operations; (b) oapital expenditures for environmental control facilities relating to continuing operations; and (c) site remediation: 1994 1995 1996 1997 (est.) 1998 (est.) (O Operation of Facilities and Waste Disposal <b) Capital Expenditures ($ in millions) $35 $22 43 15 45 17 45 13 47 12 (c) Site Remediation $31 31 20 23 26 Additional material environmental costs may arise as a result of future legislation or other developments. Grace's etrnings, competitive position and ether capital expenditures have not been, and are not expected to be, materially adversely affected by compliance with environmental requirements. See Note 11 to the Consolidated Financial Statements and "Management's Discussion and Analysis of Results of Opera lions and Financial Condition" in Lhe Financial Supplement. With the goal of continuously improving its environment, health and safety ("EHS") performance, Grace established its Commitment to Care(IM) initiative (based on the Responsible Care(R) program of the Chemical Manufacturers Association) in 1994 as the program under whioh all Graoe EHS activities are to be implemented. To the extent applicable. Commitment to Care extends the basic elements of Responsible Care to all Grace locations worldwide, embraoing spccifio objectives in the key areas of prodnet stewardship, employee health and safety, community awareness and emergency response, distribution, process safety and pollution prevention. -13- -is 16 See Item 3 below for information concerning environmental proceedings to which Grace is a parly and "Management' a Discussion and Analysis oI Results of Operations and Financial Condition" in the Financial Supplement for additional information concerning environmental matters. ITEM 2. PROPERTIES. Grace operates manufacturing and other types of plants and facilities (inclnding office and other service facilities) throughout the world, some of which arc shared by two or more of Grace's product lines. Grace considers its major operating properties to be in good operating condition and suitable for their enrrent. n:e. Alt.hongh Grace believes that., after taking planned expansion into account, the productive capacity of its plants and other facilities is generally adequate lor current operations and foreseeable growth, it conducts ongoing, long-range forecasting of its capitsl requirements to assure that additional capacity will be available when and as needed. Accordingly, Grace does not anticipate that its operations or incosie will be materially affected by the absence of available capacity. See "Management's Discussion and Analysis of Results ol Operations and Financial Condition" and page F-25 of the Financial Supplement, for information regarding Grace's capital expenditures. Additional information regarding Grace's properties is set forth in Iten 1 above and in Notes 1. 8 and 11 to the Consolidated Financial Statements. ITEM 3. LEGAL PROCEEDINGS. ASBESTOS LITIGATION. Grace is a defendant in property damage and personal injury lawsuits relating to previonsly aold ashestns-emitsining products, and anticipates that it will be named as a defendant in additional asbestos-related lawsmts in the fntnre. Grace was a defendant in approximately 41,500 asbestos - related lawsuit: at year-end 1996 (31 involving claims for property damage and the remainder involving approximately 91,500 claims for personal injury), as compared to approximately 40,800 lawsuits at year-end 1995 (47 involving claims for property damage and the remainder involving uppioximaLely 92,400 claims fur persousl injury). In most ul these lawsuits, Grace is one of nany defendants. The plaintiffs in property damage lawsnits generally seek to have the defendants absorb the cost of removing, containing or repairing the asbestos containing materials in the affected buildings. Through 1996, 135 asbestos property damage cases were dismissed without payment of any damages or settlement amounts; judgments were entered in favor of Grace in 9 cases (excluding case: settled following appeals of judgments in favor of Grace); judgments were entered in favor of the plaintiffs in 7 cases -14- -'a 17 lot a total ol $60.3 million (none of which is on appeal); and 186 property damage cases were settled lor a total ol S45U.5 nillion. Included iu the asbestos properly damage cases peudiug agaiusl Grace and others at year-end 1996 were the following class actions: (a) an action, conditionally certified by the U.S. Court ol Appeals for the Fourth Circuit in 1993 and pending in the U.S. District Court for the District ol Sooth Carolina, covering all public and private colleges and universities in the U.S. whose buildings contain asbestos materials (CENTRAL WESLEYAN COLLEGE, ET AL. V. Vi. R. GRACE, ET AL.); and (b) a purported class action (.ANDERSON MEMORIAL HOSPITAL, ET AL. V. W. R. GRACE 4 CO., ET AL.), liled in 1992, in the Court ol Common Pleas lor Hanpton County, Sooth Carolina, on behalf of all entities that own, in whale or in part, any bnilding containing asbestos materials manufactured by Grace or one of t.he other named defendants, other than hnildinga subject, to the class action lawsuit described above and any building owned by the federal or any state government. In July 1994, the claims ol most class members in ANDERSON MEMORIAL HOSPITAL, ET AL., V W. R. GRACE * CO., ET AL. were dismissed due to a ruling that a South Carolina statute prohibits nonresidents from pursuing claims in the South Carolina state courts with respect to buildings located ontside the state. The plaintiffs have requested that the court reconsider its decision. In December 1995, Grace entered into an agreement to settle the claims uuder PRINCE GEORGE CENTER, INC. V. U.S. GYPSUM COMPANY, ET AL., a class action covering all commercial buildings in the U.S. leased, in whole or in part, to the U.S. government on or after May 30, 1986. The terms of the settlement agreement (which were approved by the Court of Common Pleas ol Philadelphia Connty in Jnly 1996) are not expected to have a aignifioant effect on Grace's consolidated resells ol operations or financial position. Through yeer-end 1996, approximately 11,800 personal injury lawsuits involving 27,400 claims were dismissed without payment of any danages or settlement amount* (primarily on t.he basis that. Grace prndnct.s were not involved), and approximately 30,500 snch suits involving 66,200 claims were disposed ol lor total ol $186 million (see "lnsnrance Litigation" below). In 1991, the Judicial Panel on Multi-District Litigation consolidated in the U.S. District Court for the Eastern District ol Pennsylvania, for pre-trial purposes, all asbestos personal injury cases pending in the U.S. federal courts, including approximately 7,000 cases then peudiug against Grace; 3,600 new cases involving 7,200 claims against Grace have subsequently been added to the consolidated cases. To date, no action haa been taken by the court handling the consolidated cases that would indicate whether the consolidation will affect Grace's cost of disposing of these cases or its defense costs. Grace previously purchased insurance policies with respect to its asbestos-related lawsuits and claims. Grace has settled with and been paid by its primary insurance carriers with respect to both property damage and personal injury cases and claims. With one minor exception, Grace also has settled with it.s excess insurance carriers that, wrote -15- 18 policies available lor property damage cases; these settlements involve amounts paid and to be paid to Grace. In addition, Grace has settled with many excess insurance carriers that wrote policies available for personal injury claims. Grace is currently in litigation with certain remaining excess insurance carriers whose policies generally represent layers of coverage Grace has not yet reached. Such policies are believed by Grace to be available lor asbestos-related personal injury lawsuits. Insurance coverage lor asbestos-related liabilities has not been commercially available since 198S. Grace's aggregate accrual lor asbestos liabilities at December 31, 1996 was $994.1 million; this amount reflects all asbestos-related property damage and personal injury cases and claims then pending (except for one property damage case as to which liability is not yet estimable because Grace has not yet been able to obtain snfficient information t.hrongh discovery proceedings), as well as personal injury claims expected to be filed through 2001. Grace's ultimate exposure with respect to its asbestos-related cases and claims will depend on the extent to which its insurance will cover damages for which it may be held liable, amounts paid in settlement and litigation costs. At December 31, 1996, Grace had recorded a receivable of S331.3 million, the amount Grace estimated to be the probable recovery iron its insurance carriers with respect to pending and projected asbestos cases and claims. A May 1994 decision ol Lite U.S. Court of Appeals for the Second Circuit limited the amount of insurance coverage available to Grace with respect to property damage cages. Because Grace's insurance covers both property damage and personal injury cases and claims, the May 1994 decision has had the concomitant effect of reducing the insnranee coverage available with reaped to Grace's asbestos personal injury claims. However, in Grace's opinion (which is not based on a formal opinion of counsel), it is probable that recoveries from its insnranee carriers, along with ether funds, will be available tc satisfy the property danage and personal injnry cases and claims pending at year-end 1996, as well as personal injnry claims expected to he filed in the foreseeable fnt.nre. Consequently, Grace believes that the resolution of its asbestos-related litigation will not have a material adverse effect on its consolidated financial position. See "Insurance Litigation" below and Note 2 to the Consolidated Financial Statements for additional information. ENVIRONMENTAL PROCEEDINGS. Grace (together with certain other companies) has been designated a "potentially responsible party" ("PRP") by the U.S. Environmental Protection Agency ("EPA") with reapect to absorbing the coats of investigating and remediating pollution at various sites. At year-end 1996, proceedings were pending with respect to approximately 30 sites as to which Grace has been designated a PRP. Federal law provides that all PRPs may be held jointly and severally liable for the costs of investigating and remediating a site. Grace also is condncting investigatory and remediation activities at sites under the jurisdiction of state and/or local anthoritics. -16- 19 In November 1995, Grace receiYed a letter Iron the U.S. Department ol Energy ("DOE") inquiring as to Grace's willingness to contribute to the loutiuued cleanup ol a former Grace property located in Wayne, New Jersey. The letter asserted that Grace has a legal dnty to pay lor the cleannp and that the total cost of the cleannp nay exceed $100 nillion. The operations conducted by Grace at the Wayne site (Iron 1955 to 1970) included work done on radioactive naterials under contract with the U.S. government. In 1975, the U.S. Nuclear Regulatory Connission inspected the site, concluded that it was decontaminated in accordance with applicable regulations and released it lor unrestricted use. In 19&4, pursuant to a request from the DOE, Grace transferred the Wayne property to the DOE and made a cash payment aa a contribution towards the DOE's cleannp efforts at the site, which was acknowledged by the DOE as fulfilling any obligation Grace had t.n contribute to DOF.'a cleannp effort, while preserving the lights and liabilities of the parties under other existing applicable laws. Grace believes that the resolution of the DOE'S clam will not have a material adverse effect on its consolidated financial position. In March L993, an action was filed in the U.S. District Court for the Southern District of Texas against Grace Drilling Company, a subsidiary of Grace, the business aud assets of which have since been sold, and several other defendants, for alleged violations of the Clean Water Act and the Rivers and Harbors Act (U.S. V. FINA OIL AND CHEMICAL 00., ET AL.). The government alleged that seagrasses and seabeds around a drilling rig operated by Fina Oil and Chemical Co. were damaged in connection with the placing, servicing and removal cf the rig. In February 1997, the U.S. District Court approved a decree under which Grace agreed to pay $700,000 in penalties and $1.6 million towards a restoration project to settle this action, all of which is expected to be paid by Grace's insnranoc csrricxs on its behalf. Grace is a party to additional proceedings involving federal, state and/or local government agencies and private parties regarding Grace's compliance with environmental laws and regulations. These proceedings are not expected to result in significant sanctions or in any material liability. However, Grace may incur material liability in connection with future actions of governmental agencies and/or private parties relating to past or future practices of Grace with respect to the generation, storage, handling, discharge or disposition ul hazardous wastes aud olher materials. Grace believes that the liabilitiea for environmental remediation costs, including costs relating to environmental proceedings, that have been recorded in the Consolidated Financial Statements are adequate. In addition, Grace is presently involved in litigation with its insurance carriers seeking to hold them responsible for certain amounts for which Grace may be held liable with respect to snch costs. The outcome of such litigation, as well as the amounts of any recoveries that Giaoc may receive in connection therewith, is presently uncertain. However, Grace believes that the resolution of pending environmental proceedings will not have a material adverse effect on its consolidated financial position, results of operations or liquidity. For further information, see "Environmental, -17- rri 20 Health and Safety Matters' under Itea 1 above and "Management's Discussion and Analysis ol Results ol Operations and Financial Condition." INSURANCE LITIGATION. Grace is involved in litigation with certain ol its insurance carriers with respect to asbestos-related insnrance clams and environmental liabilities. The relief sought by Grace in theae actions would provide insurance that would partially offset Grace's estinated exposure with respect to aaonnts previously expended, and that nay be expended in the futnre, by Grace to defend claims, satisfy judgments and fnnd settlements. Grace has settled all of its asbestos-related insurance coverage actions, with the exception of MARYLAND CASUALTY CO. V. V. R. GRACE t CO., pending in the US. District Coart for the Southern District of New York. In April 1996, as a result of rnlmgs in this action favorable to Grace with respect to its asbestos-related property damage liabilities, t.he inanrer* agreed to the entry of summary judgment in favor of Grace; however, the insurers have stated chat they intend to appeal the District Coart's rulings, lhe District Court has not yet addressed Grace's claims for insnrtnce coverage for its asbestos-relaxed personal injury liabilities. Grace's only environmental insnrance coverage action is pending in the U.S. District Court lor the Southern District of New York and is tlso styled MARYLAND CASUALTY 00. V. W. R. GRACE * CO. See Noxe 2 to the Consolidated Financial Slateueuts and "Management's Discussion and Analysis of Results of Operations and Financial Condition" for additional information. Prior to 1993, Grace received from insurance carriers asbestos-related payments totaling $97.7 million, the majority of which represented the aggregate remaining obligationa owed to Grace by those carriers for primary level insurance coverage written for the period June 30, 1962 through June 30, 1987. In 1993 and 1994. Grace settled with insnrance carriers for a total of $300.2 million (portions of whieh were paid or will be paid in subsequent years), in reimbursement for smonnts expended by Grace in connection with asbestos-related litigation. Tn 1995, Grace settled with a primary-level insurer for $100 million, and with other insurers for a total of $200.3 million, including future payments of approximately $70 million. In 1996, Grace settled with additional excess-level insurers tor a total of $110.5 million (including $19.2 million to be received over the next five years) with respect to both products liability and other coverage. As a result of these settlements, Grace's asbestos-related insurance claims have been dismissed as to the primary-level product liability insurance coverage previously sold by Ihe relevaul iusurers lu Grace, as well as to many of Grace's excess-level liability insurers. However, litigation continues in New York federal court as to certain excess-level carriers that have not settled. FUMED SILICA PLANT LITIGATION. In 1993, Grace initiated legal aoiion in the Belgian courts against the Flemish government to recover losses resulting from the closing of Grace's fnmed silica plant in Puurs. Belgium. Grace is seeking damages in excess of fonr billion Belgian francs (approximately $126.1 million at the December 31, 1996 exchange rate), plus interest and lost profits. This claim was dismissed at. t.he trial court, level and is now being appealed by Grace. The trial court also determined that Grace shoald repay -18- 21 approximately 23V Billion Belgian francs (approximately $7.5 million at the December 31, 1996 exchange rate), pins interest, to the Flemish government for previously received iuvesuaeul giants, this decision is also being appealed by Grace. In Inly 1996, Grace received a favorable arbitration rnling, under which the engineering company responsible for the design and constrnction of the fumed silica plant was ordered to pay damages to Grace; the damage award is not naterial to Grace. U.S. JUSTICE DEPARTMENT LAWSUIT. The U.S. Justice Department has intervened in a QUI TAM lawsnit, originally filed in Inne 199S, pending in the U. S. District Court for the Northern District of California (UNITED STATES EX REL. ROBERT COSTA .AND RONALD THORNBURG, ET AL., V. BAKER k TAYLOR, INC., ET AT..). The complaint, in t.hiR lawsnit alleges that. Raker & Taylor Rooks, a hoot wholesaler sold by Grace in 1992, overcharged public schools, libraries and federal agencies dnnng the last ten years, including the period dming which Baker k Taylor Books was owned by Grace. Grace, Baker k Taylor, Inc. (the entity that currently operates Baker k Taylor Books) and one of the enrient shareholders of Baker k Taylor, Inc. have been named as defendants. The lawsnit seeks unspecified damages, punitive damages and civil penalties, as well as attorneys' lees and expenses and such other relief as the Court may deem proper. At this tine, Grace is unable to determine the liability, if any, to which it may be subject as s result of this lawsnit. SHAREHOLDER LITIGATION. W. R. Grace & Co., a New York corporation subsequently renamed Fresenins National Medical Care Holdings, Inc. ("Grace New York"), and members of the Grace New York Board of Directors (as well as J. P. Boldnc, who resigned as president and chief executive officer and a director of Graoc New York in Match 1995) arc defendants in a case entitled VEISER, ET AL. V. GRACE, ET AL. pending in New York State Suprene Coart, New York Coanty. The consolidated amended complaint in this lawsnit., which pnrport.s t.o he a derivative action (I.E., an action brought on behalf of Grace New York), alleges, among other things, that the individual defendants breached their fiduciary duties to Grace New York (a) by providing J. Peter Grace, Jr. (the chairman and a director of Grace New York nntil his death in April 1995) with certain compensation arrangements apon his voluntary retirement as Grace New York's chief executive officer in 1992 and (b) by approving Mx. Boldnc's severance arrangements, and LliuL Messrs. Grace and Bolduc breached their fiduciary duties by accepting such benefits and payments. The lawsnit seeks unspecified damages, the cancellation of all allegedly improper agreements, tbe cancellation of a retirement plan for nonemployee directors, the return of all remuneration paid to the directors who are defendants while they were m breach of their fiduciary duties to Grace New York, attorneys' and experts' fees end costs, and snch other relief as the Coart deems proper. Amotion to intervene in tbe case by the California Public Employees' Retirement System was granted by the Court in September 1996. Under the terms of the Distribution Agreement ("Distribution Agreement") entered into in connection with the NMC transaction described in "Strategic Objectives and Actions" above and in Note I t.o t.he Consolidated Financial Statements, Grace remains financially responsible for any liabilities incurred by Grace New York and others as a result of this -19- 22 lawsuit, including the lees tnd disbursements ol counsel lor Grace and, subject to certain conditions, counsel for the individual defendants (including certain curieul and turner directors ul the Company). Tire discussions ul Lhe Distribution Agreement appearing above and in the following paragraphs do not purport to be complete and are qualified in their entirety by reference to the Distribution Agreement, which was filed as an exhibit to the Joint Proxy Statement-Prospectus of Grace New York dated Angnst 2, 1996. In March 1996, two purported shareholder derivative class actions were filed in New York State Supreme Court, New York County, against Grace New York and Albert J. Costello, Grace's Chairman, President and Chief Executive Officer (and who previously held those offices with Grace New York), alleging that the defendants breached their fiduciary duties t.n Grace New York * shareholders hy failing to investigate and consider fully a proposal by Hercules, Incorporated to acquire or merge with Grace New York (1ZES, ETC. V. W. K. GRACE COMPANY, ET AL. and POLIEGFF, ETC. V. Vi. R. GRACE k COMPANY, ET AL.). On December 23, 1996, the parties stipulated to the dismissal of these actions without prejudice and without costs. No consideration was paid m connection with the dismissals. SECURITIES AND EXCHANGE COMMISSION INVESTIGATIONS. Grace New York was previously notified that the Securities and Exchange Commission ("Commission') bad iaaned a formal order of investigation with respect to Grace New York's prior disclosures regarding benefits and retirement arrangements provided to J. Peter Grace, Jr. and certain natters relating to J. Peter Grace III, a son of J. Peter Grace, Jr. Grace is cooperating with the investigation. The outcome of this investigation and its impact, if any, on Grace cannot be predicted at this tine. In April 1996, Grace New York received a formal order of investigation issned hy t.he Conmissinn directing an investigation into, among other things, whether Grace New York violated the federal securities laws by filing periodic reports with the Commission that contained false and misleading financial information. Pursuant 1o this formal order of investigation, Grace and others have received subpoenas from the Southeast. Regional Office of the Commission requiring the production of documents relating principally to reserves (net of applicable taxes) established by Grace New York and NNC during the period from January 1. 1990 lu lhe date ol Lhe subpoena. Grace believes that all financial statements filed by Grace New York with the Commission daring that period, the financial statements of NM2 included in its Form 10 Registration Statement filed with the Commission on September 25, 1995. and the Consolidated Financial Statements (all of which financial statements, other than unaudited quarterly fiuanoial statements, were covered by unqualified opinion* issned by Prioe Vaterbonse LLP, independent certified public accountants), have been fairly stated, in all material respects, in conformity with generally accepted accounting principles. Grace is cooperating with the investigation. The outcome of this investigation and its impact, if any, on Grace cannot be predicted at this time. -20- 23 Under the terns ot the Distribution Agreement, Urace renatns financially responsible lor any liabilities incurred by Grace Near York and others as a result ul the investigations described above, including the lees and disbursements of connsel for Grace and, subject to certain conditions, counsel for certain former directors and officers of the Company. SHAREHOLDER ACTIONS RELATING TO NMC. Grace Nev York and certain of its former officers and directors are defendants in a lawsuit entitled MURPHY. ET AL. V. W. R. GRACE CO., ET AL., which is pending in the U.S. District Court for the Southern District of New York. The first amended class action complaint in this lawsuit, which purports to be a class action on behalf of all persons and entities who purchased Grace New York's publicly traded securities daring the period from March 13, 1995 throngh October 17, 1995, generally alleges that, the defendants concealed information, and issued misleading public statements and reports, concerning INML" s financial position and business prospects, a proposed spin-off of NM2 and the matters that are the subject of investigations of NM2 by the Office of the Inspector General of the U.S. Department of Health and Homan Services, in violation of federal securities lavs. The lavsait seeks unspecified damages, attorneys' and experts' fees and coats, and snch other xeliel as the Court deems proper. Grace New York, certain of its former directors and its former president and chief executive oflicer are also defendants in a purported derivative action pending in the U.S. District Conrt for the Southern District of New York (BENNETT V. BOLDUC, ET AL.), alleging that snoh individuals breaohed their fiduciary duties by failing to properly supervise the activities of NMC in the conduct of its business. The BENNETT action seeks unspecified damages, attorneys' and experta' fees and costs, and saoh other relief as the Conrt deems proper. Under the terms of the Distribution Agreement, Grace renains financially responsible tor any liabilities incurred by Grace New York and others as a result of the lawsuits described above, including the fees and disbursements of counsel for Grace and, subject to certain conditions, counsel for the individual defendants (including certain current and forner directors and officers of the Company). In February 1996, a purported class action was filed in New York State Supreme Conrt, New York County, against Grace New York and certain of its current and farmer directors, alleging that the defendants breached their fiduciary duties, principally by failing to provide internal financial data concerning NIC to Vivra Incorporated and by failing to negotiate with Baxter International, Inc. in connection with a business combination involving NMC (ROSMAN V. W. R. GRACE, ET AL. 96-L02347). On December 19, 1996, the parties stipulated to the dismissal of this action withont prejudice and withont costs. No consideration was paid in connection with the dismissal. -21- 24 See NuLe 6 tu Lhe Consolidated Financial Statements slid "Management' * Discus nun and Analysis of Results of Operation* and Fiuauml Condi non' lor additional information concerning cerLam litigation and proceedings involving NMC. ITEM 4. SUBMISSION OP MATTERS TO A VOTE OF SECURITY HOLDERS This Ilea it inapplicable, as no natters were suborned to a vote of the Company's security holders during the fourth quarter of 199(5. EXECUTIVE OFFICERS The Coapany's current executive officers are listed below. Executive officers are elected to serve until the following annual fleeting of the Company a Board of Directors; the next such meeting is scheduled to be held on May 9. 