Kraton Polymers 10Q 2007 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Kraton Polymers LLC

(Exact name of Register as specified in its Charter)


Delaware		94-2805249
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)

15710 John F. Kennedy Blvd. Suite 300
Houston, TX 77032		281-504-4700
(Address of principal executive offices,		(Registrant’s telephone number, including area code)
including zip code)

Indicate by check mark whether the registrant (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 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YESo NOþ

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

Large accelerated filero Accelerated filero Non-accelerated filerþ

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

The equity interests of the registrant are not publicly held and the aggregate market value is therefore not determined.

DOCUMENTS INCORPORATED BY REFERENCE

TABLE OF CONTENTS


	PAGE
Part I — Financial Information
Item 1. Financial Statements and Accompanying Notes
Kraton Polymers LLC:
Consolidated Balance Sheets— September 30, 2007 (Unaudited) and December 31, 2006		4
Consolidated Statements of Operations (Unaudited) — Three Months Ended September 30, 2007 and 2006		5
Consolidated Statements of Operations (Unaudited) — Nine months Ended September 30, 2007 and 2006		6
Consolidated Statements of Cash Flows (Unaudited) — Nine months Ended September 30, 2007 and 2006		7
Notes to Consolidated Financial Statements (Unaudited)		8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		24
Item 3. Quantitative and Qualitative Disclosures About Market Risk		38
Item 4. Controls and Procedures		38
Part II — Other Information
Item 1. Legal Proceedings		39
Item 2. Changes in Securities and Use of Proceeds		39
Item 3. Defaults Upon Senior Securities		39
Item 4. Submission of Matters to a Vote of Securityholders		39
Item 5. Other Information		39
Item 6. Exhibits		40

FORWARD LOOKING STATEMENTS

This Quarterly Report on Form 10-Q includes “forward-looking statements,” as that term is defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical fact, included or incorporated in this Form 10-Q are forward-looking statements, particularly statements about our plans, strategies and prospects under the headings “Consolidated Financial Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We may also make written or oral forward-looking statements in our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and current reports on Form 8-K, in press releases and other written materials and in oral statements made by our officers, directors or employees to third parties. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or our achievements, or industry results, to differ materially from historical results, any future results, performance or achievements expressed or implied by such forward-looking statements. Such risks and uncertainties include, but are not limited to, competitive pressures in the specialty chemicals industry, changes in prices of raw materials used in our business, changes in levels of consumer spending or preferences, overall economic conditions, the level of our indebtedness and exposure to interest rate fluctuations, governmental regulations and trade restrictions, acts of war or terrorism in the United States or worldwide, political or financial instability in the countries where our goods are manufactured and other risks and uncertainties described in this report and our other reports and documents. These statements are based on current plans, estimates and projections, and therefore you should not place undue reliance on them. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update publicly any of them in light of new information or future events.

PART I — FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

Kraton Polymers LLC

Consolidated Balance Sheets

September 30, 2007 and December 31, 2006
(In thousands of U.S. dollars)


	September 30,		December 31,
	2007		2006
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	32,317	$	43,601
Receivables, net of allowances of $1,982 and $2,157		153,158		135,937
Inventories of products, net		284,430		256,785
Inventories of materials and supplies, net		12,214		10,903
Other current assets		14,217		13,308
Deferred income taxes		1,938		1,931

Total current assets		498,274		462,465
Property, plant and equipment, less accumulated depreciation of $142,171 and $105,219		403,320		403,743
Identifiable intangible assets, less accumulated amortization of $27,399 and $21,978		81,210		86,631
Investment in unconsolidated joint venture		10,102		9,376
Deferred financing costs		10,825		13,038
Other long-term assets		15,349		13,900

Total assets	$	1,019,080	$	989,153

Liabilities and Member’s Equity
Current liabilities:
Current portion of long-term debt	$	3,445	$	3,850
Accounts payable-trade		117,388		68,940
Other payables and accruals		51,736		53,130
Due to related party		20,925		9,351
Insurance note payable		1,977		739

Total current liabilities		195,471		136,010
Long-term debt, net of current portion		535,881		578,263
Deferred income taxes		35,221		40,107
Other long-term liabilities		36,366		35,032

Total liabilities		802,