1997. Name and Age R H Reher (63) Robert J. Bettacchi (54) Albert J. Costello (61) Larry Ellberger (49) lames R. Hyde (58) J. Gary Kaenzig, Jr. (52) Office Executive Vice President and General Counsel Vice President Chairman, President and Chief Executive Officer Senior Vice President and Chief Financial Officer Senior Vice President Senior Vice Preeident All the above executive officers have been actively engaged in Grace's bueiness for the past five years, other then Messrs. Costello and Ellberger. Mr. Coetello served as chairmn of the board and chief executive officer of Aaericen Cyananid Company fro* April 1993 to December 1994 and as president of Aaericen Cyenanid Company from 1991 through March 1993. Mr. Ellberger was a corporate vice president and director of corporate development end planning from October 1991 until 1995. and prior to that vice president, industrial and performance products division, of Anerican Cyananid Company. -22- First. Elected 05/ 10/93 09/01/91 02/01/90 05/ 10/ 95 05/ 01/95 07/ 06/ 95 11/14/ 96 07/06/ 95 10/ 05/ 95 25 PART II ITEM 5. MARKET FOR REGISTRANT'S COMON EQUITY AND RELATED STOOmiDER MATTERS. Except as provided below, tbe information called for by this Iten appears in the Financial Supplement under the heading "Financial Summary" opposite the caption "Other Statistics Common shareholders of record" (page F-26); under the heading "Quarterly Sanaary and Statistical Inforaation Unaudited' opposite the captions "Dividends declared per coanon share" and "Market price of conaon stock" (page F-25); and in Note 11 to the Consolidated Financial Statements (page F-20). Each share of the Company's Conaon Stock, $.01 par value ("Conaon Stock"), has an attendant Preferred Stock Purchase Right ("Right"), lhe Rights are not and will not becone exercisable unless and nntil certain events occnr (as described below). Until such events occnr, tbe Rights will automatically trade with the Conaon Stock, and separate certificates for the Rights will not be distributed. The Rights will becone exercisable on the earlier to occnr of (a) 10 days alter a person or group ("Acquiring Person") has acquired beueliciul ownership of 20$ or more of the then outstanding shares of Common Stock or (b) 10 business days (or such later date as nsy be fixed by the Company's Board of Directors) after an Acquiring Person commences (or announces the intention to coomeuce) a tender offer or exchange offer that would result in such Acquiring Person becoming the beneficial owner of 20$ or more of the then outstanding shares of Common Stock. Holders of Rights, as such, have no rights as stockholders of the Company, consequently, such holders have no rights to vote cr receive dividends, among other things. When the Rights become exercisable, each Right will initially entitle the holder to buy from the Company one hundredth of a share of the Company's beries A Junior Participating Preferred Stock, $.01 par value ("Junior Preferred Stock"), for $200, subject to adjustment ("exercise price"). If, at any tune after the Rights become exercisable, the Company is acquired in a merger or other business combination or 50$ or more of the Company's consolidated assets or earning power is sold, each Right will entitle the holder to bny a number of shares of common stock of the acquiriug coiapauy having a market value equal to twice the exercise price. Alternatively, each Right not owned by an Acquiring Person would become exercisable for Common Stock having a market value equal to twice the exercise price. Shares of Junior Preferred Stock that may be purchaaed upon exercise of the Rights will not be redeemable. Each share of Junior Preferred Stock will be entitled to a minimum preferential quarterly dividend payment of $1.00 per share but will be entitled to an aggregate dividend equal to 100 timc3 the dividend declared per share of Coanon -23- 26 Stock whenever such dividend is declared. In the event of liquidation, holders cl Junior Preferred Stock will be entitled to a niniann prelerential liquidation payment of $100 per share bnt will be entitled to an aggregate payment equal to 100 lines llie payiaeul trade per share ui Coimauu Slock. Each share of Junior Preferred Stock will have 100 votes, voting together with the Common Stock. Finally, in the event of any merger, consolidation or other transaction in which the Common Stock is exchanged, each share of Junior Preferred Stock will be entitled to receive an amount eqnal to 100 time3 the amount received per share of Common Stock. These rights are protected by customary antidilution provisions. Because of the nature of the dividend, liquidation and voting rights of the Junior Preferred Stock, the valne of the one-hundredth interest in a share of Jnmor Preferred Stock that, may he purchased npnn exercise of each Right, should approximate the value of one share of Comnon Stock. At any time after any person or group becomes an Acquiring Person, and prior to the acquisition by snch Acquiring Person of 50% or more of the outstanding shares of Comnon Stock, the Company's Board of Directors may exchange the Rights (other than Rights owned by snch person or group, which will become void ailex such person becomes an Acquiring Person) fur Common Slock or Junior Preferred Stock, in whole or in part, at an exchange ratio of one share of Common Stock, or one hnndredtb of a share of Junior Preferred Stock (or of a share of another series of the Company's Preferred Stock having equivalent lights, preferences and privileges), per Right (snbject to adjustment). At any time prior to the acquisition by a person or group of beneficial ownership of 20i or more of the outstanding shares of Common Stock, the Company's Board of Dixcotors may redeem the Rights in whole, bat not in part, at a price of $.01 per Right. The terms of the Rights may be amended by the Company's Board of Directors without the consent of the holders of the Rights, including an amendment to lower (a) the threshold al which a person becomes an Acquiring Person and (b) the percentage of Common Stock proposed to be acquired in a tender or exchange offer that would canse the Rights to become exercisable, to not less than the greater of (a) the snm of .001% pins the largest percentage of llie Company's outs lauding Common Sluck then known lu Ihe Cuupauy lo be beneficially owned by any person or group and (b) 10%, except that, from and after snch time as any peraon or group becomes an Acqniring Person, no snch amendment may adversely affect the interests of the holders of the Rights. The Rights will expire in September 2006, unless this expiration date is extended or unless the Rights are earlier redeemed or exchanged by the Company. -24- 27 The iureguing mummy of Che Rights dues uut purport to be complete dud is qualified in its entirety by reference to the Rights Agreement. which was filed as an exhibit to the Company's Form 8-E filed on October 10, 1996. ITEM 6. SELECTED FINANCIAL DATA. The information called for by this Item appears nnder the heading "Financial Summary" (page F-26 of the Financial Supplement) and in Notes 5, 6, 9 and 16 to the Consolidated Financial Statements (pages F-13, F-1S, F-1S and F-23 of the Financial Supplement). In addition, Exhibit 12 to this Report (page F-35 nf t.he Financial Snpplement.) contain* t.he ratio of earning* t.o fired charges and combined fixed charges and preferred stock dividends for Grace for the years 1992-1996. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The information called for by this Item appears on pages F-27 to F-32 of the Financial Supplement. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. See the Index to Consolidated Financial Statements and Financial Statement Schedule and Exhibits on page F-l of the Financial Supplement. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. This item is inapplicable, as no such changes or disagreements have occurred. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Except lor information regarding the Company's executive olficers (see page 22), the information called for by this Item is incorporated in this Report by reference to the definitive Proxy Statement for the Company'3 1997 Annual Meeting of Shareholders, except for information not deemed to be "soliciting material" or "filed' with t.he Connission, -25- 28 information subject lu Regulations 14A or 14C under Lite Securities Exchange Act of 1934 ("Exchange Acl") or inlomaliou subject to ihe liabilities uX Sectiun 18 of the Exchange Act. ITEM li EXECUTIVE CCMPENSATION. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. ITEM 13. CERTAIN RELATIONSHIPS AM) RELATED TRANSACTIONS. The information called lor by Items 11. 12 and 13 ii incorporated in this Report by reference to the definitive Proxy Statement for the Conpany's 1997 Annual Meeting of Shareholders, except lor information not deemed to be `soliciting material" or "filed* with the Comission, information subject to Regulations 14A or I4C under the Exchange Act. or information subject, to the liabilities nf Section 18 of the Exchange Act. PART TV ITEM 14. EXHIBITS. FINANCIAL STATEMENT SCHEDULES. AM) REPORTS ON FORM K-K. FINANCIAL STATEMENTS AM) SCHEDULES. See the Index to Consolidated Financial Statements and Financial Statement Schedule and Exhibits on page F-1 of the Financial Supplement REPORTS ON FORM 8-Jt. The Coaipany filed the following Reports on Form 8-K during the fourth quarter of 1996 and the beginning of 1997: Date of Filing October 10, 1996 November 8, 1996 Disclosure(s) Distribution of all of the shares of the Coaipany1 s outstanding common stock to the holders of the common stock of Grace New York, on a one-for-one basis. Announcement of 1996 third quarter results. -26- 29 November 21. 1990 November 22. 1996 January 8. 1997 February 14. 1997 March 4. 1997 March 12. 1997 AimouncemeiH ul the election of Larry Ellberger as clueX Xiuaucial oXXicer. Announcement that Grace had entered into a definitive agreement to sell its Asiicon separations science business to Millipore Corporation- Announcement that Grace had entered into a definitive agreement to sell its worldwide cocoa business to Archer-Damels-Midland Cos^any; announcement of the completion of the sale of Grace's Amicon separations science business to Millipore Corporation; and announcement of the release of V. R. Grace k Co.-Conn., the Company's principal operating subsidiary, from guarantees of certain borrowings by National Medical Care. Inc., a former subsidiary. Announcement of 1996 fourth quarter and full year results. Announcement, of the completion of the sale of Grace's worldwide cocoa business to Archer>Daniels*Midland Company; announcement that Grace had entered into a definitive agreement, to sell its specialty polymers business to National Starch and Chemical Company; and announcement that Grace had agreed in principle to acquire Sehurpack, Inc Announcement or the release ol additional components ot Grace's 1996 financial statements, including a consolidated balance sheet and a consolidated statement of cash flows EXHIBITS The exhibit* to thil Report ire listed below. Other than exhibits that are filed herewith, all exhibits listed below are incorporated herein by reference. Exhibits indicated by an asterisk (*) are the management contracts and compensatory plans, contracts or arrangements required to be filed as exhibits to this Report. Exhibit Amended and Restated Certificate of Incorporation of V. R. Grace k Co Where Located Bxhibit 4.1 to Form 8-K (filed 10/10/96) 27* 30 Amended end Returned By-lawn oI V. R. Grace ft Cj- Rights Ag re client by and between . R. Grace ft Co. and The Chaae Manhattan Bank, as Rights Agent Indenture dated ae oi September 29. 1992 among W. R. Grace ft Co.-Conn.. V R. Grace ft Co. and Bankers Trust Company Supplemental Indenture dated as of September 24. 1996, among V. R. Grace ft Co.-Conn.. V. R. Grace ft Co.. Grace Holding, Inc., and Bankers Trust Company, to Indenture dated as of September 29. 1992 Indenture dated as of January 28. 1993 among W. R Grace ft Co-Conn , V R. Grace ft Co and The Banlr of New York (aucceasor to NationsBank of Georgia', N.A.) Supplemental Indenture dated as of September 24, 1996, among W. R. Grace A Co.-Conn . W R. Grace ft Cn., Grace Holding, Inc., and The Bank of New York, to Indenture dated aa of January 28. 1993 364-Day Credit Agreement, dated aa of May 17, 1996. among V. R. Grace ft Co.-Conn , V. k. Grace ft Co. , Grace Holding, Inc., the several banks parties thereto, NationsBank. N.A. (South), as documentation agent, and Chemical Bank, as administrative agent, for such banks Amended and Restated Credit Agreement, dated as of May 17, 1996, among V. R. Grace ft Co.-Conn., W. R. Grace ft Co.. Grace Holding, Inc., the several banks parties thereto and Chemical Bank, as administrative agent for such banks V. R. Grace ft Co. 1996 Stock Incentive Plan W. R. Grace ft Co. 1996 Stock Retainer Plan for Nonemployee Directors Exhibit 4.2 to Fora 8-K (filed 10/10/96) Exhibit 4.3 to Form 8-K (filed 10/10/96) Exhibit 4.2 to Form 10-K (filed 3/26/93) Exhibit 4.4 to Form 8-K (filed 10/10/96) Exhibit 4.4 to Fore 10-K (filed 3/26/93) Exhibit 4.5 to Form 8-K (filed 10/ 10/96) Exhibit 4.4 to Registration Statement on Form S-l tilled B/2/96) Exhibit 4.S to Registration Statement on Form S-l (filed 8/2/96) Piled herewith* Bxhibit 10.2 to Form 8-K (filed 10/10/96)* -28- 31 ' W. R. Grace A Co. Supplemental Executive Retirement Plan. aa amended W. R. Grace A Co. Executive Salary Protection Plan, as amended K R. Grace A Co. 1981 Stock Incentive Plan, as amended V R. Grace A Co. 1986 Stock Incentive Plan. as amended W. R. Grace A Co. 1989 Stock Incentive Plan, as amended V R. Grace A Co. 1994 Stock Incentive Plan, as amended Forms of Stock Option Agreements Information concerning W. R Grace ft. Co. Incentive Compensation Program, Deferred Compensation Prograa and Long-Term Incentive Program Porm of Long-Term Incentive Program Award Form of Stock Option Agreement V. R. Grace ft Co. Retirement Plan for Outside Directors, as amended Employment Agreement dated as of April 1, 11 between V. R. Grace A Co.-Conn, and Constantine L. Hampers, aa amended Letter Agreement dated as of March 29, 1996 between V. R. Grace A Co. and Constantine L. Hampers Letter Agreement deted June 14, 1996 between V. R. Grace A Co. and Constantine L. Hampers -29- Filed herewiih* Filed herewith* Bxhibit 10.3 to Form 8-K (filed 10/10/96)* Exhibit 10.4 to Form 8-K (filed 10/10/96)* Exhibit 10.5 to Fora 8-K (filed 10/10/96)* Exhibit 10.6 to Fora 8-K (filed 10/10/96)* RxhlMt. 10(h) to Form 10-K (filed 3/28/92)* Page* 7-12 and 28*33 of Proxy Statement (filed 4/10/96)* Exhibit 10.13 to Registration Statement on Pora S-i (filed 8/2/96)* Exhibit 10.14 to Registration Statement on Fora S-l (filed 8/2/96)* Filed herewith* Exhibit 10(x) to Form 10-K (filed 3/28/92)* Bxhibit 10.1 to Form 10-Q (filed 5/15/96)* Exhibit 10.35 to Registration Statement on Form S-l (filed 8/2/96)* 32 Furu of Executive Severance Agreement between V. R. Greet A Co. and officer* elected prior to May 1996 Form of Executive Severance Agreement between V. R. Grace A Co. and officer* elected in or after May 1996 Consulting Agreement dated June 1. 1992 between V. R. Grace A Co. and Kamaky Associates, Inc. Incentive Compensation Agreement dated June 1, 1992 between National Medical Care, Inc. and Kamaky Associates. Inc. Consulting Agreement dated as of December 1993 between National Medical Care, Tnc. and Virginia A. Kamslry Amendment to Consulting Agreement, dated aa of May l, 199$, among National Medical Care, Inc.. Virginia A. Kamaky and Southeast Asia Markets, Inc. Eaploynent Agreement dated as of May 1, 1995 between V K. Grace A Co. and Albert J. Costello Amendment dated August 9, 1996 to Employment Agreement, dated as of May 1. 1995, between W. R. Grace A Co. and Albert Costello Option Agreement between W. R. Grace A Co. and Albert J. Costello, dated May 1, 1995, as amended Option Agreement between V. R. Grace A Co. and Albert J. Costello, dated March 6, 1996 Agreement dated September 23, 1996 between W. R. Grace A Co. and Donald H. Kohnken Employment Agreement dated May 15, 1995 between V. R. Grace A Co. and Larry Bllberger -30- Exhibit 10.22 Lo Registration Statement on Form S-l (filed 8/2/96)* Exhibit 10.23 to Registration Statement on Porn S*1 (filed 8/2/96)* Exhibit 10.29 to Form 10-K (filed 3/26/93)* Exhibit 10.30 to Form 10-K (filed 3/26/93)* Exhibit. 10.23 to Form 10-K (filed 3/31/95)* ' Exhibit 10.1 to Form 10-Q (filed 5/12/95)* Exhibit 10.1 to Form 10-Q (tiled 8/14/95)* Exhibit 10.7 to Form 8-K. (filed 10/10/96)* Exhibit 10.8 to Form 8-K (filed 10/10/96)* Exhibit 10.37 to Registration Statement on Form S-l (filed 8/2/96)* Exhibit 10.9 to Form 8-K (filed 10/10/96)* Filed herewith* 33 Restricted Slock, Award Agreement da led June 6, 1995 between V. R. Grace A Co. aud Larry Gllberger, as amended by letter agreement dated August 26. 1996 between Larry Bllberger and V. R. Grace A Co. Letter Agreement dated December 10. 1996 between W. R. Grace A Co. and Larry Bllberger Bridge Loan Promissory Note dated July 31. 1992 of Fred and Jacqueline Lempereur, payable to W. R. Grace & Co.-Conn. Employee Relocation Loan Agreement dated July 31'. 1992 between V. R. Grace A Co.-Conn, and Fred and Jacqueline Lempereur Employment Agreement dated August 17. 1992 between Grace Specialty Chemicals Co and Fred Lempereur Letter Agreement dated January 10, 1997 between W. R. Grace A Co. and Fred Lempereur Distribution Agreement by and among W. R. Grace k Co. . a New York corporation subsequently rensmed Preeenius National Medical Care Holdings, inc., A, R. Grace k Co.-Conn., and Pretenius AG dated February 4, 1996 Form of Inderaiification Agreement between W. R. Grace k Co. and certain directors Form of Indemnification Agreement between W. R. Grace k Co. and certain officers and directors Weighted Average Number of Shares and Earnings Lied in Per Share Computations Computation of Ratio of Earnings to Pixed Charges and Combined Fixed Charges and Preferred Stock Dividends Selected Portions of the 1996 Annual Report to Shareholders of V. R. Grace k Co. -31- Filed herewith* Filed herewith* Piled herewith* Filed herewith* Fi led herewi r.h* Pi led herewith* Exhibit 2 to Form 8-K. (tiled 2/6/96) Exhibit 10.39 to Registration Statement on Form S-L (filed 8/2/96)* Filed herewith* Filed herewith (in Financial Supplement to Form 10-K) Piled herewith (in Financial Supplement to Form 10-K) Filed herewith (in Financial Supplement to Form 10-K) 34 List o Subsidiaries ul W. R. Otacc ft CoConsent oi Independent Accountants Power* of Attorney 32* Piled herewith Filed herewith (in'Finaneial Supplement to Pont 10*11) Filed herewith 35 SiUNAlUKliS PursuauL tu the requirements of Section 13 or 15(d) ul the Securities Exchange Act of 1934, the registiant has duly cansed this Report to be signed on its behalf by the undersigned, thereunto duly authorized. W. R. GRACE & 00. By /1/ L. Ellberger Date: March 28, 1997 L. Ellberger (Senior Vice President and Chief Financial Officer) Pursuant to the requirements of the Securities Exchange Art of 1934, this Report ha a been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 28, 1997. Signature Title J. F. Akers* E. Brown* C. Cheng* E. A. Ecknann* M. A. Fox* J. W. Frick* ! if L. Ellberger (L. Ellberger) / if K. A. Browne (K. A. Browne) A. J. Costello* T. A. Holaes* V. A. Kansky* J. f. Mnrphy* ;. E. Phipps* T. A. Vandersl ice* President and Director (Principal Executive Officer) } } > Directors > > Senior Vice President (Principal Financial Officer) Vice President and Controller (Principal Accounting Officer) By signing his name hereto, Robert B. Lara is signing this doennent on behalf of each of the persona indieated above pursuant to powers of attorney duly executed by such persons snd filed with the Securities and Exchange Cmmission. By / s/ Robert B. Lama -33- Robert B. Lara (Attorney-in-Fact) FINANCIAL SUPPLEMENT W. R. GRACE & CO. ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996 37 FINANCIAL SUPPLEMENT to Annual Report on Fora 10-K. for the Year Ended December 31, 1996 W. R. GRACE * CO. AND SUBSIDIARIES Index to Consolidated Financial Statements and Financial Statement Schedule and Exhibits Page Report of Independent Certified Public Accountants on Financial Statement Schedule ...................................................................... .............................. Conaent of Independent Certified Public Accountant* ................................................................. Report of Independent Certified Public Accountanta ................................................................. Conaolldated Statement of Operation* for the three year* in the period ended December 31. 1996 ............................................................................................................. Consolidated Statement of Cash Flows for the three years m the period ended December 31. 1996 ............................................................................................................. Consolidated Balance Sheet at December 31. 1996 and 1993 . ....................................... Consolidated Statement of Shareholders' Equity tor the three years in the period ended December 31. 1996 ........................................................................... Notes to Consolidated Financial Statements .................................................................................... Quarterly Summary and Statistical Information Unaudited .......................................... Capital Expenditures. Net Fixed Assets and Depreciation and Lease Amortization ......................................................................................................................................... Financial Suanary................................................................................................................................................ Management's Discussion and Analysis of Results of Operations and Financial Condition .............................................................................................................................. Financial Statement Schedule Schedule II Valuation and Qualifying Account and Reserves ......................... Exhibit 11: Weighted Average Number of Shares and Earnings Used in Per Share Computations ................................................................................................................ Exhibit 12: Computation of Ratio of Earnings to Fixed Charges and Combined Fixed Charges and Preferred Stock Dividends ............................................ P-2 P-2 P-3 P-4 F-5 h-6 P-7 F-B-F-24 h-25 F-25 F-26 F-27 F-33 F-34 F-35 The financial data listed above appearing in this Financial Supplement are incorporated by reference herein. The Financial Statement Schedule should be read in conjunction with the Consolidated Financial Statements and Notes thereto. Financial statements of SOW- or lees-owned persons and other persons accounted for by the equity method have been omitted as provided in Rule 3-09 of Securities and Exchange Coimission Regulation S-X Financial Statement Schedules not included hove been omitted because they are not applicable or the required information is ehown in the Consolidated Financial Statements or Notes thereto. P-1 38 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE To the Shareholders sad Board of Directors of W. R. Grace & Co. Oar audits of the consolidated financial s tatclients referred to in onr report dated February 3, 1997 appearing on page 27 of the 1996 Annual Report to Shareholders of W. R. Grace 4 On. (which report, and consolidated financial statements are included in this Annual Report on Form 10-K) also incladed an audit of the Financial Statement Schedule listed on page F-l in the Index to Consolidated Financial Statements and Financial Stateamnt Schedule and Exhibits of this Form 10-K. In onr opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. / / PRICE WATERHOUSE LLP PRICE WATERHOUSE LLP Ft. Lauderdale, Florida February 3, 1997 CONSENT O7 INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We hereby consent to the incorporation by reference in the Prospectuses constituting parts of the Registration Statements on Form S-8 (Nos. 333-13637, 333-13639, 333-13641, 333-13643, 333-14101, 333-13645, 333-13647 and 333-16401) of W. R. Grace & Co. oi our report dated February 3, 1997 appearing ou page 27 of the 1996 Annual Report to Shareholders, which report is incladed at page F-3 of thia Annual Report on Form 10-K. We also consent to the incorporation by reference of onr report on the Financial Statement Schedule, which appears above. / s/ PRICE WATERHOUSE LLP PRICE WATERHOUSE LLP Ft.. Tnnderdale, Florida March 28, 1997 F-2 39 MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING Management is responsible for the preparation, as well as the integrity and objectivity, of the Consolidated Financial Statements and other financial information included in this report. Snch financial information has been prepared in conformity with generally accepted accounting principles and accordingly includes certain amounts that represent management's best estimates and judgments. Management, maintains internal control systems to assist it. in fnlfilling its responsibility for financial reporting, including selection of personnel; segregation of duties; business, accounting and leporting policies and procedures; tnd an internal audit function. While no system can ensnre elimination of all errors and irregularities, Grace's systems, which are reviewed and modified in response to changing conditions, haye been designed to provide reasonable assurance that assets are safeguarded, policies and procedures are followed and Lrausacliuns are properly executed and reported. The concept of reasonable assurance is bated on the recognition that there are limitations in all systems and that the cost of snch systems should not exceed their benefits. The Andit Committee of the Board of Directors, which is comprised of directors who are neither officers nor employees of nor consultants to Graoe, meets regularly with Grace's senior financial personnel, internal auditors and independent certified pnblic accountants to review audit plans and results, as well as the actions taken by management in discharging its responsibilities for acconnting, financial reporting and internal control systems. The Andit Committee reports its findings and recommends t.he selection of independent certified pnblic acconntants to the Doard of Directors. Grace's management, internal auditors and independent certified pnblic acconntants have direct and confidential access to the Andit Committee at all times. The independent certified public accountants are engaged to condnct the audits of and render a report on the consolidated financial statements in accordance with generally accepted auditing standards. These standards require a review of the systems of internal controls and tesLs ol Lrausaci.iou& to the extent considered necessary by the independent certified pnblic accountants for purposes of supporting their opinion as set forth in their leport. Albert J. Costello Chairman, President, and Chief Executive Officer Larry Ellberger Senior Vice President, an Qiicf Financial Officer REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS PRICE WATERHOUSE LLP One East Broward Boulevard Ft. Lauderdale, FL 33301 February 3, 1997 TO THE SHAREHOIDERS AND BOARD OF DIRECTORS OF W. R. GRACE A 00. In oar opinion, the consolidated financial statements appearing on pages F-4 through F-24 of this report present fairly, in all naterial respects, the financial position of W. R. Grace b Co. and subsidiaries at December 31, 1996 and 1995, and the resnlts of their operations and their cash floes for each of the three years m the period ended December 31, 1996, in contornity with generally accepted acconniing principles. These financial statenents are the lespousibilily of management; oui responsibility is to express an upiuiuu on these financial statements based on oar audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance abont whether the financial statements are free of naterial nisstatement, .in audit include3 examining, on a test basis, evidenoe supporting the amounts and disclosures in the financial statenents, assessing the accounting principles used and significant estimates made by management, and cvalnating the overall financial statement presentation. Wc believe that car audits provide a reasonable basis for the opinion expressed above. Price Waterhouse LLP F-3 40 CONSOLIDATED FINANCIAL STATEMENTS V R. Grace A Co. and Subsidiaries CONSOLIDATED STATEMENT OF OPERATIONS Dollar! in millions. except per ahsre amounts Sales and revenues Other income .... TOTAL ................ Cost of goods sold stirl operating expenses...................................................................... Selling, general and administrative expenses ............................................................... Depreciation and amortization ................................................................................................. Interest expense and related financing coats ............................................................... Research and development expenses ........................................................................................ Restructuring coats and asset impairments ...................................................................... Provision relating to asbestos-related liabilities and insurance coverage Gain on sales ot businesses .................................................................................................... TOTAL................................................................................................................................................ Income/(loss) from continuing operations before income taxes Provision for/(benefit from) income taxes ....................................... INCOME/ (LOSS) FROM CONTINUING OPERATIONS Income/(loss) from discontinued operations . NET IN0CfcB/(LMS) ................................................. Earnings/(loss) per share: Continuing operations Net earnings/(lose) .. 1996 1995 1994 $3,454.1 $3,552.6 $3,128.5 38.9 41.2 42.0 3.493.0 3.593.8 3.170.5 2,071.0 713 3 184.4 71.6 93.9 107.5 229.1 (326 4) 2,151.2 913.7 186.1 71.3 111.6 169 0 275.0 3.144 4 3,877.9 1.832 6 785 9 164 6 49.5 99.6 316.0 3.248.2 348.6 134.8 (2*4.1) (104.5) (77.7) (42.6) 213.8 2,643.9 (179.6) (146.3) (35.1) 118.4 $2,857.7 $ (325.9) $ 83.3 S 2.32 $ (1.87) $ ( 38) $ 31.06 $ (3.40) $ 88 The Notes to Consolidated Financial Statements, pages F-8 to P-24, are integral parts of these statements. F-4 41 CCNSOLIDATED STATEMENT OF CASH FLOWS Dollars in Billions 1996 1995 1994 OPERATING ACTIVITIES Incone/(loss) iron continuing operations before income taxes ............................................ Reconciliation to cash provided by operating activities: Depreciation and amortisation .......................................................................................................... Provision relating to asbestos-related liabilities and insurance coverage ... Provision relating to restructuring costs and asset impairments ............................ Gain on sales of businesses ............................................................................................................... Changes in assets and liabilities, excluding effect of businesses acquired/divested and foreign currency exchange: Increase in notes and accounts receivable, net .......................................................... Decrease/uncrease) in inventories ...................................................................................... Proceeds fro* asbestos*related insurance settlement* ............................................ Payments made for asbestos-related litigation settlements, judgments and defense costs ............................................................................................... .................................... (Decrease)/increase in accounts payable .......................................................................... Other ......................................................................................................................................................... & 348 6 $ (284.1) $ (77.7) 184 4 229 1 107 5 (326 4) 136.1 275.0 169.0 164.6 316.0 (126 4) 51.9 184 8 (186 6) (36 4) (74 6) (44.7) (62.1) 2.87.1 (160.3) (48.3) (40 6) (159.5) (43.4) 138 6 (198.6) 10 3 74.5 NET PRETAX CASH PROVIDED BY OPERATING ACTIVITIES OF COVTINUING OPERATIONS Net pretax cash provided by operating activities or discontinued operations .. 355.6 38 5 247 3 96.6 224.8 3L4.7 NET PKE'iAX CASH PROVIDED BY OPERATING ACTIVITIES income taxes paid ................................................................... 394 1 (170 8) 343 9 (236.9) 539 5 (86.0) NET CASH PROVIDED BY OPERATING ACTIVITIES 223 3 107.0 453.5 INVESTING ACTIVITIES (1) Capital expenditures .............................................................................................................................................. Businesses acquired in purchase transactions, net of cash acquired and debt assumed Net investing activities of discontinued operations ...................................................................... Net proceeds from divestments ......................................................................................................................... Proceeds frost disposals of assets ................................................................................................................ Other ................................................................................................................................................................................ (456.6) (32.1) (192.9) 2,720.3 36.6 (2-4) (537.6) (37.4) (295.2) 56.7 17.9 (6.0) (444.6) (276.9) (32.9) 583.9 34.0 34.9 NET CASH PROVIDED BY/ (USH) FOR) INVESTING ACTIVITIES .......................................................... 2,072.9 (SOL.6) (101.6) FINANCING ACTIVITIES (1) Dividends paid ................................................................................................................................................ Repayments of borrowings having original maturities in excess of three months Increase in borrowings having original maturities in excess of tbree months .. Net (repayments of)/increase in borrowings having original maturities of three months or lets ......................................................................................................................... Stock options exercised ........................................................................................................................... Net financing activities of discontinued operations .......................................................... Purchase of treasury stock .................................................................................................................... Repurchase of limited partnership interest ............................................................................... Other ..................................................................................................................................................................... NET CASH (USED FOR)/PROVIDED BY FINANCING ACTIVITIES Effect of exchange rate changes on cssh and cash equivalents Increase/(decrease) in cash and cash equivalent! ....................... CASH AM) CASH EQUIVALENTS, BEGINNING OF YEAR..................... (46.0) (196 1) 6 (344 3) 70.7 (136.7) (1.319 3) (297 0) .3 (2,267.8) (7) 27.7 40.6 (112.6) (68.1) 148.5 414.9 164.1 120.8 (12.1) .2 655.7 1.2 (37.7) 78.3 (132.0) (14L.2) 535.1 (605.8) 21.1 (.2) (322.8) 1.6 30.7 47.6 CASH AM) CASH EQUIVALENTS. END OF YEAR $ 68.3 S 40.6 S 78.3 The Notes to Consolidated Financial Statements, pages F-8 to F-24, are integral parts of these statements. (1) See Notes 1 and 6 for snpplenental information relating to noncash investing and financing activities. F-5 42 CONSOLIDATED BALANCE SHEET Dollars m Billions, except par value December 31. ASSETS CURRENT ASSETS Cash and cash equivalents ............................................................................................................................. Notes and accounts receivable, net....................................................................................................... Inventories .............................................................................................................................................................. Net assets of discontinued operations ................................................................................................. Deferred income taxes ....................................................................................................................................... Other current assets ......................................................................................................................................... TOTAL n.TlRRNT ASSETS ............................................................................................................................. Properties and equipment., net .................................................................................................................... Goodwill, less accumulated amortization of SIR. 6 (1993 S20 6) ..................................... Net. assets of discontinued operations health care ............................................................... Asbestos-related insurance receivable .............................................................................................. Deferred income taxes...................................................................................................................................... Other assets........................................................................................................................................................... TOTAL ASSETS .............................................................................................................................................. LIABILITIES AN) SHAREHOLDERS 1 EQUITY CURRENT LIABILITIES Short-term debt ..................................................................................................................................................... Accounts payable .......................................................................................................................... Income taxes ............................................................................................................................................................ Other current liabilities .............................................................................................................................. Minority interest ................................................................................................................................................ TOTAL CURRENT LIABILITIES .................................................................................................................... Long-term debt ....................................................................................................................................................... Other liabilities .......................................................................................................................... Deferred income taxes ....................................................................................................................................... Noncurrent liability for asbestos-related litigation ............................................................... TOTAL LIABILITIES ....................................................................................................................................... COMMITMENTS AN) CONTINGENCIES (Notes 2. 6, 9 and 11) SHAREHOLDERS' EQUITY Preferred stock, par value $.01 and $100, respectively .......................................................... Comon stock, per value $.01 end $1, respectively; 300,000,000 shares authorized: outstanding at December 31: 1996 78,493,000; 1995 - 97,375,000 ....................... Paid in capital ...................................................................................................... .............................................. Retained earnings ................................................................................................................................................ Cumulative translation adjustments ........................................................................................................ Treasury stock, at cost; December 31: 1996 - 10,000; 1995 * 53,000 comon shares TOTAL SHAREHOLDERS' EQUITY .................................................................................................................. TOTAL LIABILITIES AN) SHAREHCLDGRS' EQUITY....... ..................................................................... 1996 1995 S 68.3 631.4 376.1 297.4 183.9 17.8 1,774.9 1,871.3 40 6 .. 296.3 309 2 653.5 84,945.8 $ 40.6 596.8 491.9 323.7 206.1 22.2 1,681 3 1,736 I ill. 8 1.433 3 321.2 386 6 688.3 $6,360.6 S 315.2 274.7 123.3 773.9 -- 1.487.1 1,073.0 850.7 43.5 859.1 4,313.4 $ 638.3 339.2 103.3 836.4 297.0 2,214.2 1,295.5 852.0 44.8 722.3 5,128.8 .8 524.1 172.6 (64.6) (.5) 632.4 S4.945.8 7.4 97.4 459.8 709.0 (39.4) (2.4) 1,231.8 $6,360.6 The NoL.es lo Consolidated Financial Suieaents. pages F-8 to F-24, are integral parts of these stateaents. P-6 43 CONSOLIDATED STAT04ENT OF SHAREHOLDERS' EQUITY Dollars in millions PREFERRED STOCKS Balance, beginning of year Retirement of preferred stocks BALANCE. EM) OP YEAR .... CCAWON STOCK Balance, beginning of year ............................ Share* issued under stock incentive plant Retirement nf treasury stock; ......................... Change in par value of common stock .. .. BA1ANCR, END OF YEAR................................... PAID IN CAPITAL Balance beginning ol year ......................... Shares issued under stock incentive plans Retirement of treasury stock ......................... Change m par value ol common stock . .. Other ............................................................................. BALANCE. EM) OP YEAR................................... RETAINED EARNINGS Balance, beginning of year ................................................................... Net income/(loss) .......................................................................................... Dividends paid........................................................................ ......................... Dividend of comon equity interest in health care business Retirement of preferred stock ............................................................... Retirement of treasury stock .............................................. ................ BALANCE, EM) OF YEAR.......................................................................... CLMULATIVE TRANSLATION ADJUSTMENTS Balance, beginning of year .............. Translation adjustments ..................... BALANCE, EM) OF YEAR................... TREASURY STOCK Balance, beginning of year ............................ Purchase of common stock ................................... Shares issued under stock incentive plans Retirement of treasury stock .......................... BALANCE, EM) OP YEAR................................... TOTAL SHAREHOLDERS1 EQUITY 1996 1995 1994 S 74 S (7 4' 7.4 $ 7.4 7.4 7 4 97 4 14 (9 9) (88 1) * 94.1 33 97 4 93.3 .6 94 i 459 8 98 5 (122 3) 88 1 524 1 308.8 151.1 l-l) 459.8 287.8 20.5 .5 308.8 709.0 2,857.7 (46.0) (2,172.3) 7.4 (1.1832) 172.6 1,147.5 (325.9) (U2.6) 1.196.2 83.3 (132.0) 709.0 1,147.5 (39.4) (25 2) (64.6) (53.3) 13.9 (39.4) (67.3) 14.0 (53.3) (2 4) (1,319 3> 5.8 1,315.4 (.5! (12.1) 9.7 (2.4) $ 632.4 $ 1.231.8 $1,504.5 The Note* to ConaoliUaled Financial SUteaeuU, pages F-8 to F-24. are integral parts of these atateaienia. F- 7 44 NOi'ES 1U CONSOLIDATED FINANCIAL STATEMENTS Dollars in millions, except per share anonnts 1. BASIS OF PRESENTATION AND SUNMARY OF SIGNIFICANT ACCOUNTING AND FINANCIAL REPORTING POLICIES W. R. Grace & Co., through its subsidiaries, is primarily engaged in the packaging and specialty chemicals businesses on a worldwide basis. As nsed in these notes, the t.eri* "Cnnpany" refers t.o Grace New York (as defined helnw) through Septtubei 27, 1996, and thereafter to W. R. Grace & Co., a Delaware corporation. The term "Grace" refers to the Company an<Kor one or more ot its subsidiaries. REORGANIZATION On September 28, 1996, W. R. Grace & Co., a New York corporation subsequently renamed Freseniut National Medical Care Holdings. Iuc. (Grace New York), distributed all ol the Company's outstanding common stock (which has a par valne of 8.01 per share) to the holders of Grace New York common stock (which had a par value of $1.00 per share) on a one-for-one basis. As a result of the distribution, Grace New York's principal remaining asset was the outstanding capital stock of National Medical Care, Inc. (NMC). a health care company that was classified as a discontinued operation in the second quarter ol L995. On September 29, 1996, a wholly owned subsidiary of Fresenius Medical Care AG (FMD), a German corporation, merged with and into Grace New York, resulting in the combination of NM2 with the worldwide dialysis business ol Fresenins AG (Fresenins), a German health care corporation and the principal shareholder of FMT. The Grace New York preferred stock issued and outstanding at the time of the above distribution remained outstanding shares ot Grace New fork, and the treasury shares held by Grace New York at the time of the distribution were retained by Grace New York. Accordingly, the distribution was treated as a retirement of preferred stocks and a retirement of treasury stock within the Consolidated Statement of Shareholders' Equity for the yesr ended December 31, 1996. For further information, see the Grace New York Joint Proxy Statement-Prospectus dated August 2, 1996 (Joint Proxy Statement-Prospectus), the Company's Prospectus dated Angnst 2, 1996 (Prospectus), and Notes 6 and 13. PRINCIPLES OF CONSOLIDATION The consolidated financial statements inclnde the accounts of Grace and majority-owned companies. Intercompany transactions and balances arc eliminated in consolidation. Investments in affiliated companies (20v50% owned) are accounted for under the equity method. RECLASSIFICATIONS Certain amounts in prior years' consolidated financial statements and related notes have been reclassified to contorn tc the current year's presentation and as required with respect to discontinued operations. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires that management mike estimates and assumptions affecting the reported amounts of assets and liabilities (including contingent assets tnd liabilities) at the date of the consolidated financial statements and the reported revenuea and expenses during the reporting period. Actual anonnts could differ from those estimates. CASH EQUIVALENTS Cash equivalents consist of highly liqnid instruments with natnrities of three months or less when purchased. The recorded anonnts approximate fair valne bcoausc of the short maturities of these investments. INVENTORIES Inventories ire stated at the lower of cost or market. The nethods used to determine cost include first -iaJ fir st-ont and, for substantially all U.S. chemical inventories, last-in/firsc-out. Market valnes lor rav materials are based on current cost and, lor other inventory classifications, net realizable valne. PROPERTIES AND EQUIPMENT Properties and equipment are stated at the lower of cost or fair valne. Depreciation of properties and equipment is generally computed nsing the straight-line method over the estimated useful life of the asset. Interest is capitalized in connection with major project expenditures and amortized, generally on a straight line basis, over the estimated useful life of the asset. Folly depreciated assets are retained in propenies and equipment and related accumulated depreciation acconnts until they are renoved from service. In the case of disposals, assets and related depreciation arc removed from the accounts and the net amonnt, less any proceeds from disposal, is charged or credited to income. GOODWILL Goodwill arises from certain pnrehase transactions and is amortized nsing the straight-line method over appropriate periods not exceeding 40 years. RESEARCH AfO DEVELOPMENT COSTS Research and development costs are charged to expense as iucuried. F-g 45 IMPAIRMENT In 1995, Grace adopted Statement ot Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets Lu Be Disposed Of." In accordance with this statement, Grace reviews long-lived assets and related goodwill for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset nay not be fully recoverable. INCOMs TAXES Grace uses an asset and liability approach for the accounting and financial reporting of income taxes. FOREIGN CURRENCY TRANSLATION Foreign currency transactions and financial statements (except for those relating to countries with highly inflationary economies) are translated into II. S. Hollars at. enrrent. exchange rates, except, that revenues, costs and expenses ire translated at average exchange rates during each reporting period. The financial statements of subsidiaries located in countries with highly inflationary economies are remeasured as if the functional currency was the U.S. dollar. The remeasurement creates translation adjustments that are reflected in net incone. FINANCIAL INSTRUMENTS Grace euLers into interest rale swap agreements and foreign exchange forward and option contracts to nanage exposure to fluctuations in interest and foreign currency exchange races. Grace does not bold or issue derivative financial instruments for trading purposes. The cash differentials paid or received nnder interest rate swap agreements sre scorned and recognized sa adjustments to interest expense. The related amounts payable to or receivable from the counterparties are included in other current liabilities or notes and accounts receivable, net. Cash flows related to interest rate swap agreements arc classified within operating activities in the Consolidated Statement of Cash Flows, consistent with the interest, payments on the underlying debt. The fair valnes of interest rate swap agreements are not recognized in the Consolidated Financial Statements, as these agreements modify the interest rate basis (i.e., whether fixed or floating rate) of debt instruments of similar face amounts and tenor. Gains or losses resulting from the settlement prior to maturity of interest rate swap agreements are either deferred (recorded as other liabilities or other assets) snd amortized to interest expense and related iiuauciug costs over a period relevant to Ute agieeueul (if Lbe underlying debt remains outstanding) or recognized immediately (if the underlying debt haa been repaid or retired). Grace enters into foreign currency forward and option contracts to hedge transactions and firm commitments denominated in foreign currencies and, from time to time, net investments iu foreign aubaidieries. Gains or losses on hedges of transactional exposures sre recorded as adjustments to gains or losses on the underlying transactions. Gains or losses on hedges of foreign currency-denominated firm commitments arc deferred and recorded as part of the basis in the transaction in the period in which the transaction is ennanimated. Gains and losses on forward contracts that hedge net investments in foreign snbsiditries are recorded in the cumulative translation adjustments acconnt m shareholders' equity. Cash flows related to foreign cnrrency forward and option contracts are classified within operating activities in the Consolidated Statement of Cash Flows. OTHER INCOME Other income consists of interest income, equity in earnings of affiliated companies, gains on sales of investments aud other ileus. EARNINGS PER SHAKE Earnings per share are computed on the basis of the weighted average number of common shares outstanding. ASBESTOS AND RELATED INSURANCE LITIGATION 46 Through December 31, 1990, 135 asbeslu* properly damage caues were dismissed without payment. of any damages or settlement anouuis; judgment* were entered in favor oi Grace iu nine cases (excluding cases settled following appeals oi judgment* iu favor uf Grace); judgment* were euLered m favor of the plaintiffs m seven cases for a total of $60.3 (none of which is on appeal); and 186 property damage cases were settled for a total of $450.5. Property danage case activity for 1996 and 1995 is as follows: Decenber 31, Cases outstanding, beginning of year . New cases filed ............................................ Settlements .......................................................... Dismissals ............................................................ Judgment*, net ................................................. Caaes outstanding, end of year ........... 1996 47 1 (9) (.1) (1) 31 PERSONAL INJLRY LITIGATION Personal injury claims are generally similar to eaeh other (differing primarily in the type of asbestos*related illness allegedly suffered by the plaintiff). However, Grace's eatimated liability tor such claims is influenced by numerous variables, including the solvency of other former asbestos producers, cross-claims by co*defendants, the rate at which new claims axe filed, the jurisdiction in which the filings are made, and the defense and disposition costs associated with these claims. Through December 31, 1996, approximately 11,800 asbestos personal injury lawsuits involving 27,400 claims were dismissed without payment of any damages or settlement amounts (primarily on the basis that Grace products were not involved), and approximately 30,500 lawsuits involving 66,200 claims were disposed of for s total of $186.0. Personal injury claim activity for 1996 and 1995 is as follows: Decenber 31, Claims outstanding, beginning of year New claims .......................................................... Claims under amended complaints (1) . Settlements ........................................................ Dismissals .......................................................... Judgments, net ................................................. Claims outstanding, end of year .... 1996 92,436 30,274 8,298 (36,630) (2,866) (1> 91.511 1995 65 5 (18) (4) (1) 47 1995 67,889 34,306 2,120 (9,585) (2.288) (6) 92,436 Grace is a defendant in property danage and personal injnry lawsuits relating to previously sold asbestos-containing products and anticipates that it will be named as a defendant in additional asbestos-related lawsuits in the future. Grace was a defendant in approximately 41,500 asbestos-related lawsniti at December 31, 1996 (31 involving claims lor prupeily damage and the remainder involving approximately 91,300 claims for personal injnry), as compared to approximately 40,800 lawsuits at December 31. 1995 (47 involving claims for property damage and the remainder involving approxinately 92,400 claims for personal injnry). PROPERTY DAMAGE LITIGATION The plaintiffs in property danage lawsuits generally seek to have the defendants absorb the coat of removing, containing or repairing the asbestos-containing materials in the affected buildings. Each property danage case is nniqoe in that. t.he age, type, size and nse of the hnilding, and t.he difficulty of asbestos abatement, if necessary, vary from structure to strnctnre. Thus, the amounts involved in prior dispositions of property damage cases are not necessarily indicative of the amounts that may be required to dispose of cases in the fntnre. Information regarding product identification, the amount of product m the building, the age, type, size and use of the building, the jurisdictional history of prior cases and the court in which the case is pending provide meaningful guidauce as Lu the rauge of potential costs. Some of this information is not yet available in the property damage cases currently pending against Grace. Accordingly, it is not possible to estimate with precision the costs of defending against and disposing of these cases. In accordance with SFAS No. S, Grace has recorded an accrnal for all existing property damage cases for which sufficient information is available to form a range of estimated exposnre. At December 31, 1996 and 1993, estimates were not accrued for one and four cases, respectively, due to insufficient information. Grace believes that the number of property damage cases to be filed in the fntnre and the costs associated with these filings are not estimable. (1) Of the 8,298 claims shown, eppronsu lely 1,500 were filed under amended complaints in 1990. The revaluing clams relate lu disputed Xiliugs that were aubmilled to local counsel iu prior year# but were uot reported to Grace until 1990, wtieu a majority oi such clams waa settled. ASBESTOS-RELATED LIABILITY Subject to the factors discussed above. Grace estivates that its probable liability is as follows with respect to the defense and disposition of asbestos property damage and personal injury cases and clams at December 31, 1996 and 1995: December 31, Current liability for asbestos-related litigation (3) Noncurrent, liability for asbestos-related litigation Total asbeatoa-relatert liability (4) .............................. 1996(1) S135 0 859 1 $994 1 (1) Reflects property danage and personal injury cases and clams pending at December 31, 1996, as veil as personal injury clams expected to be tiled through 2001 See discussion below. (2) Retlects property damage and personal injury eases and clams pending at Deceaber 31, 1995, as well as personal injury claims expected to be filed through 1998 See discussion below. (3) Included in 'other current liabilities* in the Consolidated Balance Sheet. (4) Excludes one property daatge case at Deceaber 31, 1996 as to which the liability is not yet estiaable because Grace has not yet been able to obtain sufficient information through discovery proceedings. Prior to 1995, Grace recorded noncash charges to reflect its estimate of the costs of defending against and disposing of the asbestos property damage and personal injury cases and claias then pending. In the fourth quarter of 1995, Grace determined that it had adequate experience to reasonably estimate the coats of defending against and disposing of aabeatos personal injury clams to be filed during the three-year period 1996-1998 end recorded a noncash charge of $260.0 ($169.0 after-tax), primarily to reflect auch anticipated filings. Based on certain developments during 1996, Grace determined m the 1996 fourth quarter that it had adequate experience to reasonably estimate the costs of defending against and disposing of asbestos personal injury claims to be filed during the five-year period 1997-2001 and recorded a noncash charge of $348.4 ($226.4 after-tax), primarily to reflect such anticipated filings. The 1996 provision also reflects increases in the estimated costs of defending against and disposing of personal injury claims pending at year-end 1996, and the 199$ provision also reflects increases in the estimated costs of defending against and disposing of certain property damage caeca pending at year-end 1995 and personal injury claims filed during 1995. However, as discussed above, these estimates arc P-10 1995(2) $100 0 722 3 $822 3 47 uoc necessarily indicative uX actual costa. Baaed un the Xactoia discussed above, Grace does not believe that it can reasonably estimate ilie munbtr and deXeiisc and disposition coits ui personal injury claims that, nay be brought against Grace alter 2001. The accruals recorded Xor Xu lure cases and claims are not discounted to their present values; Xurther. the actual cash payments related to future cases and claims are expected to continue beyond 2001. ASBESTOS-RELATED INSURANCE RECEIVABLE Grace previously purchased insurance policies with respect to its asbestos-related lawsuits and claims. The following tables display the activity in Grace's notes receivable and asbestos*related insurance receivable accounts during 1996 and 1993: 1996 199? NOTES RPORTVABIE Notea receivable from insurance carrier*, beginning of year, ner of discount of $11.6 in 1996 (1995 - $15.0) .. Proceed* from asbestos-related insurance settlement*.................................................................................... ................................... Current year a*besto*-related insurance settlements .................................................................................................................................... Current, year amortization, net.................................................................................................................................................................. .... S118 4 $ IS? 0 (9?.3) (127 0) 19 2 55 0 4.2 3 4 Notes receivable from insurance carriers at year-end, net of discount of S7.4 (1995 - $11.6) (1) ................ S 48 5 % lit 4 INSURANCE RECEIVABLE Asbestos-related insurance receivable, beginning oi year ...................................................................................................................... Proceeds from asbestos-related insurance settlements ................................................................................................................. Adjustments to asbestos-related insurance receivable (2) ......................................................................................................................... Transfers from asbestos-related insurance receivable to notes receivable from insurance carriers ................................. Other ............................................................................................................................................................................................................................................... S321.2 $ 512.6 (91.2)(1303) 119.3(15 0) (19.2) (55 0) 1.2 8.9 Asbestos-related insurance receivable, end of year (1) ...................................................................................................................... S331.3 $ 321.2 Total amounts due from insurance carriers..................................................................................................................................................... S379.8 $ 439.6 (1) See Note 7 for classification between current portion (classified in 'notes and accounts receivable, net*) and noncurrent portion (claaeified in 'other assets") in the Consolidated Balance Sheet. (2) Reflects noncash adjustments to receivable in conjunction with increases in esbestos-related Liability and lower than estimated proceeds from settlements with insurance carriers caused by reduced coverage available for certain years. See discussion below. Notes receivable from insurance carriers represent amounts due from insurance carriers in reimbursement for amounts previously paid by Grace in defending and disposing of asbestos cases and claims; payments under these notes will be received through 2001. These notes do not bear steted interest rates end, therefore, have been discounted using e weighted average interest rate of 6.7% (which Grace estimates as its borrowing rate for the terms of the notes). Installments due in 1997 are classified as 'current* in the Consolidated Balance Sheet. The asbestos-related insurance receivable at December 31, 1996 predominantly represents amounts expected to be received from carriers under settlement agreements in reimbursement for defense and disposition costs to be paid by Grace in the future in connection with property damage and personal injury cases and claims pending at year-end 1996 and personal injury claims expected to be filed through 2001 (through 1998 as of December 31, 1995). In the fourth quarter of 1996, Grace recorded a noncash pretax benefit of $119.3 ($77.5 after-tax), primarily representing the additional insurance proceeds Grace expects to receive in reimbursement lor the cash outflows associated with personal injury claims expected to be tiled against Grace through 2001. As a result of fourth quarter 1995 insurance settlements and a reassessment oi its insurance receivable, Grace recorded a noncash net pretax charge of $15.0 ($9.7 after-tax) daring the fourth quarter of 1995. This charge reflected a reduction in the receivable, primarily dne to lower than estimated proceeds Iron settlements with insurance carriers (caased by the reduced coverage available for certain years) and a discount on notes receivable received in connection with prior settlements, partially offset by an increase in expected future reimbursements of costs to defend against and dispose of property damage cases pending at year-end 1995 and personal injury claims to be filed through 1993. Certain of Grace's insurance carriers have become insolvent. From time to time, Grace has been successful in collecting funds from insolvent, carriers. Dowever, since recovery from these carriers is not probable, Grace has not accrued a related receivable. INSURANCE LITIGATION Grace has settled with and been paid by its primary insurance carriers with respect to both property damage and personal injury cates and claims. With one minor exception, Grace has also settled with its excess insurance carriers that wrote policies available for property damage cases; those settlements involve emonuts paid and to be paid to Grace. In addition, Grace has aettled with many excess insurance carriers that wrote policies available for personal injury claims. Grace is currently in litigation with certain remaining excess insurance carriers whose policies generally represent layers of coverage Grace has not yet reached and, therefore, are not reflected in the asbestos-related insurance receivable referred to above. Snch policies are believed by Grace to be available for asbestos - related personal injury lawsuits. Insurance coverage lor asbestos-related liabilities has not been commercially available since 1985. F-ll 48 In September 1993 the U.S. Court ol Appeals loi the Second Circuit ruled that, under New York law (which governs a significant portion of the policies that provide Grace's ashes lot-related insurance coverage), coverage lor asbestos property damage cases is triggered based on the date of installation of asbestos-containing materials. This decision was initially reversed in the lonrtb quarter of L993 but subsequently confirmed in the second qusrter of 1994. As a result of this decision (which had the effect of reducing the amount of insnrance coverage available to Grace with respect to asbestos lawsuits) Grace recorded a noncash pretax charge of $316.0 ($200.0 after-tax) in the second quarter of 1994. Grace's ultimate expoanre with respect to its asbcstos-rclatcd oases and claims will depend on the extent to which its insnrance will cover damages for which it. nay he held liahle, amounts paid in settlement and litigation costs In Grace's opinion, it is probable that recoveries from its insnrance carriers (including amounts reflected in the receivable discussed above), along with other funds, will be available to satisfy the property danage and personal injury cases and claims pending at December 31, 1996, as veil as personal injury claims expected to be filed in the foreseeable inture. Consequently, Grace believes that the resolution of its asbestos-related litigation will not have a uaieiial adverse eilecl on its consolidated iiuaucial position. 3. ACQUISITIONS AND DIVESTMENTS ACQUISITIONS During 1996, Grace acquired a manufacturer of flexible packaging, a producer of can coatings and closnre sealants for the rigid container indnst.ry, and kidney dialysis centers purchased by NM2 prior to disposition, for a total of $122.1 in cash. In 1995, Grace made acquisitions totaling $260.8, ail of which involved cash purchases of kidney dialysis centers and medical imaging facilities by NIC. Acquisitions in the first quarter of 1995, prior to the classification of NMC as a discontinued operation (see Note 6). totaled $41.1. Acquisitions by NM2 after the first quarter of L995 are presented as an investing activity and are included in net investing activities of discontinued operations in the Consolidated Statement of Cash Flows for 1996 and 1995. In 1994, Grace made acquisitions totaling $351.7, primarily in health care. These include the purchases of Hbae Nutritional Services, Inc. tor $131.8 in cash and kidney dialysia centers and other health care businesses for an aggregate of $145.3 in cash. 1994 acquisitions also included construction chemicals businesses and a European flexible packaging bnsiness. DIVESTMENTS During 1996, Grace completed divestments for gross proceeds totaling $5,394.0 (inclusive of debt assumed by buyers). In addition to the disposition of NMD (see Notes 1 and 6), Grace sold its water treatment and process chemicals bnsiness to Betz Laboratories, Inc. for cash proceeds of S636.4 (subject to adjustment), the final $100.0 of which was paid in January 1997, plus the assumption of certain liabilities. Sales and revenues of the water treatment and process chemicals business for the six months ended June 30, 1996 and for the years ended December 31, 1995 and 1994 were $201.2, $398.5 and $363.4, respectively; its financial position and results of operations were not significant for those periods. The divestment of this bnsiness and Grace's biopesticides business resulted in a pretax gain of $326.4, and an after-tax gain of $210.1 ($2.28 per common share), in continuing operations. In 1996 Grace also divested its worldwide separations acienoe business (Amicoo) and the transgenic plant business of its Agracetus subsidiary. These bnsinesses hart previously been classified as discontinued operations In 1995, Grace realized gross proceeds of $58.8 (inclusive of debt assumed by the buyers) from divestments, including payments received in connection with divestaents completed in prior years. The operations divested consisted of three snail units of Grace's construction products business, the composite naterials basiness, Grace's transportation services business and vartoas investments. In 1994, Grace realized gross proceeds of $646.2 (inclusive of debt assuiaed by Use buyers) Iron dives incuts, including payments received in connection with divestaents completed in prior years. Substantially all of the businesses divested daring 1994 had previously been classified as discontinued operations. Divestment proceeds in 1994 included $42.S received for Grace's remaining interest in The Restaurant Enterprises Gronp, Inc. (REG). See Note 6 for a discussion of divestment activity related to discontinued operations. 4. RESTRUCTURING COSTS AND ASSET IMPAIRMENTS RESTRUCTURING COSTS Grace recorded restrnctnring charges of $75.4 in 1996 and $129.8 in 1995 ($49.0 and $85.1 after-taz, respectively). Grace began implementing a worldwide program in 1995 to streamline processes and reduce general and administrative expenses, factory administration costs and noncore corporate research and development expenses. Under this program, Grace has implemented, and expects to farther implement, additional cost redactions and efficiency improvements, as it farther evaluates and reengineers its operations. In connection with these actions, Giaoe recorded pretax charges of $53.7 and $21.7 m the second and fourth quarters of 1996, respectively. These charges primarily relate to headcount reductions, the restrnctnring of Grace's European packaging operation* (in srcaa such as working capital management, manufacturing and sales) and the farther restrnctnring of Grace's corporate research activities, certain of which are now conducted at product, line facilities. F-12 49 The cumpoueuis ol ihe 1996 uul 1995 res irucuirmg charge*, speudiug and uUier activity during 1995 and 1996, and Lite renaming reserve balances at December 31, 199G. were aa follows: Employee Termination Plant/Office Benefits Closures Asset Write-downs Other Costs Restructuring provisions recorded in 1995 ......... Cash payments during 1995 ..................... Noncash activity ....................................... Restructuring reserve at December 31. 1995 .. Restructuring prnvisions recorded in 1996 Cash payments during 1996 ..................... Noncash activity ..................................... Restructuring reserve at December 31, 1996 .. S 74.3 (13.01 $ 61.3 69.3 (57.8) $ 72.8 $13.4 (3.5) $ 9.9 6. 1 (.) SIS.4 $ 18.6 -- '.4.3) S 14.3 -(14.3) $ S 23.5 (3.1) (1.5) S 18.9 (16.0) S 2.9 Total S129.8 (19.6) (5.8) $104.4 75 4 (74 4) (14 3) $ 91.1 Employee termination benefits primarily represent severance pay and other benefits (including benefits under long-term incentive programs paid over time) associated with the elimination of approximately 1,300 positions worldwide, with more than 60% of the eliminated positions coning from worldwide corporate staff functions and the restructuring of Grace's worldwide packaging operations. Through December 31, 1996, approximately 800 positions had been elisunated worldwide. ASSET IMPAIRMENTS During 1996 and 1995, Grace determined that, due to various events and changes in circumstances (including the worldwide restructuring programs described above), certain long-lived aeaete and related goodwill were impaired. Aa a result, in the fourth quarters of 1996 tnd 1995, Grace recorded noncash pretax charges of $32.1 and $39.2, respectively ($20.9 and $26.6 after-tax, respectively), the majority of which related to asiets that will continue to be held and used in Grace's packaging and specialty chemicals businesses. The components of the 1996 and 1995 charges were (a) goodwill and other intangibles of $11.1 and $4.7, respectively; (b) properties and equipment of $9.0 and $20.0, respectively; (c) long-term investment* of $6.7 and $8.6, respectively; and (d) other assets of $5.3 and $5-9, respectively. Grace determined the amounts of the charges based on various valuoiion techniques, including discounted cash flow, replacement cost end net realizable value for assets to be disposed of, as prescribed by SFAS No. 121. 5. INCOME TAXES Grace applies SPAS No. 109, 'Accounting for Income Taxes," which specifies on asset and liability approach requiring the recognition of deferred tax aaaeta and liabilities with respect to the expected future tax consequences of events that have been recorded in the Consolidated Financial Statements and tax returni. If it ii more likely than not that all of a portion of deferred tax assets will not be realized, s valuation allowance is provided against such deferred Lax assets- The components of income/ (loss) fro* continuing operations before income taxes and ihe related provision for/ (benefit fron) income taxes are at follows: CONTINUING OPERATIONS 1996 1995 L994 Income/(loss) from continuing operations before income taxes: Domestic ............................................................................................................. Foreign ............................................................................................................. $101.5 247.1 $348.6 $(401.1) 117.0 $(284.1) $(174 4) 96 7 $ (77 7! Provision for/ (benefit from) income tares: Federal - current ...................................................................................... Federal deferred ................................................................................. State and local - current ........................................................................ Foreign - current ........................................................................................ Foreign deferred ...................................................................................... $ 7.6 35.1 i .4 54.3 36.4 $134.8 === $ 37. R (154 3) 1.5 61.4 (50 9) $(104.5) $ (77 2) (7 2) 23 44 6 (5 1) $ (42 6) ~= F* 13 50 Tlic components of income/(loss) from consolidated operations before income taxes and the related provision for/(benefiL Irani income taxes are as follows: CONSOLIDATED OPERATIONS 1996 1995 1994 Income/ (loss) from consolidated operations before income taxes: Foreign ...................................................................................................................... $2,847.1 259.4 $3,106.5 Provision for/(benefit from) income taxes: Federal current ................................................................... Federal - deferred ................................................................. State and local current ................................................. Foreign current ................................................................... Foreign - deferred ................................................................. ....................... $ 75.6 57.0 18.9 60.9 36.4 $ 248.8 $(480.5) 72.7 $(407.8) $ 44 3 94.8 $139.1 $ 105.6 (226.3) 21.7 68.5 (Si.4) 9 (81.9) $ 25.3 (34.8) 21.8 49. I (5.6) $ 55 8 At December 31, 1996 and 1995, deferred tax aasets and liabilities consisted of the following items: NET DEFERRED TAX ASSETS 1996 1995 Provision relating to asbestos-related expenses, net .. Reserves not yet deductible for tax purposes ..................... Research and developaent expenses ............................................... Postretiremont benefits other than pensions ....................... State deferred taxes ............................................................................ Foreign net operating loss carryforwards .............................. Pension and insurance reserves ..................................................... Tax credit carryforwards ................................................................... Capitalized inventory costs and inventory reserves Other ............................................................................................................. $240.4 167.8 102.7 95.2 70.1 37.0 31.9 31.9 11.0 39.8 $219.4 223.6 115. 8 88.9 70.1 47.1 35.2 27.2 11.9 43.9 Total deferred tax assets ............................................................ 827.8 883.1 Depreciation and anortization ........................................................ Prepaid pcnaion cost ............................................................................. Other ................................................................................................................ 154.0 76.8 75.0 112.6 104.8 20.1 Total deferred tax liabilities ................................................. 305.8 237.5 Valuation allowance for deferred tax asseta 72.4 97.7 Net deferred tax assets S449.fi $547.9 The valuation allowance shown above arises Iron uncertainty as to the realization of certain deferred tax assets, pnnarily state and local net operating loss carryforwards and net deferred tax assets. Tax planning strategies during 1996 enabled Grace to reverse the valuation allowance on tax credit carryforwards during the year. Based upon anticipated future results. Grace has concluded that it is sore likely than not that the remaining balance of the net deferred tax assets, after consideration of the valuation allowance, will be realized. At December 31, 199fi. there were $31.9 of tax credit carryforwards with expiration dates through 2001. Additionally, there were foreign net operating loss carryforwards with a tax benefit of $37.0 having various expiration dates. The U.S. federal corporate tax rate reconciles to the effective tax rate for continuing operations as follows 1996 1995 1994 L.S. federal corporate tax rate ...................................................................................................... Increase/(decrease) in tax rate resulting Iron Nontaxable income/nondeductible expenses ............................................................................. Basis difference on sale of investment .................................................................................... U.S. state and local income taxes, net of L'.S. federal income tax benefit .. U.S. and foreign taxea on foreign operations ...................................................................... General buiiness credits .................................................................................................................... Valuation allowance for deferred tax assets ........................................................................ Other, net ........................................................................................................... ................................... Effective tax rate 35.0% (1.6) .4 4.8 .1 38.7% (35 0>* (35.0)1 (7) 2 98 (5) (14 4) 38 (1.4) (10.5) 1.5 .3 (9.1) (6) (36.4)% (54.8)% 51 U.S. state and local and foreign taxes have not been provided on approximately $230.4 uX undistributed earnings oi certain foreign subsidiaries, as such earnings axe expected to be retained indefinitely by such subsidiaries for reinvestment. The distribution of these earnings would result in additional foreign withholding taxes of approximately $22.5 and additional U.S. federal income taxes to the extent they are not offset by foreign tax credits. It is not practicable to estimate the total tax liability that would be incurred npon such a distribution. 6. mSCONTTNIW) OPERATIONS HEALTH CASE NIC As discussed in Note 1, Grace New York completed the distribution of the Company's common stuck, and Lhe combination of NMC wiLli the worldwide dialysis business of Fresenius in September 1996. Prior to the completion of these transactions, Grace received a tax-free distribution fiota MiC of approximately $2,300 (consisting of cash and the assumption of debt). As part of these transactions, fox each Grace New York common share outstanding at the close of trading on September 2?, 1996, Graoe New York shareholders received one share of a new class ol Grace New York preferred stock and 1.04909 American Depositary Shares (ADS), each representing one-third of an ordinary share of FM2 (which ADSs collectively represent approximately 44.84 of FU2'a common equity}. The distribution of approximately $2,300, along with t.he 44.84 common equity interest in FM2, valued at approximately $2,200 (based upon the number cl ADSs and their initial price per share on September 30, 1996), resulted in a transaction valned at approximately $4,500. That amount, less Grace New York's investment in NhC and transaction costs, resulted in a tax-free gam to Grace of approximately $2,500, in discontinued operations. The 44.84 common equity interest in FhC is reflected as a dividend of approximately $2,200 williiu the Consolidated Statement ol Shareholders' EquiLy. In connection with these transactions, NMC borrowed approximately $2,500 under a stand-alone credit agreement, primarily to fund the distribution to Grace. Grace guaranteed S950.0 of this borrowing, bat the guarantee was released as to $800.0 in November 1996 and the balance in December 1996. Under the terms of the trenaaoiions, MdC will remain responsible ior all liabilities, if any, resulting from the previously reported investigation by the Office of the Inspector General (DIG) of the U.S. Department of Health and Human Services and certain related natters. In Jnly 1996, an agreement was entered into with the U.S. government under which, subject to certain conditions and limitations, (a) FMT! and Grace New York guaranteed the payment, of the obligations, if any, of NMC to the U.S. government in respect of the DIG investigation and another proceeding; (b) Grace guaranteed the obligations of FMC under the foregoing guarantee with respect to acts and transactions that took place prior to the consummation of the transaction (but only if such obligations become due and payable and remain uncollected for 120 days); and (c) NMC delivered a standby Letter of credit in the principal amount of $150.0 iu Xavor oX Lhe U.S. government to support its payment uX such obligations. See Notes 7 and 20 to the consolidated financial statements included in the Prospectus, and "Basinets of Freseniut Medical Care -- Regulatory and Legal Matters -- Legal and Regulatory Proceedings -- OIG Investigation" and "-- OIG Agreements" in the Joint Proxy Statement-Prospectus, lor additional information. Ami con On Dcocmbcr 31, 1996, Grace completed the sale of Amicon, resulting in a pretax gain of $70.4 and an altei-tax gain of $40.0 ($0.44 per common share of the Company) The sale price was $125.0 (inclusive of debt assailed), subject to i post-closing working capital adjustment; $6.5 was paid at closing and the balance was paid ia January 1997. COCOA Grace's cocoa business was classified as a discontinued operation in 1993. During the fourth quarter of 1995. Grace revised the divestment plan for the business. The revised plan focused on the improvement of operating cash flow through the adoption of new strategies and a new global organizational structure. while better positioning the business for outright sale. As a result of this revised divestment plan, Grace recorded an additional provision of $151.3 (net of in applicable tax effect of $48.7) related to the cocoa bnsiness and other remaining discontinued operations. In December 1996. Grace annonnccd that it had entered into a definitive agreement to sell the coooa business to Archer-Daaiels-Midland Company. As s resnlt, in the fourth qnart.er of 1996, Grace reassessed its estimated loss nn the divestment of t.he business and reversed previously recorded provisions of $31.9 (net of an applicable tax effect of 518.1), within income from discontinued operations. The divestment of the cocoa bnsiness was coapleted in February 1997 with Grace receiving $470.0 (inclusive of debt assumed by the bnyer), subject to adjustment. OTHER In the fourth quarter of 1996. Grace classified its thermal and emission control syatams business (TEC Systems) as a discontinued operation. In connection with classifying TEC Systems as a discontinued operation, Grace recorded a provision oi $4.6 (net of an applicable tax benefit of $2.4) related to TEC Systems' anticipated net operating resalts through the expeoted date of divestment, as well as the loss anticipated on the divestment. F-15 52 In May 1990, Grace completed the calc of the irtnisgetnc plant business ul iu Agracetu# subsidiary lo (.he Muusamo Company Xor $150.0, resulting in pretax gain oX $129.0 ($79.4 aXleftax, oi $0.80 per cummun share oX tJie Company). Additionally, in March 1990, Grace sold ita luicruwave buaineaa Xur gross proceeda oX $3.9. In February 1995, Grace sold its composite materials business for gross proceeds of $3.0. During 1994, Grace sold its battery separators business and a portion oX its engineered materials and systems businesses lor gross proceeds oX $316.2. approximating prior estimates Grace also sold its animal genetics and Caribbean Xertilizer operations in 1994 lor proceeds oX $44.1. In 1994, Grace also sold substantially all oX its interests in Colowyo Coal Company (Colowyo) for proceeda oX $218.3. including $192.8 of proceeds iron a nonrecourse financing secured by a portion of the revenues from certain long-term coal contracts. Grace retained a limited partnership interest in Colowyo. entitling it to share in the revenues from these coal contracts. These businesses were classified as discontinued operations in 1993 (other than TEC Systems in 1996 and Colowyo in 1992). RESULTS OF OTSrrNTTNtJRn OPERATIONS losses from Grace's discontinued operations (other than its discontinued health care operations and TEC Systems), subsequent to their classification as such were $11.6 in 1996, $45 2 in 1995 and $14.2 in 1994. Theae amounts have been charged against established reserves as adjusted in 1996 and 1996 Results of Grace's discontinued operations that have not been charged against previously established reserves are as follows: 1996 1995 1994 HEALTH CARE (THROUGH 1996 THIRD QUARTER) Sales and revenues ........................................................................ Income from operations before taxes(l) ......................... Income tax provision .................................................................... Income from discontinued health care operations $1,666.9 $ 60.3 35.5 $ 24.8 $2,076.8 $ 104. 6 82.6 s 22,0 SI .875.1 s 227.1 102.4 s 124.7 TEC SYSTEMS (PRIOR TO CLASSIFICATION AS A DISCONTINUED OPERATION AT DECEMBER 31, 1996) Sales and revenues ......................................................................................................................................................... $ 102.5 Loss from operations before taxes ....................................................................................................................... S (18.5) Income tax benefit ......................................................................................................................................................... (7.2) Loss from discontinued TEC Systems operations ................................................................................. $ (11.3) t 112.9 5 (28.3) (11.3) $ (17.0) 89.7 s (10.3) (4.0) S (6.3) Total operating results .................................................................................................................................... $ 13.5 GAIN/(NET LOSS) ON DISPOSITIONS OF BUSINESSES ........................................................................................... PROVISION FOR/(BENEFIT FROM) INCttC TAXES CN DISPOSITIONS OF BUSIFCSSES .............................. 2,716.1 85.7 $ 5.0 (200.0) (48.7) s 118.4 TOTAL INCOME/ (LOSS) FROM DISCONTINUED OPERATIONS $2,643.9 s (146.3) s 118.4 (1) Reflects an allocation of interest expense based on the ratio of the net assets of the health care businesses as compared to Grace's total capital. The above operating results include interest expense allocations of $76.3. $93.5 and $60.4 for LS96, 1995 and 1994, respectively. For financial reporting purposes, the assets, liabilities, results of operations and cash flows of Grace Cocoa Associates, L.P. (LP) axe included in the Consolidated Financial Statements as a component oi discontinued operations, and the oatside investors' forner interests in LF (at Decenber 31, 1995) are reflected as a ninority interest in the Consolidated Balance Sheet. Grace purchased the ninority interest daring the fourth quarter of 1996 in anticipation of the sale of the cocoa business. The net assets of Grace's renaining discontinued operations (excluding intcrconpany assets) at December 31, 1996 arc as follows: COCOA OTHER TOTAL Current assets ...................................................................................... .. Properties and eqnipnent, net ................................................... Investments in and advances to affiliated companies . Other assets ........................................................................................... $312.3 185.8 59.2 $48.2 21.4 12.1 5.9 $360.5 207.2 12.1 65.1 Total assets .................................................................................... . $557.3 $87.6 $644.9 Current liabilities .......................................................................... . $241.3 $21.5 $262.8 Other 1 iahi 1 ities ............................................................................... *1.1 3.6 84.7 Total liabilities ........................................................................ . $322.4 $25.1 $347.5 Net assets ........................................................................................ .. $234.9 $62.5 $297.4 F 16 7. OTHER BALANCE SHEET IT01S 1996 1995 NOTES AND ACCOUNTS RECEIVABLE. NET Trade receivables, less allowances of $11.3 (1995 $12.8) .................................................................................... Notes receivable from dispositions of businesses ............................................................................................................ Asbestos-related insurance receivable - current ............................................................................................................. Notes receivable from insurance carriers current, netof discounts of $2.5 (1995 - $4.3) ... Other receivables, less allowances of $.2 (1995 - $.1) .............................................................................................. $501 7 215 6 35 0 17 2 61 9 $488.5 62.0 46.3 $831 4 $596.8 INVENTORIES Raw and packaging material* .................................................................................................................................................... In process................................................................................................................................................................................................. Finished products................................................................................................................................................................................... General merchandise ......................................................................................................................................................................... Less Adjustment of certain inventories to a last-in/iirst-out (LIFO) basis .......................................... $100 9 $137.1 67 6 78.0 179 0 248.6 " 73 4 76.6 (44.8) (48.4) $376.1 $491.9 OTHER ASSETS Prepaid pension cost* ..................................... Long-term receivables, less allowances of$42.7 (1995 - $24.7) ............................................................................. Deferred charges ..................................................................................................................................................................................... Long-term investments .......................................................................................................................................................................... Notes receivable from insurance carriers -noncurrent, aetof discounts of $4.9 (1995 - $7.3) .. Patents and licenses ............................................................................................................................................................................ Investments in and advances to affiliated companies ................................................................................................. Other ............................................................................................................................................................................................................... $275.1 152.9 102.4 57.4 31.3 15.8 9.5 91 $245.8 146.5 106.9 69.4 56.4 34.0 17.4 11.9 $653.5 $688.3 In 1995. Groce entered into agreements to sell up to $300.0 of interests in designated pools of trade receivables ($180.0 pertaining to MIC). At December 31, 1995, $295.8 had been received pursuant to such soles ($179.8 pertaining to NriC); these amounts were reflected ss reductions tc trade accounts receivable. Under the terms of these agreements, new interests in trade receivables were sold as collections reduced previously sold trade receivables. While only interests in designated pools of trade receivables were sold, the entire designated pools were available as the sole recourse with respect to the interests sold. There was no further recourse to Grace, nor was Grace required to repurchase any of the trade receivables in the pools. The costs related to such sales were expensed as incurred and recorded as interest expense and related financing costs. There were no gains or losses on these transactions. These agreements were terminated as to Grace in connection with the PMC transaction discussed in Note 6. Inventories valued at LIFO cost comprised 26.6% and 21.64 of total inventories at Deceabei 31, 1996 and 1995. respectively. The liquidation of prior years' LIFO inventory layers in 1996, 1995 and 1994 did not materially affect the cost of goods sold in any of these years. 8. PROPERTIES AND EQUIPMENT 1996 1995 Land ........................................................................................ Buildings ............................................................................. Machinery, equipment and other ............................ Projects under construction ................................... $ 51.5 622.6 2,088.1 545.7 S 44.1 595.5 1,967.1 548.2 Properties and equipment, gross ....................... Accnmnlated depreciation and amortization .. 3,307.9 3,154.9 (1,436.6) (1,418.8) Properties and equipment, uel ............................ $ 1,871.3 S 1,736.1 Interest costs are incurred in connection with the financing of certain assets prior to placing them in service. Interest costs capitalized in 1996, 1995 and 1994 vcrc $23.5, $21.3 and $9.4, respectively. Depreciation and lease amortization expense relating to properties and equipment, anonnt.ed to $179.7. $179.5 and S157.9 in 1996, 1995 and 1994, respectively. (trace's rental expense tor operating leases amounted to $25.6, $25.7 and $28.8 in 1996, 1995 and 1994. respectively. See Note 11 for information regarding contingent rentals. F-17 54 Al December 31, 1990, minimum future payment* for operating leaves aie: 1997 .......................................................... 1998 .......................................................... 1999 .......................................................... 2000 .......................................................... 2001 ........................................................ Later years .......................................... $ 26.3 22.3 18-8 17.1 11.4 20.8 Total minimum lease paynents $116.7 The above minimum lease payments reflect anticipated sublease income of $12.3 per year for 1997 through 2001 and a total of $17 .1 in later years. 9 DEBT 1996 1995 SHORT-TERM DEBT Bank borrowings (6.1k and 6.2* weighted average interest rates at year-end 1996 and 1995, respectively) (1) ... Current maturities of long-term debt .......................................................................................................................................................................... Other short-term borrowings (2) ..................................................................................................................................................................................... S 178.7 J 295.3 105.5 22.2 31.0 320.8 S 315.2 $ 638.3 LOG-TERM DEBT Coemercial paper (5.8* end 6.2* weighted average interest rates at year-end 1996 and 1995, respectively) (l)-;. S 77.8 $ 45.7 Bank borrowings (6.1* and 6.2* weighted average interest rates at year-end 1996 and 1995, respectively) (1) ... 272.2 304.3 8.0* Notes Due 2004 (3) ........................................................................................................................................................................................................ 276.0 300.0 7.4* Notes Due 2000 (3) ........................................................................................................................................................................................................ 248.7 287.0 7.75* Notes Due 2002 (3) ..................................................................................................................................................................................................... 119.0 131.0 Term Loan Agreement (6.3* weighted average interest rate at year-end 1996 and 1995) (4) ................................................... 30.0 Medium-Term Notes, Series A (6.9* weighted average interest rate at year-end 1996 end 1995) (5) ................................. 113.5 128.5 Sundry indebtedness with various maturities through 2002 ........................................................................................................................... 71.3 91.2 Leas current maturities of long-term debt 1,178.5 105.5 1,317.7 22.2 SI,073.0 $1,295.5 Full-year weighted average interest rate on total debt (6) . 7.3* 7.8* (1) Under bank revolving credit agreements in effect at year-end 1996, Grace may borrow up to $1,000.0 at interest rstee based upon the prevailing prime, federal funds and/or Eurodollar rates Of that amount, $650.0 is available under short-tern facilities expiring on May 16, 1997, unless extended, and $350.0 is available under a long-term facility expiring in September L999. These agreements also support the issuance of commercial paper and bant borrowings, $528.7 of which was oatstanding at December 31, 1996 (inclnded in both short-term debt and long-term debt above). At December 31, 1996, the aggregate auuuut ul net unused and unreserved borrowings under short-term and long-term facilities was $471.3. Grace's ability to borrow under its existing facilities it subject to compliance with varions covenants, including covenants requiring maintenance of total debt to total capitalization and interest coverage ratios. (2) Represents borrowings under various lines of credit and other miscellaneous borrowings, primarily of non-U.S. subsidiaries. (3) During the third quarter of 1994, Grace sold $300.0 of 8.0* notes dne 2004 at an initial public offering price of 99.794% of par, to yield 8.03%. During the first quarter of 1993, Giace sold at par $300.0 of 7.4% notes dne 2000. During 1992, Grace sold at. par $150.0 of 7.75% notes dne 2002. Interest on all three series of notes is payable semiannually, and the notes may not be redeemed prior to maturity; however. Grace has repurchased notes from time to time in response to unsolicited offers. (4) Daring the second quarter of 1995, Grace entered into a three-year term loan agreement matnrmg on April 24, 1998. The agreement provided for interesL at a Eurodollar Iloaliug race, payable semiannually. Grace's borrowings under this agreement were repaid in October 1996 with proceeds from the NU2 transaction discussed in Note 6, snd the agreement was terminated. (5) The Medinm-Tern Notes (MINs) bear interest at either fixed or floating rates and have maturity dates through July 19, 1999. Interest on each fixed-rate MIN is payable semiannually, and interest on each floating-rate MIN is payable either monthly or quarterly, depending on the issue. (6) Computation includes interest expense allocated to discontinued operations. beliednied maturities of long-term debt ontstanding at December 31, 1996 are: 1997 - $105.5; L998 - $9.0; 1999 - $350.5; 2000 - $316.9; 2001 - $.5; and thereafter - $396.1. Payment of a majority of Grace's borrowings may be accelerated, and its principal borrowing agreements terminated, upon the occurrence of a defanlt under other Grace borrowings. Total iuLeresL expense and financing costa, including amounts allocated to discontinued operations, were $147.9 for 1996, $164.8 for 1995 and $109.9 for 1994. Including amounts allocated to discontinued operations, interest payments made in 1996, 1995 and 1994, excluding related financing costs, amounted to $154.4, $183.1 and $101.8, respectively. F-18 55 10. FINANCIAL INSTRUMENTS DEBT AND INTEREST RATE SWAP AGREEMENTS Grace's debt and interest rate management objective is to reduce the cost of borrowing over the long tern. This debt nanageaent strategy emphasizes na in taming borrowing liquidity by developing and maintaining access to a variety of long-term and short-term capital markets. Grace's interest rate profile is managed separately by using interest rate swap agreements to modify the rate profile of the underlying debt. Most of Grace's interest rate swap agreements currently have t.he effect of converting fixed-rate t.ern debt into variable-rate debt based on LIDOR. Grace enters into only standard swap agreements that have readily quantifiable impacts on interest cost and are characterized by broad market liquidity. The maturities and notional amounts cf interest rate swap agreements generally match the underlying debt, resulting in changes in the fair valne of these interest rate swap agreements being substantially offset by changes m the fair valne of the debt. Grace does uut use derivative financial instruments (interest rale or foreign currency) for trading purposes and is not a party to leveraged instruments. At December 3L, 1996 and 1995, the notional amounts of interest rate swap agreements that convert fixed-rate debt to variable-rate were $505.5 and $1.157.5. respectively, and the notional amounts of interest rate swap agreements that convert variable rate debi. to fixed rate were $36.0 and $626.0, respectively. Notional amounts are used in calculating the amounts paid or received under interest rate swap agreements but do not represent assets or liabilities of Grace or provide a meaningful estimate of risk. Daring 1996 and 1995, Grace realized negative cash flows from interest rate swap agreements of $13.5 and $16.5, respectively. Tn addition, interest expense was reduced by $8.9 and $11.1 m 1996 and L995, respectively, dne to the amortization of deterred gams on interest rate agreements. Uaamortized net gains as of December 31, 1996 and 1995 were $22.8 and $31.7, respectively. FAIR VALUE OF INTEREST RATE SWAP AGREEMENTS, DEBT .AND OTHER FINANCIAL INSTRUMENTS At December 31, 1996 and L99S, Giace would have been required to pay ueL amounts of $34.7 and $32.5, respectively, to terminate its interest rate swap agreements. At those dates, the fair values of Grsce's long-term debt were $1,207.1 and $1,361.1, respectively (as compared to recorded valnes of $1,178.5 and $1,317.7, respectively). Fair valne is determined based on expected future cash flows (discounted at market interest rates), quotes from financial institutions and other appropriate valuation methodologies. At December 31, 1996 and 1995, the recorded values of other financial instruments such as cash, short-term investments, trade receivables and payables and short-term debt approximated their fair valnes, based on the short-term maturities and floating rate characteristics of these instruments. FOREIGN CURRENCY CONTRACTS Grace conducts business in a wide variety of currencies and consequently enters into foreign exchange forward and option contracts to nanage its exposure to fluctuations in foreign cnrrency exchange rates. These contracts generally involve the exchange of one currency for another at a future date. At December 31, 1996 and 1995, Grace had nuliunal amounts of appiuxiiaalely $50.2 and $45.5, respectively, in contracts to buy or sell foreign currencies in the future. CREDIT RISK Grace is exposed to oredit risk to the extent of potential nonperformance by counterparties to financial instruments. The counterparties to Grace's interest, rate swap agreements and foreign exchange contracts comprise a diversified group of major financial institutions, all of which arc rated investment grade. Credit risk is further reduced by bilateral netting agreement* between Grace and its counterparties. At Decenber 31, 1996, Grace's credit exposure was not significant and was limited to the fair values of these instruments; Grace believes the risk of incurring losses due to credit risk is remote. MARKET RISK Exposure to market risk on financial instruments results from fluctuations in interest and currency rates during the periods in which the contracts are outstanding. The mark-to-market valuations of interest rate and foreign exchange agreements and associated underlying exposures are closely monitored at all tines. Graoe uses portfolio sensitivities and stress tests to monitor risk. Overall financial strategies and the effects of using derivatives are reviewed periodically. 11. COMMITMENTS AND CONTINGENT LIABILITIES ENVIRONMENTAL Grace is subject to lost contingencies resulting iron environmental laws and regulations. Grace accrnes for anticipated costa associated with investigatory and remediation efforts where an asaesameut has indicated that a loss ia probable and can be reasonably estimated. These accrnals do not take into account any discounting for the time value of money. At December 31, 1996, Grace's liability for environmental investigatory and remediation costs related to continuing and discontinued operations totaled $256.4, as compared to $2$0.3 at Ceoember 31, 1995. These amounts refleot provitiona of $77.0 ($50.0 after-tax) recorded in the fourth quarter of 199S and $40.0 ($26.0 after-tax) recorded in the first quarter of 1994, which are reflected in the Consolidated Statement of Operations at F-19 56 part of cost of goods sold and operating expenses. The 1995 provision related principally to increased cost estimates associated with live lorner nannfactaring sites. Grace is in litigation with certain excess insurance carriers regarding the applicability of the carriers' policies to environmental remediation costs; given the uncertainties inherent in this litigation, Grace has not recorded a receivable with respect to such insurance coverage (except in one instance where a settlement with a carrier has been reached). Grace made cash payments of $20.3 in 1996, $31.3 m 1995 and $30.S in 1994 to remediate environmentally impaired sites. These amount; have been charged against previously established reserves. Grace's environmental liabilities arc reassessed whenever circumstance a be cone better defined and/or remediation efforts and their costs can be better estimated. These liabilities are currently evaluated quarterly, based on available information, including the progress of remedial investigation at each site, the current status of discussions with regulatory authorities regarding the method and extent of remediation at each site and the apportionment of costs among potentially responsible parties. As some of these issues are decided (the outcomes of which are snbiect to nncertainties) and/or new sites are assessed and costs can be reasonably estimated, Grace will continue to review and analyze Lhe need lor adjustments to Lhe recorded accruals. However, Grace believes that it is adequately reserved for til probable and estimable environmental exposnret. Grace's classification of its environmental reserves between enrrent and nonenrrent liabilities is considered appropriate in relation to expected future cash ontlays. CONTINGENT RENTALS Grace is the named tenant or guarantor with respect to leases entered into by previously divested businesses. These leases, some of which extend through the year 2017, have future ninimun lease payments aggregating $203.1, offset, by $201. 8 of anticipated fnt.nre minimnn rental income from existing tenants and subtenants. In addition, Grace is liable for other expenses (primarily property taxes) relating to the above leases; these expenses are paid by tenants and snbtenants. Grace believes that the risk of significant loss from these lease obligations is restate. However, a significant portion of the rental income and other expenses is payable by tenants and snbtenants that have filed for bankruptcy protection or are otherwise experiencing financial difficulties. Further, Grace may iucui losses as a result of unforeseen developments that can not be reasonably estimated. 12. MINORITY INTEREST Minority interest in the Consolidated Financial Statements as of December 31, 1995 consisted of a limited partnership interest in LP (see Note 6). Four Grace entities served as genersl partners of IP, snd its sole limited partner acquired its interest in exchange for a $300.0 cash capital contribntion ($297.0 of which was funded by ontside investors). In November 1996, Grace purchased the limited partnership interest. For financial reporting purposes, the assets, liabilities, results of operations and cash flows of LP were included in Grace's Consolidated Financial Statements as a component of discontinued operations and the limited partnership interest was reflected as a iiiuuiiLy interest. At December 31, 1995, the asseLs ul LP consisted of Grace's worldwide cocoa business and long-term notes and demand notes doe from cr guaranteed by Grace. Grace sold its cocoa bnsineas in February 1997. 13. SHAREBDLDERS' EQUITY Under its Certificate of Incorporation, the Company is authorized to issne 300,000,000 tbares of eomnon stock, $.01 par value. Of the common stock unissued it December 31, 1996, approximately 13,190,000 shares were reserved for issuance pursuant to stock options and other stock incentives. The Certificate of Incorporation also authorizes 53,000,000 shares of preferred stock, $.01 par value, none of which has been issued. 3,000,000 of snch shares have been designated Series A Junior Participating Preferred Stuck and are reserved for issuance in connection with the Coapany's Preferred Stock Purchase Rights (Rights). A Right trades together with each oatstanding share of coaaon stock and entitles the bolder to purchase one hundredth of a share of Series A Junior Participating Preferred Stock under certain circumstances and snbjeot to certain conditions. The Rights are not and will not become exercisable unless and until certain events occur, and at no tiae will the Rights have any voting power. Grace New York initiated a share repurchase program m April 1996. Through Septeabei 27, 1996, Grace New York acquired 9,864.800 shares of its conmon stock nnrter this program for $727.1, or an average price of approximately $73.70 per share. From September 28, 1996 (see Note 1) through December 31, 1996, the Coapany acquired 11,193,700 shares of its conmon stock for $592.2, or an average purchase price of $52.90 per share. Prior to year-end 1996, the Company retired substantially all of these shares of treasury stock using the cost method. The weighted average number of shares of coaaon stock outstanding daring 1996 was 91,976,000 (1995 - 95,822,000; 1994 - 93,936,000). Dividends paid on the Grace New York preferred stocks issued and outstanding prior to the NMC transaction, as discussed in Notes 1 and 6, amounted to $.4 in 1996 and $.5 in each of 1995 and 1994. F 20 14. STOOC INCENTIVE PLANS Each stock option granted under the Company's stock incentive plans has an exercise price equal to the lair market value of the Company * canon stock on the date of grant Options becone exercisable at the tine or tines determined by the Coapensation Cotmittee of the Company's Board of Directors and nay have terns or up to ten years and one nonth In connection with the transactions described in Notes 1 and 6, the number of shares covered by outstanding options and the exercise prices of such options were adjusted to preserve their economic value. The following table sets forth information relating to such options, as so adjusted: 1996 Number of Shares Average Exercise Price 1995 Number of Shares Average Exercise Price 1994 Number of Shares Average Exercise Price Balance at beginning ol year, as adjusted .. Options grsnted ... ................................. Options exercised .......................................................... Options terminated or canceled ............................ Balance at end of year, as adjusted .... 8.833,450 1.009.818 9.843,268 (3,331,555) (371,947) 6.139,766 $26 06 51 47 11,819.009 2.645.693 $24.53 10.813,635 30.05 2.109,692 24.56 28.21 14,464 702 (5,513,119) (118,133) 24.67 27.23 12,923,327 (941,504) (162,814) 30.92 8,833.450 26.06 11.819,009 $23 50 27 23 18.81 24.05 24.53 At December 31, 1996, options covering 3,994.828 shares (1995 6,477,63?; 1994 - 8,746.414) were exercisable and 6,975,000 shares (1995 2,970,186; 1994 5.506,863) were available for additional grants. Currently outstanding options expire on various dates through October 2006. The Company has adopted SPAS No. 123, "Accounting for Stock-Based Compensation.* As permitted by SPAS No. 123, the Company continues to follow the measurement provisions of Accounting Principles Beard Opinion No. 25, 'Accounting for Stock Issued to Employees," and does not recognize compensation expense for its stock-based incentive plans. Had coapensation cost for the Company's stock-based incentive compensation plans been determined based on the fair value at the grant dates for awerds under those plans consistent with the methodology prescribed by SFAS No 123, the Company's net income and earnings per share for 1996 ond 1995 would have been reduced to the pro forma amounts indicated below. 1996 1995 Net incooe/(losj): As reported ............................ Pro forma ................................... $2,857.7 $(325.9) $2,354.0 $(334.3) Earnings/ (lots) per share: As repur Led .............................. Pro forma ................................... $ 31.06 $ (3.40) $ 31.02 $ (3.49) These pio forna amounts nay not be indicative of future pro forna incone and earnings per share. The fair value of each option is estimated on the date of grant using the Flaclc-Schnlet option pricing nodel, with the following historical weighted average assunptions applied to grants in 1996 and 1995: 1996 1995 Dividend yields ....................... Expected volatility .............. Risk-free interest rates .. Expected life (in years) .. 1% 26% 6% 4 3a 25% 7% 4 Eased upon the above assumptions, the weighted-average fair value of options granted dnring 1996 and 1995 was $14.00 and $7.00, respectively. P-21 15. PENSION PLANS Grace maintains defined benefit pension plans covering employees of certain units who fleet age and service requirements. Benefits are generally based on final average salary and years of service. Grace funds its U.S. pension plans in accordance with U.S. federal laws and regulations. Non-U S. pension plans are funded under a variety of methods as required under differing local laws and customs and. therefore, cannot be summarized. Approximately 60* of U.S. and non-U.S. plan assets at December 31. 1996 were common stocks, with the remainder pnsiarily fixed-income securities. Pension cost/ (benefit) is comprised of the following components: Service coat on benefits earned during the year ....................... interest cost on benefits earned in prior year* ....................... Actual <return)/lost on plan assets ................................................. Deterred loss/(gain) on plan aatets ................................................... Amortization ot net loss/(gams) and prior service costs .. Aet curtailment and settlement gaxn(l) ............................................ Net pension cost/(benefit) ............................................................... 1996 U.S. Non-lJ S. $ 15.2 55.5 (98.2) 30.4 .1 (1.3) * 1.7 $ 10.7 23. 1 (39.1> 8.2 ( 3i (2.4) S 0.2 1995 u s. Non-L.S. 1994 U.S Non-U.S. $ 14.6 50 6 (132.3) 71. 1 () J 3.2 $10.5 2L.4 (32 0) 26.2 (.*) * $ 5.3 $19 8 46 9 16.9 (84 6) (7.1) 1(8.1) $13.4 19 3 10 6 (33 4 (1 6 $ 4.3 (1) As a result of selling its water treatment and procesa chemicals business in 1996. Grace's U.S. and non-U.S. plans recognized curtailment gains of $1.3 and $6.3. reapectively. The funded statue of these plena wet as follows: U.S. ASSETS EXCEED ACCUMULATED BENEFITS ACCUMULATED BENEFITS EXCEED ASSETS 1996 1995 1996 1995 Non-U. S. ASSETS EXCEED ACCUMULATED BENEFITS ACCUMULATE) BENEFITS EXCEED ASSETS 1996 1995 1996 1995 Actuarial present value of benefit obligation: Vested ............................................................................................... $655.4 Accumulated benefit obligation $659.3 $679.6 $55.6 $52.0 $161 8 $680.4 $55.7 $52.0 $162.5 $133.5 $133.9 $75.2 $67.5 $82.8 $75.1 Total, projected benefit obligation.............................. Plan atceie at fan value ................................................... $680,8 822.2 $710.0 795 8 $57.0 $55.7 $183 2 313 4 Plan auseia in eaceaa ul/(le* lban) projected benelii obligation ............................................................... Liiaeiorlized net (gain)/loas at iniLial adoption Luaatoriixed prior teivioe coat .............................................. Unrecognized net loss/(gain) .................................................. 141.4 (00.4) 34.3 47.5 85.8 (73.7) 41.7 97.6 (57.0) 4.2 13.7 8.9 (55.7) 4.S 1C.3 8.6 130 2 (4 7) 41 (17 3) Prepaid/(accrued) penaion coat ................................... $162.8 $151.4 S(30.2) $(25.9) $112.3 $189 4 302 5 $103 3 6. 1 $92.4 7.3 113 1 (0 3) 3C (16 O' (97.2 > (85.1) 3. 8 4.5 15.0 (3.2) $94 4 $(78.41 $(83.8) The following significant assuaptiona vere used in 1996. 1995 and 1994: Diacount rate at Decetiber 31................ R*pected long-ter* rate of return .. Rate of coopenaation increaae ........... IJ.S. 1996 Non -US 1995 TJ.S Non-U.5. US 8.0% 9.0 4. S 3.4 - 8.7% 6.0 10.5 2.5 * 7.5 7.3% 9.0% 4.5 5.1 - 11.6% 6.0 - 10.5 4 0 - 7.5 8 5% 90 55 1994 5.0 12.0% 6 0 - 10 5 40- 7.5 59 16. OTHER POSTRETIREMEN? BENEFIT PLANS Grace provides certain other postretirement health care and life insurance benefits for retired employees of specified U.S. units. These retiree medical and life insurance plans provide various levels of benefits to employees (depending on their dates of hire) who retire from Grace after age 55 with at least 10 years of service. The plans are currently unfunded Grace applies SFAS No. 106. which requires the accrual method of accounting for the future costs of postretirement health care and life insurance benefits over the employees' years of service. Grace pays the coats of postretirement benefits as they are incurred. Included in other liabilities as of December 31, 1996 and 1995 are the following: Accumulated postretirement benefit obligation: Retirees ........................................................................ Fully eligible participants ............ . ... Active ineligible participants ... . Unrecognized net loss ................................... Unrecognized prior service benefit ... Accrued postretirement benefit obligation 1996 1995 $199.9 6.4 43.7 250.0 (39.9) 32.8 $242.9 $209 0 15 2 34 4 258.6 (54 9) 44 3 $248.0 Net periodic postretirement benefit cost for 1996. 1995 and 1994 is comprised of the following components Service coat ................................................................................................................ Interest cost on accumulated postretirement benefit obligation Amortization of net loss ............................................................................ Amortization of prior service benefit ..................................................... Curtailment gain ...................................................................................................... Net periodic poetretirement benefit cost 1996 1995 1994 $ 1.9 $ 1.6 $ 2 1 19.0 18.3 16.2 1.9 .2 1.2 (3-7) (4.3) (4-3) (-9) $ 18.2 $ 15.8 $ 15 2 During 1996. Grace's retiree medical plans were amended to enhance benefits to retirees effective January 1, 1997. This amendment, including a previous plan amendment, decreased the accumulated postretirement benefit obligation by $32.8 at Decenbei 31, 1996 and will be amortized over an average renaming intore service life of approximately 10 years. Medical care cost trend rates were projected at 9.2% in 1996, declining to 6.U% through 2001 and renaming level thereafter. An increase of one percentage point in each year's assnned medical care cost trend rate, holding all other assumptions cons taut. Mould increase the annual net periodic postretirement benefit cost by $2.3 and the acconnlated postretirement benefit obligation by $19.9. The discount rates at Decenbei 31, 1996, 1995 and 1994 were 8.0%. 7.3% and 8.5%, respectively. Effective Jannary 1, 1994, Grace adopted SFAS No. 112, "Employers' Accounting for Pcstemploynent Benefits," which requires accrual accounting for nonaccunmlating postemploynent benelits. Grace's primary postenploynent obligation is for disabled workers' medical benefits; these are currently included in accrued postretirement costs under SFAS No. 106. The adoption of SFAS No. 112 did not have a material effect on Grace's results of operations nr financial position. F-23 60 17. geographic area information The table below presents information related to Grace's continuing operations by geographic region lor the years 1996 *1994. United States Asia Latin and Canada Europe Pacific America Total Sales and revenues ............................................... Pretax operating income/ (loss) (1) (2) . Identifiable assets (3) ................................... 1996 1995 1994 1996 1995 1994 1996 1995 1994 $1,690 1.735 1.606 (.13) (*> (190.1 1,963 2,132 1.879 SI,036 1.120 939 52 44 69 879 998 905 $468 445 366 53 61 55 505 411 308 $240 253 218 $3,454 3.553 3, 129 29 10! 9 (72) 20 (46) 203 3,550 246 3.787 208 3,300 Pretax operating income and identifiable assets arc reconciled below to income/ (loss) from continuing operations before income taxes and total assets. respectively, as presented in the Consolidated Statement of Operations and the Consolidated Balance Sheet. 1996 1995 1994 Pretax operating income (1) .......................... Gain on tales of businesses .......................... Interest expense end related financing costs (2) . Corporate restructuring costs and asset impairments/other activities Provision for corporate governance ......... Gain on sale of remaining interest in REG ................... Other income/(expenses), net (2) .............. $ 101 S (72) $ (46) 326 (72) (71) (50) (18) (122) (30) 27 12 11 (9) Income/(loss) from continuing operations before income taxes ............ S 349 S (284) $ (78) Identifiable assets (3) ................................... General corporate assets (4) ....................... Net assets of discontinued operations .. Total assets ................................................... 13,550 1,099 297 S3,787 815 1,759 $3,300 860 2,071 $4,946 S6.361 $6,231 -- (1) Includes (a) 1996, 1995 and 1994 pretax provisions of $229, $275 and $316. respectively, relating to asbestos-related liabilities and insurance coverage (see Note 2); and (b) 1996 and 1995 pretax charges of $90 and $87, respectively, relating to restructuring costs, asset mpairnenti and other costs (see Note 4). (2) Corporate interest and financing costs and nonallocable expenses are not reflected in pretax operating income because significant, finauciug decisions are centralized at the corporate level. Other incone/(expenses), net include6 interest income relating to the settlement of prior years' federal income tax returns of $7.5 and $9.8 in 1996 and 1995, respectively. (3) Includes asbestos related receivables and settlements doe from insurance carriers, net of discounts, of $331 and $49, respectively, in 1996; S321 and S118, respectively, in 1995; and $513 and $187, respectively, in 1994. (4) General corporate assets consist principally of deferred tax assets, prepaid pension costs snd corporate receivables and investments. At. December 31, 1996, general corporate assets inclnde S215.6 cf receivables froa the sales of Amicon and Grace's water treatment and process chemicals business. 18. SUBSEQUENT EVENT In February 1997, Grace announced that it had entered into an agreement to sell its specialty polymers business to National Starch and Chemical Company for $147.0, subjeot to adjustment. The transaction is expected to be completed in the second qnarter of 1997. F-24 61 QUARTERLY SIAMARY AM) STATISTICAL INFORMATIO-J UnaudiLed dollars in millions, except per share QUARTER ENDED March 31 June 30 Septenber 30 December 31 1996 Sales and revenues ....................................................... Cost of goods sold and operating expenses . Net income/(loss) .......................................................... Earnings/(loss) per share: Net earnings/(loss) .............................................. 862 512 63 $ .65 S 920 549 334 S3 45 S 821 503 2.518 $27.66 S 851 507 (57) $ (.70) Dividends declared per common share .................. $ 125 $.125 $ .125 $ .125 Market pTice of common stock: (1) High .......................................................................... $ 52 V 16 S 53 5/16 $ 52 s f,nw................................................................................... 34 3/4 45 5/8 33 1/16 Close ............................................................................... 50 5/8 . 45 5/8 52 56 1/4 46 1/4 5t 3/4 1995 Sales and revenues ................ Cost of goods sold and operating expenies Net income/(loss) Earnings/(loss) per share: Net earnings/(loss) .............. . $ 830 482 47 * .50 5 901 527 79 $ 83 % 916 542 22 $ .22 Dividends declared per coomion share ................ $ .35 $ 35 $ .35 Market price of cosson stock: (i) High ................................................. Low ................................................... Close .............................................. $ 35 1/8 $ 41 15/16 $ 24 13/16 33 1/16 34 5/16 39 9/16 45 7/8 39 5/8 43 3 906 600 (474) $ (4.87) $ .125 $ 42 11/16 35 1/4 38 1/16 (1) Principal market: New York Stock Exchange. The stock prices for 1995 and the first nine smiths of 1996 have been adjusted so that they are on a basis costparable to the stock prices following the disposition of NriC. CAPITAL EXPENDITURES, N2T FIXED ASSETS AMD DEPRECIATION AM) LEASE AMORTIZATION Dollars in nillions Capitol Expenditures (1) 1996 1995 1994 Net Fixed Assets 1996 1995 1994 Depreciotion and Lease Amortisation (2> 1996 1995 1994 Operating units ................................. General corporate ............................ Total continuing operations Discontinued operations .............. $397 57 454 3 $455 49 504 34 $327 $1,691 $1,565 $1.249 30 180 155 144 357 1.871 1,720 1.393 88 ** 16 337 $164 16 180 $163 17 180 $142 16 158 Total $457 $538 5445 $1,871 $1,736 $1,730 $180 $180 $158 (EOGRAPHIC LOCATION United Slates aud Canada ............ Europe ..................................................... Other tress .......................................... Subtotal ....................................... General corporate ............................ Total continuing operations Discontinued operation* .............. Totl ............................................... $186 83 128 397 57 454 3 $457 $242 100 113 455 49 504 34 $538 $200 75 52 $941 403 347 $854 440 271 S702 381 166 327 1.691 1.565 1,249 30 180 155 144 357 1,871 1.720 1.393 86 * 16 337 $445 SI.871 SI.736 SI.730 S82 58 24 164 16 180 S1S0 $82 60 21 163 17 180 $180 $75 51 16 142 16 158 $158 (1) Exclude* capital expenditure* of discontinued operation* subsequent to their classification as such. (2) Certain 1995 and 1994 amount* have been reclassified to conform to the 1996 presentation. F* 25 62 FINANCIAL SUMARY (1) Dollars in millions, except per share amounts 1996 1995 1994 STATEMENT OP OPERATIONS Sales and revenues .......................................................................................... Cost of goods sold and operating expenses ..................................... Depreciation and amortization ................................................................. Interest expense sod related financing costs ................................ Research and development expenses .......................................................... Income/ (loss) from continuing operations before income taxes Provision for/(benefit from) income taxes ....................................... Income from continuing operations before special items (2) Income/ (loss) from continuing operation* .......................................... Income/(loss) from discontinued operations (3) .......................... Cumulative effect of accounting changes .......................................... Net. income/(loss) ............................................................................................. FINANCIAL POSITION Current assets .............................................. Current liabilities ................................... Properties and equipment, net ............ lotal assets ................................................... lotal debt ........................................................ Shareholders' equity cosnton stock DATA PER CCMGN SHARE Earnings from continuing operations before special items (2) .. Earnings/(loss) from continuing operations ............................................ Cumulative effect of accounting changes ................................................... Net earnings/(loss) .................................................................................................. Dividends ......................................................................................................................... Book value ...................................................................................................................... Average common shares outstanding (thousands) ..................................... OTHER STATISTICS Dividends paid on common stock ........................................................................ Capital expenditures .......................................................................... .. Common shareholders of record ................ ........................................................ Common stock price range (4) ............................................................................. Number of employees continuing operations (thousands) .............. $3,454.1 2.071.0 184.4 71.6 93.9 348.6 134. 8 222.5 213.8 2.643.9 2,857.7 S3.552.6 2.151.2 186.1 71.3 111.6 (284.1) (104.5) 205.7 (179.6) (146.3) (325.9) $3,128.5 1,832.6 164.6 49.5 99.6 (77.7) (42.6) 163.9 (35 1) 118.4 83.3 $1,774.9 1,487.1 1.871.3 4.945.8 1,388.2 632 4 SI. 681.3 2,214.2 1.736.1 6.360.6 1,933.8 1.224.4 $2,228.9 2.231.5 1.730.1 6.230.6 1.529 7 1.497 1 $ 2.41 2.32 31.06 .50 8.06 91.976 S 2.14 d-87) (3.40) 1.175 12.57 95,822 $ 1.74 (.38) .88 1.40 15.91 93,936 $ 45.6 456.6 17,415 56 1/4 - 33 1/16 17.4 S 112.1 537.6 19,496 45 7/8 - 24 13/16 20.3 $ 131.5 444.6 18,501 29 15/16 23 19.9 FINANCIAL SIAMARY (1) Dollars in millions, except per share amounts STATEMENT OF OPERATIONS Seles and revenue# ............................................................................................. Coat of goods sold and operating expenses ....................................... Depreciation and amortization ................................................................... Interest expense and related financing costa ................................. Research and development expenses .......................................................... Income/(loss) from continuing operations before income taxes 1993 $2,824.7 1.692.9 153.9 43.0 100.8 44.5 1992 $2,985.2 1.814.0 164.6 49.4 99.5 91.9 Provision lor/(benefit from) incane taxes ................................... Iucone iron continuing operations before special- item (2) Income/ floss) Iron couliuuuig operations ..................................... Income/(loss) iron discontinued operations (3) ..................... Cunulative eilect oi accouuLing oUauges ....................................... Net iucone/(losa) .......................................................................................... FINANCIAL POSITION Current assets .............................................. Current liabilities ................................... Properties and equipment, net ........... Total assets ................................................... Total debt ........................................................ Shareholders' equity - coraon stock DATA PER CCMdDN SHARE Earnings from continuing operations before special items (2) Earnings/(loss) from continuing operations ................................... Cumulative effect of accounting changes ............................................ Net earnings/(loss) .............. .......................................................................... Dividends ............................................................................................................... Hook value ............................................................................................................. Average ccwmian shares outstanding (thousands) .............................. CJTHRR STATISTICS Dividends paid on common stock ............................................................... Capital expenditures ...................................................................................... Comsion shareholders of record................................................................. Common stock price range (4) ................................................................. Number oi employees - continuing operations (thousands) 16.4 128.1 28.1 (2.1) 26.0 $2.077.6 1.992.6 1.454.1 6.108.6 1.706.1 1.510.2 $ 1.39 .30 .28 1.40 16. 16 91.461 $ 127.9 309.6 L9.358 9/16 22 5/16 19.8 84.1 152.8 7.7 (112.2) (190.0) (294.3) 52,091.4 1.639.6 1.707.9 5.598.6 1.819.2 1.537.5 $ 1.70 .08 (2.12) (3.29) 1.40 17. in 89.543 $ 125.4 398 4 20,869 29 - 20 19.4 (1) Certain prior-year amounts have been reclassified to conform to the 1996 presentation. (2) Income from continuing operations before special items reconciles to income/(loss) from continuing operations as follows: 1996 1995 1994 1993 1992 Income from continuing operations before special items .... Special items (after-tax): Gain on sales of businesses ................................................................... Restructuring costs and asset impairments/other activities Provisions relating to asbestos-related liabilities and insurance coverage ........................................................................ Provision for corporate governance ................................................... Provisions for environmental liabilities at former manufacturing sites ............................................................................... Gain on sole of remaining interest in REG ................................... Provision relating to fumed silica plant ..................................... Postretirement benefits prior to plan emendnents ................... Income/ (lose) from continuing operations ........................................ 5222.5 $ 205.7 $ 163.9 $ 128.1 $ 152. 210.1 (69.9) (138.0) -- -- (148.9) (178.7) (200.0) (100.0) (18.6) (30.0) (26.0) 27.0 (140. (5. $213.8 $ (179.6) $ (35.1) $ 28.1 $ 7. The special itema included in the foregoing table also have been excluded in determining earnings per common share from continuing operations before special items. (3) Comprised of income from operations of $13.5, $5.0 and SU84 in 1996, Market Sagmanft/End Ut Customer Ranafits Growth toetors Fresh reel meats .Smoked and processed meats Fish Poultry CJieese Prepared foods Huked goods Produce Food and beverage canning and bottling Nonti kkI consumer and industrial products Preserve flavor and armna F.nhance product shelf life and appearance Improve merchandising Protect against bacteria and other exmenninants Custom-ta3on.xl to sjxedfic food applications Available globally Employ innovative resin and film processing technologies Combine expertise in Ixxh food and packaging sciences Offer total systems: technical service, equipment design and installation, training and package design Emergence of middle class and enhanced dislributioh systems in developing Asia Pacific and Latin American countries Global growth programs Case-ready packaging 7BrTTM Irags for Ixtne-in meats Precut produce packaging Display films laminates Extensions/adaptations of picxlucts from one region to auotlier Increasing consumer demand for healthy, "convenience" foods Commercial and residential construction ' Airports ' Tunnels > Dtxks and ortier marine structures Bridges Strengthen, protect and add longevity to structures - Improve customer profitability' and productivity * Customer-focused product development -Provide on site technical support - Lower life-cycle costs Infrastructure development in Asia Pacific and Latin America Selected acquisitions lo extend global reach and technological leadership * New value-added and specialty products Petroleum refining for transportation fuels and petrixhemicals Plastic resins for plastic films, gas distribu tion pifx-s and molded plastic products Coalings Plastics Personal care products looda Pharmaceuticals Building products Chemical products Increase product yield and quality in refinery pnxesses Improve control for environmental issues Managed globally for worldwide availability Offer creative approaches lo a wide variety of process applications based on catalysis and silica technology Flexible manufacturing for rapid customer response Close customer relationships lead to proprietary products and facilitate new product introductions Growth in Asia Pacific markets Increasing refining complexity requires greater use of higher-perfomumce catalysts Strong plastics growth driven by increasing consumer demand Emerging technologies in customer processes New environmental regulations Abundant new applications for silica products $2,79* $3,151 $3,252 *4 *9 94 Soles from Continuing Operations F irhKfng riweneo Utx's n4Uj>| Financial Highlights 1 mlllmv exctf* per`txnv amounts Sales and revenues Income from continuing operations before special items Income from continuing operations Capital expenditures Depreciation and amortization Total assets Total debt Common sltareltoklers' equity- *996 $3,454 $223 $214 $457 $184 $4,946 $1388 $632 Other Information Ticker symbol Common sliares outstanding - end ofyear Common shares outstanding - average Earnings per share from continuing operations before special items Dividends paid per share GRA 78,493,000 91.976,000 $2,41 $.50 Global Market Leadership Grace Is proud of the global leadership positions it ftolds in each of its Imsinesses-- leadership that is a result of leading-edge technology, strong customer relationships and the ability to serve customers anywhere in die world. Grace h3s an unrivaled global infrastructure, with manufacturing operations in each region and a sales staff tltat virtually eovers the globe. More than lutlf of its sales come from outside North America. Growing Profitably The New Grace is managed as an integrated, global operating company, focused on profitably growing its packaging, catalysts and silica products, and construction products businesses. The Company is dedicated to continuously improving its product portfolio and its financial performance. The New Grace places significant emphasis on financial discipline and operating efficiency The Company ended 1996 with a 12% operating margin Learnings before interest and taxes as a percent of sales;, up from 9 50'-'' in 1995. Grace expects to achieve its longer-term laigct of 15% in 1998 During 1996, Grace reduced operating costs and improved asset productivity. It exceeded a target of $1UL) million in annu alized overhead savings It reduced working capital by 2% of sales and inventory Jays on-hand nearly 20%. It consolidated support Junctions and manufacturing and ware housing operations; initiated an additional $25 million cost-reduction program in Europe; and improved manufacturing processes and supply chain management. All three of Grace's core businesses are growing steadily, and further profitable growth is expected to be generated by new product introductions, geographic expansion, continued penetration of existing and new market segments, and a dedication to continuously improving operaung effectiveness and efficiencies. GRACE W. R. Groc, & Co. One Town Cantor Road Boca Raton, FI U.S.A. 33486-1010 For more information, coll: 800GRACE99 or 361-362-2000 fax: 561-362-2193 To Our Shcireholcters clcome to The New Grace. We areiceftaiftly proudbf the company that has emerged from the taony di3nges|ia|>lemenied since 1995 and of the more than 17,000 employees who have contributed to i nir success. Today, we are focused on profitably growing our three global market-leading businesses: packaging, catalysts and silicas, and construction products. We are managing Grace as an integrated, global operating company. And we are dedicated to continuously improving our piocitict portfolio and our financial pcrfonnance. The New Grace is definitely a new company. During 1996, wc delivered .significant value in shareholder;. Each of our continuing businesses had record sales and earnings. We also received approximately $3 billion in after-tax cash proceeds from dispositions of several noncore businesses We used these proceeds to reduce debt and repur chase 21 million shares by year end, significantly improving the capital structure of Tlie New Grace. A New Spirit. A Bright Future. We are committed to ensuring the continued growth and outstanding performance of 'file New Grace. We continue to emlirace change and build on our fundamental strengths: tedinology, customer service and global market leadership Innovative Technology Each of our businesses provides value-added products and services, driven largely by technological leadership. Ibis technology is protecting the world's food products, strengtliening and protecting the world's i w. a. GIACE l co. structures and helping fuel the world's transportation systems More than Wn ol our 1996 sales were derived from products developed during the past five years Solid Customer Relationships Grace people have never lost sight of what is mast essential to success--serving our customers. Our jiroduets are often vital to the performance of customer product' and processes, so we continually strive to anticipate needs and innovativcly apply our tedinokigies to provide best-value solutions. We work in partnership with our customers to ensure lush their success and their customers' success. Global Markat Leadership We are proud of the gloixil leadership positions we hold in each of our businesses--leadership flint is a result of our leading-edge ledinology, strong customer relationships and the ability' to serve our customers anywliere in tlie work! Our goal is to remain nutnlier one or two in each of the markets we serve. We have an unrivaled global infnismicture, with manufacturing operations in each region and a sales stall that virtually covers the glolve. More than half o! our sales come from outside Ninth America. We expect strong growth from tlie developing regions of Asia Pacific, Latin America and Eastern Eurojie. and we continue to expand into new markets such as China and Kussia. Growing Profitably In 1999. ujx-rjiing income from continuing operations was up 12%. Of special note was the dramatic improvement hy our construction products business, which more titan tripled its operating income compared to 1995. We had record sales, hut we missed our growth target in 1996. due to an extra ordinary convergence of market factors that imparted our packaging and fluid cracking catalyst businesses. Wc expect these factors to diminish throughout 1997. Our other businesses enjoyed strong sales growth, with a large percentage coming from newly introduced products. And all otir businesses continued to improve operating efficiencies. We ex|>ect increased sales to come from new pnxlmi imnxliulions, geographic expansion and continued penetration of existing and new market segments. Many examples of outstanding growth opportunities tin each of our businesses are highlighted throughout this re[X>ri We also expect to make selected acquisitions to complement our existing businesses. During 1990, we acquired companies to complement our precut produce packaging position, our container sealants and coatings business and our construction products business Tlte New Grace places significant empliasis on financial discipline and operating efficiency. We ended 1990 with a 12% ujierating margin (earnings before interest and taxes as a percent of sales), up from y s% in 1995, but shv of our stated goal of 13% for the year. However, wc expect to achieve our longer-term target of 15% in 1998. We've icduced operating costs and improved asset productivity. During 1990, we exceeded our target of $KX) million in annualized overhead savings. We reduced working capital by 2% of sales and inventory davs-on-hand nearly 20%. We consolidated manufacturing and warehousing operations and support functions: initiated an additional $25 million cost-reduction program in Europe: and improved manufacturing processes and supply chain management. Highly Focused. Value-Driven. As 1 look back on the past year and a half. I am pleased at how much we have accomplished and ltow we have delivered on our stated oltjeetives. 1 am excited about the abundant opportunities we see for profitable growth. I am confident that we have tlte technical, manufacturing, marketing and management capabilities in place to bring new products successfully from our labs to our customers around the world. 1 want to thank shareholders who were owners of "old" Grace for your continued confidence and to welcome New Grace owners to our highly focused, value-driven company. And to all Grace employees, I thank you for helping create The New Grace. qJgmi Albert J. Costello Chairman. President and Chief Executive Officer February 28. 1997 1996 Sales by Core Product Line Cjt2ce PockoQwto ^B Z->oe M Curort Ofrv sen Pevf uric 1996 Sales by Region BB Ufi' Ain*'*.!. Ayy cycfi t-.rupg BB Mgrih Awenca 2. 2 W. R. CRACK 4 CO. Grace at a Glance Grace Packaging Profile Products J Gary Kaen/.ig, Jr.. President 1996 sales: $2 billion 11,500 employees 28,000 customers in 100 counities Headquarters. Boca Raton, Florida Key manufacturing sites: Atsugi, Japan; Chicago. Illinois; 1-pemon, France: Fawkner. Australia; Iowa Park, Texas; Kuantan, Malaysia; Mississauga, Canada; Passirana. Italy; Reading, Pennsylvania; St. Neots, U.K.; Sao Paulo, Brazil; Simpsonvillc, South Carolina Ctyuvac* flexible plastic packaging systems Dorex' container sealants and coatings for cans and bottles Omicnmrigid plastic cups and tul>s lor dairy foods Formpacm foam trays for supermarket and institutional food service I Grace Construction Products * Roliert J. Bettucchi. President * 199(i sales: S4.55 million * 1,900 employees * Meack]uarters: Cambridge, Massachusetts * Key manufacturing sites: Ajax, Canada; Chicago, Illinois; Hong Kong; Houston, Texas; Inchon, Korea: Passirana, Italy, Santa Ana, California; Sitiga|xne; Slough. U.K., Wilmington. North Carolina Concrete admixtures Cemenr additives "Masonry products Waterproofing products and systems Fire protection products i Grace Davison James R. Hyde, President 1996 sales: $"32 million 2.700 empkiyces Headquarters: Baltimore. Maryland Key manufacturing sites: Aiken, South Carolina; Chattanooga, Tennessee: Cincinnati, Ohio; Curtis Bay. Maryland: Kuantan, Malaysia; Lake Charles, Ijouisiana; Sorocaha, Brazil: Valleyflekl, Canada; Worms, Germany Fluid cracking catalysts and additives Hydroproccssing catalysts Polyolefin and dietrueil catalysts aixl carriers Silk a products Zeolite- adsorbents Market Sygmcntt/End ll Customer Benefits Growth Factors Fresh red meals Smoked and processed meats Fish Pi Hillry Cheese Piepared foods Baked gexxis Prexlucc Food ami I revenue canning and bottling Nonfexxl ronsuintT and industrial jtnxluets Preserve flavor and aroma linlianoe prcxiuct slielf life and appearance Improve merchandising Pnxect against bacteria and odvr (.ontumnants Custom-tailored 10 stxvific food applkatxxis Available gfohally Employ innovative resin and film processing teclinologics Combine c-.vpeni.se in Ixxh frxxl and packaging sciences Offer total systems technical servke. equipment design and installation, training and package design Kmcigence of middle class and enhanced distribution systems in developing Asia Pacific and Latin Amencan countnes > Glotxil giowlh programs Case-ready packaging 7710'TM Ijags for Ixme-iti meats Precut prcxlucc packaging lXsplay filnvs Laminates Fjclensiuns/adaptiitions of pnxlucts from one region lo anolhei Increasing consumer demand for healthy, "convenience" foods " Commercial and residential eonstructiexi Anpons r 'funnels 1 locks and oilier marine structures ` Hi klges - Strengthen, prtxetl and add longevity to structures Improve customer |xofilability and productivity * Customc-r-fexiisc-cl prexluct development * Provide on-site ret linkal supfxirl * Lower life-cycle costs * Infrastructure clevelo)xnenl in Asia Pacific anti Latin America * Selected actjuisitkins to extend glolxil reach and technological leadership * New value-added and specially products Petroleum re-fining fot transportation fuels and |>etroclieinkals * Plastic rc-sins for plastic films, gas distribu tion pi|x-s and molded plastic products Coalings Plastics Personal care products Fc x xls Pharmaceuticals * Building prexJucts * (lltemical products Increase prexluct yield and quality in refinery prtxesses Improve control for eiivininmenlal issues Managed glolsallv ftr w-orldwide availability Offer creative approaches to a wide variety of process applications based on catalysis and silica technology Flexible iiiunufacluring for rapid customer response Close customer relationships lead to proprietary pnxJucts and lacilitate new prexluct inlnxluctions ('.rem-tli in Asia Pacific markets Increasing refining complexity requires greater use of higher-performance catalysis Strong plastics growl11 driven by increasing consumer demand Kmerging technologies in customer processes New enviionniental regularkms Abundant new applications for silica pmducts 4. 3 W. t. OHACI CO. Building on Success Mt linjj k-t I mi ill rj,\ \ ,i11k ,h It let I pr< nlitris .mil mT' ii iv* . Mr* Htu i-i iMi tinn k*I;m it .. l'.I* d ul pri'M'ik r...utilM;m<ltnU piMipIt* ;iiv 11 u * louikl.tli< >it lm (jkkv ^ siiruvss in p.irk;ijini! i.tl.il\Ms .mil >ilir;i |h<k(ik'Iv :m<l 11 msiuu\v mi pnulikl'' llw\\ is tiraiv usinii llk*si 11 rmpi'tiiiv r summits k iiv;`k' v;ihk' ;iiul yn>'\ pmlii;il*l\ * cir;i<vs I"\ihio iamplo\ivs ;uounil ilk* world ,nv work in;' * in;iik*!. mi i\iik i:Nri ;iml iL.ii hini* hii'lkt u impiovo f htI n m:mi r ru*i\ il.i\. i ii.u i* i mph n ri s .ir li h\ i-i m; i mk.i.milinu svmiv t< rush hiutm litklin.u new .ipplu mil ns tor <ir:uv nvlim >l ;.'\ i ' \ oli pm;4 Iti>Iu*1 ipliir ;ulil<*il prmliu l.v pursuing ik*\\ opportunities. i:\p:m< lini' ^rtk'ikphn K'.k h: :i. ri It'kihii^ pn hUk i ikli\ it\ : miming im imk >r\ : Ii m i*iins pn kIiu lii hi iumv uiiim >lkl;iiiu;> siipph liiii's: up.ui.klinv nnimjLji'itKTU inlomuiiinn s\ slums; onluikin** skills; .mil MitMiultniii;' pmirssrs i ii;n u rmplmtrs .m i u :Mm;> \ ;ilm in .ill llii si' w .i\ s .ilkI mi >i\\ In 1V96, Groce Construction ftoducts initiated o series of Monokotv product (mining sessions for fireproofing appticatoi* in the U.K. and France. In addition to providing instruction in die technology ond technique*. of applying Monokote products, Grace used these training sessions to highlight the productivity and cost advantages of Monokol* fireproofing, demon strating a commitment to helping customers impiove tbeii profit potential and business productivity. As a result of these training sessions. 10 of the largest fireproofing applicator'; in the U.K. ond Franco have (oined Groce's "leam 1 Quality Applicator Network." In 1996, Groce mor e than doubled fire protection sales in Europe and is well positioned to exceed aggressive 199/ growth targets. Business Process Audits Uncover Hidden Productivity Business process audits at Grace Pecltepmp'* monufortwiing centers in Epernon, France and Hamburg, Germany identified opportunities to optimise resources, streornline production, better nionoge inventory and shipping processes and improve customer service. The audits helped Epernon employees redact, inventory 2^% ond days-orvhond 36`V. In Hamburg, shrink products inventory dropped 26c and s. days-on-hnnd 46V Following the audits, employees nt both sites under went intensive, advanced ti oining on inventory control systems, enabling them to Epernon Plont Improves Inventory Management interpret and use data more efficiently. Product coding mul i.tistrfoulion procedures were integrated end simplified. New reporting systems were developed to hark manufacturing and revenuo cyde times. In oddition to one-time inventory cost reductions, these two audits yielded annual savings of $1 million in interest on working capital. Ongoing efforts to hotter manage assets continue, and process changes pioneered at Epernon and Hamburg ore being implemented company-wide. Analytical Support Gives Customers an Edge Grace Davison brings petroleum refining customers more thon half a century of experience in fluid crocking catalysts and additives. Customers worldwide rely on Groce Davison's technical support to provide customized catalyst solutions for their operations, help them optimize unil performance and solve problems. An extensive customer catalyst testing program and a sophis ticated analytical database are two important tools that Groce Davison engineers use to provide technical support. Customers submit over 15,000 catalyst samples every year, and more than 50 different analyses are performed on each sample. The results are placed in o database which currently holds data on over 100,000 catalyst samples. In many cases, improving unit operations or solving problems requires changing the catalyst formulation. Immediately accessible in the database are specifications of more than 2,100 different catalysts and over 900,000 production sample results. These help Groce Davison engineers quickly provide new cotolysl formulations that will improve customer operations. Groce Davison's flexible manufacturing process allows for rapid response to cotolyst formulation changes and ensures that customers' new objectives ore met quickly. With around-the-clock and oround-the-world availability, this technical support is o high value-added benefit for Groce Davison customers. Interregional Training Enhances Kuantan Start-up Prior to the July 1996 start-up of the Company's new shrink films and silica products plants in Kuantan, Malaysia, more than 40 new employees traveled from Malaysia to the Groce Packaging plant in Seneca, South Carolina and the Groce Davison plant in Worms, Germany to learn first hand how to run the sophisticated production lines and monoge the state-ofthe art manufac turing processes that served at models for the operations then under construction In Kuantan. Groce Davison person nel spent up to three months looming how to manufacture mkronixed silica. They also focused on theory, applica tion, quality control and safety procedures. In addition to time spent in Worms, the new employees visited plants in Curtis Bay, Maryland and Sorocaba, Brazil. At the Seneca packaging films plant, Kventan process technicians spent six months teaming both the theory and handeon operation of a packaging Bn# and an electronic cross-linking unit. They also studied safely procedures. The Kuantan engineering staff studied the electrical and mechanical design of the production linos. The focus was on engineered analytical training, which is a thorough, consistent and systematic approach to shoring process knowledge. This training system is estimated to have reduced process training time up to 60%, efficiently promoting bast process and 'We are proud to have safety practices, reducing process variation and allowing such o highly skiled, local new employees to meet team running the sophisticated quality, yield and productivity expectations. Past experience pockaging production lines in has shown a minimum $0 our Kuantan plant. The training return on each $ 1 invested in engineered analytical training. we underwent at our sister plant in South Carolina was essential to our start-up." Michael Jar, Grace Packaging Plant Manager--Kuantan t. 7 W. ft. OR ACt I CO. Grace's fc/rpseTM sltrinkoge-reducing admixture is a breakthrough in concrete technology because il addresses concrete's tendency to shrink and then crack. Eclipse reduces shiinkoge by as much os 80%, dramatically reducing-- or even eliminating--concrete crocking. It was developed through a technical partnership with ARCO Chemical. When ARCO Chemical begun research on shrinkage reduction, it approached Grace, seeking help from a company with a thorough understanding of construction materials. Researchers at Grace Construction Products were working an a similar protect, and ARCO Chemical knew that Grace was committed to new product development. This coNoboration resulted in an innovative new admixture after only two years of formalized joint development-- sufficient time to adequately test long-term performance, but sig nificantly less time than if the parties hod woiked olone. In partnering on this research, Grace saved an estimated $2 million in development and lest ing costs and reduced the time required to bring the product to market by one to two years, building on the success of this partnership, Groce Construction Products has now formalized the search for potential development partners as o major component of its RAO process and is currently in the formative stager, of severol other product development partnerships. Sales of products introduced in the post five yeoi >, such us Eclipse shrinkage-reducing admixture, generated 25% of total construction products sales in 1996. Groce Packaging Introduces a New System tor hcst> Red Meat Distribution Cryovoc* case-reody packaging for fresh red meats enables retailers to mute effectively manoge their inventories and redirect labor from in-store meat cutting to highei -value met chandising. Prepared in centralized processing plants and delivered fresh to retoilers, cose-reody meats are prepackaged in convenient sizes for consumers. This packaging solution provider consumers with enhanced quality and product availability. Groce Packaging is working dosely with selected retailers in North America and Europe to implement ease-ready packoging systems for fresh red meats, Increasing ctccep tonce of this new distribution system foi fresh red meats is evidenced by a significant increase in sales of coseready packoging in 1996 over 1995. When Albert Hcijn BV, Holland's largest grocery retoilei, implemented o rodicol chonpe in logistics for fresh red meat distribution, it colled on Groce Packaging to help it reduce operating costs through o more efficient inventory system. After a series of successful production trials, Albert Heijn wanted 10 Cryoyoc case-ready pockogirtg lines installed and operational within two months. A Groce team from Holland onrl France hod all lines up and running on time With 16 lines today producing consumei-reody fresh red meats foi more than 600 stores, Albert Heijn has halved Hie time between product ordering ond in-store display and introduced o more efficient stocking system based on actual product purchases rather than ostimoted demand. With its new fresh red meat logistics system fully operational, Albert Heijn is one of Europe's largest case-reody retailers and the largest customer worldwide for Cryovat modified atmosphere packaging for fresh meat typlkodom. Consumers particularly in North America--typicoly associate a bright red color with freshness in selecting red meats. The freshest red meats are actually o much darker red almost purple--color. Red meats are bright red only after exposure to oxygen. Cryovac case-ready packaging preserves freshness by providing o bonier to oxygen. Because many consumers have developed a preference for the brighter red coloring, Groce Packaging scientists devel oped a unique vacuum pockoge with on oxygen barrier film that con be easily peeled off by the retailer to trigger the color change just before stocking the display case. A breathable film layer remains over the packaged meat, letting oxygen pass through to change the color, usually within about 20 minutes. After market tasting of the new packaging indicoted satisfaction with consumers, two major North American retailers ore expanding availability of Cryovac cose ready packaging systems throughout their stores. On-Line Training Cost-Effectively Promotes Safety Awareness To promote continuous improvement tn safety performance at Grace Davison'* lake Charles, Louisiana manufacturing complex, a computer-based safety training program was developed. This program allows employees to train at their own pace. t ensures consistency in training curriculum, increases the speed at which employees receive new information, enhances safety awareness by raising the ievel of expertise within the Company and cost effectively expands training capabilities. The program consists of more than 200 fob specific safety training modules and includes interactive triggers to modify content based on prior knowledge. Within three months of introduction, all 300 Groce Davison lake Charles employees had completed the training. Prior to the on-line training, 100% compliance hod been dtfficult to achieve. Since 5.82 the system is virtually self-managing, with personnel notified electronically of the 243 approach of retraining dates, compliance for regulatory, safety and job-specific training is 9A 95 96 100%. As evidence of On-line Training Reduces Accidents fcecofdocie yrrtrior> pw- '00 the increased safety awareness generated by the training, accidents hove been reduced 64% over the post 14 months. This new training system, which is expected to lower safety training costs by 60%, wftl be expanded globally. The Company alto is adapting the computer-based training concept to facilitate employee training in other areas of environ- "We've conducted audits to measure ment, health end safety, the effectiveness of our computer-based mduding process safety management. safety training. Ninety days after course completion, our employees have a retention rate of 93%. They also give the new training system an approval rating of 98%.* Dean Courviiie, Groce Davison General Foreman/Troining--Lake Charles 8. 9 W. ft. GRACE L CO. Cryovoc ' "breathable" films mean less spoilage and greater preservation of quality onit flavor throughout the distribution chain. CtyoYOC case-ready packaging for meats and poultry offers retafers benefits in inveritoiy mrmuqemeni, merchorv disitKi oncl distribution efficiencies. Cryovoc flexible packaging systems help food service operutois achieve efficiencies in ptepo* ration and storage* while imploring the quality and consistency of condiments, soups, sauces, dressings, pie fillings, juices, stews ond more. Grace Packaging -- Protecting the World's Food & More With consumers wonting greater convenience, demand has never been greater for "home replacement meals' such as precooked meats, soups, salads, ethnic specialties and pasta dishes. Grace is the world s leading supplier of flexible plastic packaging and container sealing systems for foods, Ileverages and consumer pnxlucls. In 1990. Grace Packa^irifi achieved 3-1 conseculive years of record sales and earnings growth. In the pasl five years, sales have grown at an average annual rate of 8% However, due to an exuaotdinary convctgence of external factors in 199b--liigh grain prices impacting pack aging sales to North American Iteef tinil pork processors: "mad cow" disease in Europe; and lower demand for shrink films in Asia Pacific--sales and (irotiLs increased only modestly. Market conditions liave begun to improve, and Grace Packaging expects to grow both sales and profits in 1997 by introducing new products, entering new market segments, improving operating efficiencies, and expanding its jx.-nelralkn) of developing legions-- particularly Asia Pacific and Linn America Approximately Italf tit Ute projected sales growth will come from programs to transfer existing technology horn one region to another. Tlic other half is expected lo come lit an new programs with glolxtl ptxentia]. Clear Competitive Advantages A unique combination of competitive strengths has contributed to the success of Grace Packaging It uses innovative resin and film processing technology, coupled with expertise in Iloth the food and packaging sciences Its total systems appmuch oilers customers a single source lor all of their packaging needs. Grace Packaging has a global presence anti lias dcvelo|>cd unparalleled relationships with food processors and retailers all over the world A global business lor more- than 30 years, it continues to strengthen its global capabilities by leveraging research and process technologies and sharing liest practices throughout the organization. Focusing on Global Growth Programs Graces patented TBGTM--total lioneguaid-- packaging for bone-in meats reduces spoilage rates and enhances inventorymanagement. Htglily abuse-resistant, TBG lugs are becoming the standard tor bone-in pork packaging in North America and are revolutionizing |xirk distiilxition in Europe. One European supermarket plans to use liiG packaging in all of its nearly 600 stores by the end of 1997. During 1996. Grace Packaging met increasing customer demand for 77J<7bags in Europe with a new production line In Ejicmon. France Case-ready meats are another highpotential growth opportunity for Grace. Hrc-pared in centralized processing plants and delivered fresh to retailers, case-ready meats are prepackaged in convenient sizes for consimxrrs This packaging solution provides consumers with enlianced quality and product availability. It helps retailers more effeclively manage- tlieir inventories and allows tlv-ro to redirect lalxx frexn in-stexv meal cutting to higher-value merchandising Grace 1`achagirtg lias used its expertise in ctx*xrnision technology to intnxluce a variety of thinner-gauge laminates. Tlie.se liglitweigln, high-performance materials are exceptionally well-suited for packaging cheese, smoked and processed meats axik-in meats and poultry The growing preference by consumers lor pit-pared lixxis to take home--eitlier fiom a restaurant or tile supermarket--should help drive highc-r demand for this pac kaging Hrecut prtxfucc is a small but rapidly growing market segment, offering healthy choic es and convenience to consumers to. it W. It OtACE a co. I Grace's sophisticated packaging materials match the breathing rates of different vegetables, help maintain freshness and entrance shelf life. The acquisition of Cypnss Packaging in mid-1996 positions Grace as the market leader in precut produce retail and institutional market segments, wlrich are expected to grow at an average annual rate approximating 25% over the next five years. Gruce Packaging lias a broad portfolio of strong, high-clarity films for consumer and industrial products. In 1996, Grace introduced a very thin film that provides the atxue protection required for software, audio and video cassettes, office and art supplies, greeting cards, posters and other paper products. This new film improves product appearance, creates efficiencies on the packaging line and, despite Its revolutionary thinness, performs as well as standard shrink films. Other catalysts for growth in display films include increased demand In packaging for warehouse clubs, and both growth of a middle class and enhanced distribution systems in emerging countries, particularly in the Asia Pacific region, where Grace started production in 1996 at a new display films plant in Malaysia. Integrating Container Products Capabilities During 1996, Grace merged its Grace Guntamer Products business into Grace Packaging to capitalize on technology and market synergies. GracePackaging is actively focusing on shared competencies in polymers and polymer processing, packaging and food science, emerging technology platforms such as oxygen scavenging, and a common approach to product devekrpment processes. Grace's innovative oxygen-scavenging tedinokigy maintains food and [leverage quality--without preservatives--and increases shelf life, which helps customers reduce product rotation and distribution casts Oxygen-scavenging sealants for beer bottle crowns were introduced worldwide in 1996. The 1996 acquisition of Bayern .5A. de C. V. in Mexico provides greater access to the rapidly growing Latin American market and will support the North American market with a full range of closure sealants and coatings. Grace also is globally extending Bayern's innovative technologies in can coatings and bottle sealants. Improving Oparating Effictonciat Grace Packaging is improving global operating efficiencies to increase profits at an even faster rate than sales. It improved asset management in 1996, reducing capital expenditures as a percentage of sales from 19% in 1995 to about 12% in 1996. Carrying time on accounts receivable was reduced nearly 10%. Inventory days-on-hand were reduced nearly 20% and total inventory, almost 13%. Grace Packaging is now reexamining its entire supply chain to realize further productivity gains. Other initiatives have focused on orga nizational effectiveness European operations were restructured, and $25 million in annual cost savings were iden tified. $10 million of which were implemented by year-end 1996. Realignment in North America resulted in a more market-focused opera tion. In Asia Pacific, Grace [Packaging moved local talent into key positions to strengtlien tlie organi zation. The marketing function in Latin America was upgraded to pro mote rapid expansion and identify new growth opportunities -- Mw* hOmk1 aBPhufcy j &19UJ & flund Mftft h fUtfyw/iwfcM fat tmfan timrr. D'affey Contain Oract conlavw itdonti ond cooing mum lh* Integrity of mom than 450 bflKon cam and boriUt annually. A first-of-tts-kind, thin-gouge shrink film is newly developed for lightweight, low-abuse products, such os audio and video cassettes, office supplies and other printed poper products. New Grace sealant technology maintains freshness--with no preservatives--in oxygen-sensitive bever ages such as beer. 12. 13 W. I. GRACE * CO. Grace Construction Products -- A Record Year of Growing Profitably W7 IM2 Sale* Increase 10% m 1996 |S tnAont) Core Ptoducl !>**> Dtamwd TiuduU Imw> Grace Construction Products' record three fold improvement in pretax operating income anil 10% sales growth in 1996 resulted from improved productivity and increased customer acceptance of new value-added products and product enhancements. Grace concrete, cement and masonry products, waterproofing systems and fire proofing products enhance customer productivity and profitability. They prolong structural life with less maintenance and enable contractors to compete more prof itably. ITiese advantages, together with providing quality customer service, devel oping new products, expanding glnhally and improving productivity, form a solid basis for continued profitable growth. commercial use protects against ice dams and wind-driven rain. Monobote* MK-6s enables contractors to lx more pricecompetitive on smaller fireproofing jobs. New and specialty products should generate 50+% of construction products sales by 2000. Global Growth Across Ad Product linos Worldwide sales of cement additives and concrete admixtures increased through customer acceptance of new value-added pnjducl conversions and stronger construction markets in North America; gains in cement additives in France and Central Europe; gains in concrete products in tlx- U.K., Italy and Spain: infrastructure projects in Asia and an Australian acquisition, hurdler growth 1 Monokotm* firproof ing oncaws and inwtatM structural stool to protect against failure in the event of fire. Improving Operating Efficiencies Grace Construction IJroducts has significantly improved operating efficiencies. It has consolidated production operations, restructured global R&D and reduced man ufacturing costs in roofing underlayinents and fireproofing, it also lias trained 100% of its workforce in quality' management lectmiques and significantly upgraded information systems in North America. Introducing New and Value-Added Products In 1996. sales of new' and enhanced products increased nearly 35% versus 1995 and represented over 25% of total construction products sales. Polarset* noncorrosive set accelerator enables customers to pour and "work" concrete in cold temperatures without using corrosion-causing chemicals, DCI* corrosion-inhibiting admixture prolongs the life of concrete structures ADVA FlowTM superplasticizer cost-effectively improves concrete finishing. l')tor UltraTM self-adhered roofing underiayment for Is expected as developing economies continue ro convert from hand-mixing concrete on the job site to more sophisti cated and efficient ready-mix operations. Increased customer accep- , tancc of new products drove world wide waterproofing sales growth Growth in fireproofing | depends on increased use of struc tural steel. In 1996, increased fireproofing sales resulted from continued strengthening in nonresidcntial construction in North America; strategic marketing initiatives in Europe such as a customer training program; and continued peneiraiion of Asia Pacific markets. Robert J. Beftoccbi President, GroceConstruction Products .Conthfidgei Mossochusetf* ; "OurnKon} performance M belhtolei growth ond profitoWbyeOWd wot the direct resub o^hard work, dedication ond innoeofton by every member of cor worldwide employee team. In redefining our cost structure and busineu poirfblie* and implementing soond.strahigic plans ineocb of our core product Unev we estoblhhed d rr-cf-solid foundation for further prOtiMble growth. This brings as much <doset ts tentttlnpcw vbfon (ii rtt.c /. ( cV r.rrpjft . M*lf udb*`rrd tcnu<i :i rt ihot i >vi,<imii. n> ,) <>' t uqciinst Ip> fiItt no > l < |nri"> n Off 'Dll r* *< ' oi i ir.ol j| vtf- H y dr coprocessing catalysts improve the quality of feeds [ for finished refined product* such as gn'olinf. Gasoline is produced using llui'.l crocking cata lyst*, Huid Tracking tnlntysl additives allow refin>rs lo m#-et the challenge at refoirnuloted gasoline'. Syloid' silicas control gloss ut the coatings that lirthli automotive dashboard and tiirn elements and leather and vinyl upholstery Phonosorb*} desiccont odsorbents prevent inltrnol condiinotion in imukohng gloss windows and assure a dear view. Sylodcnt silicas enhance cleaning capabilities and thicken toothpastes. Syloid' silicas act as thickeners, anti-coking agents, glkfcmts, active tnyredient turners, moisture scavenge* ir tobletting aids, oil absoibe-fs und gloss reducers in pharmoceufifuU and perianal core products ^ ^ . Sybbfac ' tilitos moke 'piastre him easier to handle!, open ami fill. ^ ^KS.WSWMOCOBS'y. . ^ ^ , R. Hyde President, Grom l>twiMin flttltftfWII/ /Wnryfrmd My 3S yeidrA ^ -V^V ;bo$tteiv I 'ye never jpOv .. tye..x--' hova thv n0ht fttimologifes, the right products the,global reach and tnemonufpchjrir^,R?vb1fty , ^fbkeifulffldydirtftJge of the Opppffedrftes before pplitulions for our.silica produtK y limille^sj-w^g^i.onT mially m ponding t>t teorrtging rhfirmry morkrt snvnrol door\ for nnw fluid tracking catalyst applications. Estaloting consumption of fuel, plastics, c&Otings and Othc products due to improved qualify ol lif in A&io Pacific should fuel growth .-in all our businesses. 1 Daroctor ' silica adsorbents prevent beer front clouding by adsorbing proteins during chillproofing. Papers using new $y(ojotw silicas for color reproduction offer excellent color "snap" and improved print resolution. They also absorb excess ink for quick drying. Syloid ' silicas ore used to control gloss in paints and coatings. Foi example, they provide exceptional clarity, depth and smoothness in wood finishes. 1995 and 1994, respectively. 1996 also includes (a) the gain of $2,603 1 on the dispositions of NhC, Aaicon and Agracetns and (b) a $31.9 reversal of a previously recorded provision for Grace's cocoa business, partially offset by (c) the charge of $4.6 recorded in connection with the classification of TEC Systens as a discontinued operation. 1995 includes a provision of $131.3 relating to Grace's remaining discontinued operations, primarily Grace's cocoa business. (4) The stock prices ior 1995 - 1992 and the first nine months of 1996 have been adjusted so that they are on a basis comparable to the stock prices following the disposition of NNC. F-26 63 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESLLTS OF OPERATIONS AH> FINANCIAL CONDITION REVIEW OF OPERATIONS OVERVIEW Sales and revenues decreased 3% in 1996 versus 1995, and increased 14% in 1995 over 1994. Excluding divested businesses frosi all periods, sales and revenues increased 3% in 1996 over 1995 and 14% in 1995 over 1994. Pretax incore/(loss) fron continuing operations was $348.6 Billion in 1996, $(284.1) million in 1995 and $(77.7) Billion in 1994. As noted in the table below, pretax income/(loss) iron continuing operations for all three years was affected by various special ites. Grace's 1996 pretax operating incone before special itens of $419.4 Billion increased 14% over 1995, and 1995 pretax operating incone before special itens of $367.4 million increased 19% over 1994. Excluding divested businesses, pretax operating incone before special itens increased 12% in 1996 over 1995 and 20% m 1993 over 1994. For all periods presented, pretax operating results have been restated to reflect the classification of certain businesses as discontinued operar.i on*. R. GRACE A CO. AND SUBSIDIARIES PRETAX OPERATING RESULTS - CONTINUING OPERATIONS 1996 (Do)lars in tn l linns) 1995 1994 Sales and revenues, before divested businesses ................................................................... $3 .252.2 Sales snd revenues ot divested businesses (1) ...................................................................... 201 9 Sales and revenues ................................................... ............ ................................. $3 .454.1 $ 3.150.9 401.7 $ 3.552.6 S2 .758 7 369 8 S3,128 5 Operating incone before special itens and divested businesses ................................... t 417.4 Operating incone of divested businesses (1) ............................................................................ 2.0 Operating ineone before special itens (2) ...................................................................... Special itens: Gain on sales of businesses ............................................................................................................. Restructuring costs and asset inpairnentt/other activities ..................................... Provisions relating to asbestos-relatsd liabilities and insurance coverage.. Provision for corporate governance.............................................................................,............. Provisions for environmental liabilities at forner manufacturing sites ... Gain on sale of remaining interest in REG ............................................................................ $ 419.4 326 4 (107.5) (229.1) .. Operating income/(loss) fron continuing operations ................................................. $ 409.2 Other incone/ (expenses) (3): Interest expense snd related financing costs ................................................................. Other income/(expenses). net ...................................................................................................... (71.6) 11.0 Income/(loss) fron continuing operations ........................................................................ t 348.6 $ 374.0 (6.6) s 367.4 (209.5) (275.0) (30.0) (77.0) $ (224.1) (71.3) 11.3 $ (284.1) S 311.7 (1.9) s 309.8 (316,0) (40.0) 27.0 s (19.2) (49.5) (9.0) s (77.7) (1) Primarily reflects Grace's water ireatnent and process chcnicala business, divested in June 1996. (2) Reflects the allocation of general corporate overhead, general corporate research expenses and certain other incone and expense itens that can be identified with continuing operations. (3) Corporate interest and financing costs and nooallocable expenses are not reflected in pretax operating incone fron continuing operations because significant financing decisions are centralized at the corporate level, other income/(expenses), net includes interest income relating to the settlement of prior years' federal income tax returns uX $7.5 million m 1990 aiui $9.8 nilliun in 1995. W. R. GRACE A CO. AM) SUBSIDIARIES (excluding divested businesses) SALES AND REVENUES Packaging Container Total Packaging ................................................. Catalysts and other silica-bated products Construction..................................................... \ .. Other (i;> ................................................................. Sales anrl revenues.......................................... (Dollars m millions) 1996 1995 1994 . Percentage Change '96 VS '9? '95 vs. < $1,735.4 $1,692.1 $1,417 5 274.7 279.9 252 9 2.6 % (1.9) 19.4 % 10.7 $2,010.1 732.2 435.0 74.9 $1,972.0 699.9 397.2 81.8 $1,670 4 615. 1 387 1 86.1 $3,252.2 $3,150.9 $2,758 7 1.9 4.6 9. 5 (8.4) 3.2% 18.1 13.8 2.6 (5.0) 14.2 % SALES AM) REVENUES ESTIMATED VARIANCE ANALYSIS 1996 AS A PERCENTAGE OP 1995 1995 as a Percentage of 1994 VOLLME PRICE/MIX TRANSLATION TOTAL Volume Price/Mix Translation iotai Packaging..................................... ....................... Container .............................................................................. Total Packaging.................................................................. Catalyst! and other silica-based products .. Construction ................................................................................ Other (1) ...................................................................................... Sales and revenues ........................................................... 39% 1.0 3.4 7.2 8.8 (5.9) 4.7% (!* (3) (.9) (1.3) .9 .1 (.*)* ( 3)* (2.6) (.6) (1.3) (.2) (2.6) (.7)* 2.6 (1.9) 1.9 4.6 9.5 (84) 3.2 t 10.2 % 49 94 4.7 .4 (8.2) 9.7 % 6.0 % 8 5.2 4.7 1.1 (8) 1.7 % 3.2 % 50 3.5 4.4 1.1 4.0 2.8 % 19 4 % 10 7 18.1 13.8 2.6 (5.0) 14.2 % (1) Primarily reflects Grace's specialty polymers business, which is expected to be divested in 1997. P-27 64 SALKS AM) KKVLNULS As noted iii Lbe preceding table, sales aud revenues (excluding divested businesses) increased 3% in 1996 over 199S, reflecting a favorable volume variance estimated at 5% (with increased volumes in all core product lines), offset by unfavorable price/product nit and currency translation variances estimated at 1* each. The following is a discussion of the sales and revennes of Graoe's product lines. PACKAGING 1996 sales increased 3% over 199S, a year in which sales increased 191 over 1994. 1996 laminate sales increased in all regions, particularly in T.at.in America and Asia Pacific dne to market share growth, and in North America primarily dne to a strong fourth qnarter in the rolistock and processed and prepared foods market tegmenta. 1996 sales growth in bags was modest overall. Sales volumes in bags increased in Latin America dne tc economic improvement in Argentina, increased cattle slaughter rates in Urngnay and higher per capita beef consumption in Brazil. Growth in North American bag sales, due to continued penetration of TBG (total boueguaid) bags in the fresh red meat segment, was partially offset by lower volumes in the meat producing and processing industries, et higher corn prices led tc reductions in beef herds, which in torn drove down volumes. Sales of bags in Asia Pacific and Europe were flat, as the negative effects of reduced beef consumption doe to oonsnmer feara associated with the outbreak of E. ooli bacteria and the publicity surrounding bovine spongiform encephalopathy in the United Kingdom --- commonly referred to as "mad cow disease' --- were partially offact by the positive effects of increased consumption of other lresh red meats, poultry and lish. Film sales in 1996 were flat, as sales growth in Europe was offset, by sales declines in North America and Asia Pacific dne to continued pricing pressures. The improvement in Europe resnlted from growth in demand in the U.K. bakery market segment and higher sales from new prodnet introductions. CONTAINER Sales decreased slightly in 1996 versus 1993, as sales declines in closure compounds (dne to lower consumer demand for beverage products in Europe end a decrease in market ahare in Asia Pacific) were partially offset by volume increases from improved market penetration of can coating products in Latin America (primarily dne to the 1996 acquisition of Bayern S.A. de C.V., a Mexican producer of oan ooatingi and oloanre aeslanta for the rigid container industry). North American container sales were np slightly dne to strong sales of can sealing compounds. CATALYSTS AND OTHER SILICA-BASED PRODUCTS 1996 ssles of catalysts and other silica-bascd products benefited from continued expansion into new markets and the introduction of higher-value-added products and new technologies, partially offset by competitive pricing pressures. Volumes increased in all regions, especially in Asia Pacifio dne to an increase in market share in refinery catalysts. However, in Enrope and North America, refinery catalyst sties continued to be negatively impacted by competitive pricing pressures. Polyolefin catalyst sales were positively impacted by the strong resin market, and silica/adsorbent tales benefited from new product applications in Enrope and Asia Pacific. CONSTRUCTION Sales increased in all regions and within all prodnet. lines, especially in North Ancrioa, where volumes in conoxctc and waterproofing products benefited from growth in housing starts and infrastructure projects. Also significantly contributing to the increase was the positive inpact of an increase in market share for fire protection and concrete products in Asia Pacific. Sales also have risen due to the introduction of new products. OPERATING RESULTS - 1996 COMPARED TO 1995 Pretax operating income before special items (excluding divested businesses) increased 124 in 1996 as compared to 1995. at cost nanagenent programs continued to favorably impact results across all regions and product lines. As further discussed belov under "Statement of Operations: Restructuring Costs, Asset Impairments and Other Costs,' Grace has implemented a worldwide program to streamline processes and reduce general and administrative expenses, factory administration costs and noncore corporate research and development expenses. In addition. North American results in 1996 were positively aflected by sales volume increases in construction products and bags and laminates, partially offset by a decline in refinery catalyst, sales. European resalts vere favorably impacted by volume increases in construction prodnets and siiicas/adsorbents. In Asia Pacific, resnlts declined, reflecting lower pricing and an unfavorable prodnet mix in bags, and volume declines in closure compounds, partially offset by volume increases in construction products end refinery and polyolefin catalysts, as discussed above. Also affecting 1996 resnlts were higher expenses associated with the start-up ul new silica and packaging plants in Kuan tan, Malaysia. Latin American results were favorably impacted by volume increases in bags ind can coating prodnets, as discussed above. OPERATING RESULTS - 1995 COMPARED TO 1994 As noted above, sales and revenues (excluding divested businesses) increased 144 in 1995 over 1994, reflecting fivorable volume, price/product mix and currency translation variances estimated at 104, 14 and 34, respectively. Pretax operating income before special items (excluding divested businesses) increased 204 in 1995 over 1994. Vnlnmes increased in all core prndnet lines. Packaging volume increases reflected higher sales of bags, films and laminates in all regions, other than laminates m Latin America. Container volume increases resulted from increased tales of esn sealing prodnets in Asia Pacific and coating prodnets in Latin F-28 65 America. Volume increases in catalysts and other silica-based products reflected higher sales in all regions, especially refinery catalysts in Asia Pacific and .Europe, and silica/adsorbent products in Europe and Asia Pacific. North American operations experienced reduced profitability in refinery catalysts, refiners continued to experience low margins, as the narrow spread between light and heavy erode oil prices led enstoners to crack higher-quality light crude (which requires fewer catalysts). Construction products experienced volune increases, primarily in Asia Pacific dne to increased construction activity, partially offset by volome decreases in fire protection products in North America (dne to a small market share decline) and waterproofing products in North America and Europe (doe to higher material costs and a slowdown in the nonresidential construction market). Operating income before taxes also benefited from an economic recovery in Europe that revitalized key markets and the absence of costs incurred in 1994 to streamline European packaging and container operations, partially offset by higher operating costs incurred to increase market share in the Asia Pacific region. STATEMENT OF OPERATIONS INTEREST EXPENSE AND RELATED FINANCING COSTS Excluding amounts allocated to discontinued operations, interest expense and related financing costs of $71.6 million in 1996 were flat versus L995. Including amounts allocated to discontinued operations, interest expense and related financing costs decreased L0% in 1996 over 1995, to $147.9 nillion, primarily dne to lower average short term interest rates. Grace's debt and interest rate management objectives are to rednee its cost of funding over the long term. To manage the interest profile on its debt, Grace enters into interest rate agreements; during 1996 most of thcic agreements effectively converted fixed-rate debt into variable-rate debt. These agreements have readily quantifiable impacts on interest, cost, and are characterized by broad market liquidity. bee 'Financial Condition: Liquidity and Capital Resources" below lor farther information on borrowings and interest rate agreements. RESEARCH AM) DEVELOPMENT EXPENSES Research and development spending decreased 16% in 1996 versus 1995. The decrease reflects the positive impact of cost management initiatives, primarily the closing of Grace's corporate research facility, the transfer of core research and development activities to existing product line facilities, and the termination of activities not related to Grace's core packaging and specialty chemioala businesses. Research and development activities include research m specialty packaging, catalysts, construction materials and process engineering. RESTRUCTURING COSTS, ASSET IMPAIRMENTS AND OTHER COSTS Restructuring Costs Grace recorded restructuring charges of $75.4 million in 1996 and $129.8 million in 1995 ($49.0 million and $85.1 nillion after-tax, respectively). Grace began implementing a worldwide program in 1995 to streamline processes and reduce general and aduiuislraLive expenses, faclury administration costs and noncore corporate research and development expenses. Under this program Grace has implemented, and expects to farther implement, additional coat redactions and efficiency improvements, as it farther evaluates and leengineers its operations. In connection with these actions, Giace recorded pretax charges of $53.7 million and $21.7 nillion in the second and fourth quarters of 1996, respectively. These charges primarily relate to headcnnnt. redactions, the restructuring of Grace's F.nropean packaging operations (in areas snch as working capital management, nannfactnring and sales) and the farther restructuring of Grace's corporate research activities, certain of which are now conducted at product line facilities - The coaiponenta of the 1996 and 1995 restructuring charges, spending and oilier acliviiy during 1995 and 1996. and Lite renaming reserve balances si December 31, 1996. were as follows: Employee Termination Benefits Plant/Office Closures Asset Write-downs Other Costs Total Restructuring provisions recorded in 1995 ... Cash payments during 1995 ................ Noncash activity ..................................... s 74.3 ' (13.0) S Restructuring reserve at December 31. 1995 .. s 61.3 Restructuring provisions recorded in 1996 ... Cash payments during 1996 ................ Noncash activity ................................ 69.3 (57.8) 13.4 $ (3.5) 18 6 (4.3) $9.9 $ 14.3 6.1 (.6) (14 3) $23.5 (3.1) (1.5) $129.B (19.6) (5. 8) $18.9 $104.4 (16.0) 75.4 (74.4) (14 3) Restructuring reserve at December 31, 1996 . s 72.8 S 15.4 $ $ 2.9 $91.1 tmployee termination benefits primarily represent severance pay and other benefits (including benefits under long*term incentive programs paid over time) associated with the elimination ol approximately 1,300 positions worldwide, with more than 60* of the eliminated positions coming from worldwide corporate staff functions and the restructuring of Grace's worldwide packaging operations. Through December 31, 1996, approximately 800 positions had been eliminated worldwide. F-29 66 Grace's estimated annual cost savings under the restructuring prograns are expected to total approximately $140 aillion when tally realized, with approximately $100 million being realised annually as a result ui tbe actions taken throngh the end of 1996. The remaining actions nnder the programs are expected to be substantially implemented daring 1997. Asset Impairments During 1996 and 1996, Grace determined that, dne to various events and changes in circumstances (including the worldwide restructuring prograns described above), certain long-lived assets and related goodwill were impaired. As a result, in the fourth quarters of 1996 and 1995, Grace recorded noncash pretax charges of $32.1 nillinn and $39.2 million, respectively ($20.9 million and $26.6 million after-tax, respectively), the majority of which related to assets that will continue to be held and used in Grace's psekaging and specialty chenicals businesses. The components of the 1996 and 1995 charges were (a) goodwill and other intangibles of $11.1 nillion and $4.7 million, respectively; (b) properties and equipment of $9.0 nillion and $20.0 million, respectively; (c) long-term investments of $6.7 million and $8.6 million, respectively; and (d) other assets ol $5.3 million and $5.9 million, respectively. Grace determined the amounts of the charges based on varioas valuation techniques, including discounted cash flow, replacement cost and net realizable value for assets to be disposed. Other Coats In the fourth quarter of 1995, Grace recorded pretax charges totaling $40.5 million (S25.9 million after-tax) relating to the write-down of corporate assets ($27.0 million) and working capital assets ($13.5 million). INC0MJ TAXES Grace's effective tax (benefit) rates were 38.7% in 1996, (36.8)% in 1995 and (54.8)% in 1994. Excluding the special items shown in the table under "Review of Operations: Overview' above, Grace's effective tai rates were 38.0%, 33.1% and 34.8% in 1996, 1995 and 1994, respectively. The lower ellective Lax rate in 1995 compared tu 1996 was largely due Lu the reversal in 1995 of a valuation allowance on foreign net operating losses. The lower effective tax rate in 1995 compared to 1994 was primarily due to the reversal m 1995 of the valuation allowance on foreign net operating losses and lower state income taxes, partially offset by higher taxes on foreign operations. Grace has provided a valuation allowance relating to uncertainly as to the realization of certain deferred tax assets, primarily state and local net operating loss carryforwards and net deferred tax asacta. Tax planning strategies dnring 1996 enabled Grace to reverse the valuation allowance on tax credit, carryforward* during the year. Eased on anticipated fnt.nre results, Grace has concluded that it is more likely than not that the remaining balance of the net deterred tax assets, alter consideration of the valuation allowance, will be realized. DISCONTINUED OPERATIONS HEALTH CARE Dnring 1996, Grace completed the separation of National Medical Care, Inc. (NMC) and sold its separations science business (Amicon). These businesses, representing Grace's principal health care businesses, had been classified as discontinued operations in 1995. 1996 income from discontinued operations of $2,643.9 million inclndes income ol $24.8 million ($60.3 nillinn pretax) from health care operations, a tax-free gain of approximately $2.5 billion on the NMC transaction, snd a gain of $40.0 million (S70.4 million pretax) on the sale of Amicon. (Loss)/income from discontinued opeiattons of $(146.3) Billion in 1995 and $118.4 Billion in 1994 includes income from health caie operations of $22.0 million ($104.6 million pretax) and $124.'' million ($227.1 million pretax), respectively. COCOA Grace's cocoa business was classified as a discontinued operation in 1993. During the fourth quarter of 1995, Grace revised the divestment plan for the business. The revised plan focused on the improvement of operating cash flow through the adoption of new strategies and a new global organizational structure, while better positioning the business for outright sale. As a result of this revised divestment plan, Grace recorded an additional provision of $151.3 Billion (net of an applicable tax effect of $48.7 million) related to the cocoa business and other remaining discontinued operations. In Decenber 1996, Grace announced that it had entered into a definitive agreement to sell the cocoa hnsinesx to Archer-Danie1s-Midland Company. As a result, in the fourth quarter of 1996, Grace reassessed its estiaated loss on the divestment ot the business and reversed previously recorded provisions of $31.9 million (net of an applicable tax effect of $18.1 million), within income from discontinued operations. The divestment of tbe cocoa business was completed in Febrnary 1997, with Grace receiving $470.0 million (inclusive of debt assumed by the buyer), subject to adjustment. OTHER In the fourth qnarter of 1996, Grace classified its thermal and emission control systems business (TEC Systems) as a discontinued operation. In connection with clasaifying TEC Systems as a discontinued operation, Grace recorded t provision of $4.6 million (net of an applicable tax benefit of $2.4 million) related to TEC Systems' anticipated net operating results throogh the expected date of divestment, as well as tbe loss anticipated on the divesT.raent. In May 1996, Grace completed the sale of the transgenic plant business of its Agracetus subsidiary to tbe Monsanto Company tor $150.1) million, resulting in a pretax gain of $129.0 million ($79.4 million after-tax, or $0.86 per common share of the Conpany). Additionally, in March 1996, Grace sold its microwave business for gross proceeds of $3.9 million. F - 30 67 In February 1995, Grace sold it* composite materials business ior gross proceeds of $3.0 million. During 1994, Grace sold its battery separators business and a portion of its engineered naterials and systeas businesses lor gross proceeds ui $316.2 million, approximating prior estimates. Grace also sold its animal genetics and Caribbean fertilizer operations in 1994 lor proceeds of $44.1 million. In 1994, Grace also sold substantially all of its interests in Colowyo Coal Company (Colowyo) for proceeds of $21$.3 million, including $192.8 million of proceeds from a nonrecourse financing secured by a portion of the revenues from certain long term coal contracts. Grace retained a limited partnership interest in Colowyo, entitling it to share in the revenues iron these coal contracts. These businesses were classified as discontinued operations in 1993 (other than TEC Systems in 1996 and Colowyo in 1992). TINANCIAL CONDITION LIQUIDITY AND CAPITAL RESOURCES Grace's continuing operating activities provided net pretax cash of $355.6 million in 1996, versos $247.3 million in 1995. The improved cash flow from operations iu 1996 was oil set by Use expenditure ol $2.1 million lor the defense and disposition of asbestos-related property damage and personal injury litigation, net of amounts received under settlementa with insurance carriers, compared to a cash inflow from asbestos-related litigation, net of insurance recoveries, of S97.0 million in 1995. After giving effect to the net pretax cash provided by operating activities of discontinued operations and payments of income taxes, the net cash provided by operating activities increased $116.3 million in 1996 versns 1995. Investing activities provided $2,072.9 million of cash in 1996, largely reflecting net cash proceeds of $2,720.3 million from divestments ol businesses. This exclnderi (a) $100.0 million received in Jsnnary 1997 on the 1996 sale of the water treatment and process chemicals business; and ib) $115.6 million received m January 1997 on the 1996 sale of Amicon. Grace made capital expenditures of $456.6 million in L596, primarily related to the packaging and catalysis and other silica-based prodncis businesses. Also, net investing activities of discontinued operations for 1996 used $192.9 million of cash (compared to $295.2 million in 1995); primarily decreasing as a result ui the disposition of NMC iu the 1996 third quarter. Grace anticipates total capital expenditures ior 1997 to approximate $300 million, all of which will be directed towards its core businesses. Net cash used lor financing activities in L996 was $2,267.$ million, primarily reflecting redactions in debt, the repurchase of stock (discussed below), and the payment of dividends, pertially offset by proceeds from the exercise of employee stock options. Total debt was $1,38$.2 million at December 31, 1996, a decrease of $545.6 million from December 3L. L995. In addition to the reduction of debt, in 1996 Grace terminated agreements to sell np to $300 million of interests in designated pools of trade receivables, $180 million of which pertained to NMC. At Tlecenher 31, 1995, $295.8 million had been received pursnant to snch sales, S179.8 million of which pertained to NMC. Grace initiated-a program in April 1996 to xepnrchaae 10.0 million shares of its common stock. As of September 27, 1996, Grace bad acquired 9.864,$00 shares under this program at a cost of $727.1 million (or an average price of approximately $73.70 per share, before adjustment for the effect of the NM2 transaction on Uie price per share of Grace stock). Following the NMC transaction, Grace implemented a second progran to repurchase np to 20a of the approximately 89.0 million shares then outstanding. Through March 4, 1997, Grace had repurchased 16,019,900 shares at a cost of $849.L million (or an average price of approximately $53.00 per share). As Grace's balance sheet is restructured to support its core hnsineasea, Grace is targeting * ratio of debt, (net of cash and short.-term investments) to earnings before interest, taxes, depreciation and amortization (EBITDA) of 1.6 to 2.0. Grace believes this ratio is the appropriate measure of leverage lor management purposes because it compares debt to the pretax cash flow available to service debt. Also, it is not subject to distortion (as traditional debt/equity or debt/ capital ratios are] following a major share repurchase progran such as those Grace has executed. At the targeted debt/EBITDA. level of 1.6 to 2.0, Grace benefits iruu the taa advantages ul debt liuaucmg ou its overall weighted average cost of capital while retaining the financial flexibility to invest in the continued growth of ita core baainesaet. Grace believea it can safely exceed its target leverage rtnge on a short-tern basis to oeet its investnent needs. The cash received and to be received from divestnents is being ased to reduce debt and repurchase shares to bring the capital structure within the target range. At December 31, 1996, the debt/EBITDA ratio was 2.3, outside the target range primarily due to the timing of the share repurchases ahead of cash divestment proceeds. It is expected that the ratio will be within the target range in 1997. Tn May 1996, Grace entered into a revolving credit agreement, expiring May 1997, providing for total borrowings of $1.85 billion, and terminated three previous agreements providing lor total borrowings of $850 million. Daring the fourth quarter of 1996, Grace reduced the borrowings available under this new credit agreement to $650 million, reflecting the completion of the MC transaction. In addition, Grace continnes to have $350 nillion available under a separate long-tern facility expiring on September 1, 1999. Thus, Grace had committed borrowing lacill Lies totaling $1.0 billion, of which $471.3 nillion was available, at the end of L996. In October 1996, Grace announced that it expected to divest four noncore businesses by late 1996 or 1997. The businesses to be sold were Grace's cocoa business, Anicon, TEC Systems and Grace's specialty polyneri business. As noted above, in December 1996, Grace completed the sale of Amicon and announced that it bad entered into a definitive agreement to sell its cocoa business. In Febrnary 1997, Grace completed the sale of the cocoa business and entered into an agreement to sell its specialty polymers business. Grace expects to complete the sale of its specialty pelyners hnsiness in t.he second quarter of 1997 and t.he sale of TEC Systems in 1997. F-31 68 ASBbS 10S - KHLA'IHU MAHERS Grite is a defendant in lawsuit* relating Lu previously sul(l asbestos-containing products. In 1996, Grace paid 32.1 Billion lor the defense and disposition of asbestos-related property damage and personal injnry litigation, net of amounts received nnder settlements with insurance carriers. Daring the ioarth quarter of 1996. Grace recorded a noncash pretax charge of $229.1 million ($148.9 million alter tax), primarily to reflect the estimated costs of defending against and disposing of personal injury claims expected to be filed through 2001. The estimated costs nsed to determine the amonnt of this charge have not been discounted to their present values, and the time period over which the associated cash is actually expended is likely t.n extend beyond 2001. The balance sheet, at. year-end 1996 includes a receivable of $331.3 million dne from insnrance carriers. Grace also has recorded notes receivable of $53.9 million ($48.5 million after discounts) lor amounts to be received from 1997 to 2001 pursuant to settlement agreements previously entered into with insurance carriers. Although the total amounts to be paid in 1997 with respect to asbestos-reli ted claims (after giving effect to payueuts u> be received Iruu insnrance carriers), cannot be precisely estimated, Grace expects that it will be required to expend approximately S75-$100 million (pretax) in 1997 to defend against and dispose of sach claims (after giving effect to anticipated insurance recoveries). Ihe amounts with respect to the probable coat of defending against and disposing of asbestos related claims and probable recoveries from insurance carriers represent estimates and are on an nndisconnted basis: the oatcomes of such claims cannot be predicted with certainty. Sec Note 2 to the Consolidated Financial Statements for farther information concerning asbestos-related lawsuits and claims. ENVIRONKENTAI MATTERS Grace is subject to loss contingencies resulting from environmental laws tnd regulations. Worldwide expenses of continuing operations related to the operation and maintenance of environmental facilities and the disposal of hazardous and nonhazardout wastes totaled $44.5 million in 1996, $42.6 million in 1995 anil $35.0 million in 1994. Such costs are estimated to be $45.0 million in 1997 and $47.0 million in 1998. In addition, worldwide capital expenditures for continuing operations relating to environmental protection totaled $17.1 million in 1996, compared to $14.9 million and $21.5 million in 1995 and 1994, respectively. Capital expenditures to comply with environmental initiatives in future years are estimated to be $13.0 nillion in 1997 and $12.0 million in 1998. Grace also has incurred costs to remediate environmentally impaired sites. These costs were $20.3 million in 1996, $31.3 million in L995 and $30.8 million in 1994. These amonnts have been charged against previously established reserves. Fntnre cash nnt.lays for remediation costs are expected to total S23 0 million in 1997 and S26.0 million in 1998. Expenditures have been funded from internal soarces of cash and are not expected to have a significant effect on liquidity Grace accrues for anticipated costs associated with investigatory and remediation efforts where an assessment has indicated that a loss is probable and can be reasonably estimated. In the fonrth quarter of 1995 and the first quartei of 1994, Grace recorded pretax provisions of $77.0 million and $40.0 million ($50.0 million and $26.0 million after-tax), respectively. The 1995 provision related principally to increased cost estimates associated with five former manufacturing sites. At December 31, 1996, Grace's liability for environmental investigatory and remediation costs related to continuing and discontinued operations totaled $256.4 million, aB compared to $280.3 million at December 31. 1995. These accruals do not take into account, any disconnt.ing for t.he time valne of noney. Additionally, Grace is in litigation with certain excess insnrance earners regarding the applicability of the carriers' policies to environmental remediation costs; given the uncertainties inherent in this litigation, Grace has not recorded a receivable with respect to such insurance coverage (except in one instance where a settlement with a carrier has been reached). Grace's environmental liabilities are reassessed whenever circumstances become better defined and/or remediation efforts and their costs can be better estimated. These liabilities are currently evaluated quarterly, based on available information, including the progress of remedial investigation at each site, the entreat status of discussions with iegnlatory authorities regarding the method and extent of remediation at each site and the apportionment of costs among potentially responsible parties. As some of these issues are decided (the outcomes of which are subject to uncertainties) and/or new sites are assessed and costs can be reasonably estimated, Grace will continne to review and analyze the need for adjustments to the recorded accruals. However, Grace believes that it is adequately reserved for all probable and estimable environmental exposares. 69 SCHEDULE II W. R GRACE * CO. AM) SUBSIDIARIES VALUATION AM) QUALIFYING ACCOUNTS AM) RESERVES (in mlliuiu) For the Year 1996 Description Additions (deductions) Balance at beginning of period Charged (credited) to costs and expenses Other, net** Balance at end of period Valuation and qualifying accounts deducted fron assets: Allowances for notes and accounts receivable . . . . Allowances for long*tern receivables ................................ Securities of divested businesses.......................................... > i 1 12.9 24.7 3.5 x x s 4.9 x 3.7 S S (6.3) t 14 3 x 04 S 11.5 42 7 39 Valuation allowance for deferred tax assets................... i 97.7 I (25.3) $ S 72.4 Reserves: foreign employee benefit obligations* i 95.3 x 6.9 s (17.3) % 84.9 Discontinued operations............................................................ i 366.7 $ (105.7) % (91.S) S 169.2 For the Year 1995 Description Additions (deductions) Charged Balance at (credited) to beginning costs and ol period expenses Other, net** Balance at end of period Valuation and qualifying accounts deducted fron ssseta: Allowances for notes and accounts receivable . . . . Allowances for long*tern receivables ................................ Securities of divested businetees.......................................... Valuation allowance for deferred tax assets................... Reserves: Foreign employee benefit obligations* ............................ Discontinued operations................................................................. X X X X X X 95.2 20.6 4.9 137.0 x x x x 82.5 239.3 X X 131.2 x 3.7 $ $ (32.0) $ (213.5) X 0.4 s (1.4) X (7.3) X 10.6 127.4 X X 2.2 X .X 12.9 24. 7 3.5 97.7 95.3 366.7 Tor the Year 1994 Description Addj.tj.oQ5 (deductions) Balance at beginning ol period Charged (credited) to coats and expenses Other. nei** Balance at end oi period Valuation and qualifying accounts deducted from assets: Allowances for notes and accounts receivable . . . . 1 50.3 s 102.2 $ (57.3) $ 95.2 Allowances for long-term receivables ................................ ; 13.4 s 6.9 S 0.3 % 20.6 Securities of divested businesses.......................................... I 161.2 s s (156.3) $ 4.9 Valuation allowance for deferred tax assets................... i 129.7 s s 7.3 % 137.0 Reserves: Foreign employee benefit obligations* ............................ Discontinued operations....................... i 64.4 $ U.6 $ ! 132.1 s 107.2 $ 6.5 S .s 82. 5 239 3 Represents legally mandated employee benefit obligations, primarily pension benefits, relating to Grace's operations in Europe. ** Consists of additions and deductions applicable to buaineaaes acquired, disposals of businesses, bad debt write-offs, foreign currency translation, reclassifications (including the deconsolidation of amounts relating to discontinued operations) and miscellaneous other adjustments. F- 33 LaserD II PRINT SUMMARY Accounting: Disabled Date Printed: Time Printed: 11/03/97 10: 48 AM. Company Name: Exchange: Ticker Symbol: Company Number: W R GRACE & CO DE N GRA W017250000 Document Type: Document Date: Amendment: Document Number: 10-K 12/31/96 97566699 Pages Printed: 103 LaserlL Conpany Nana: Exchange: Ticker Symbol: Company #: Document. Type: Document Date: Amendment: Document #: Disclosure SEC EDGAR Filing W R GRACE & CO DE N GRA WD172SOOOO 10-K 12/31/96 97566699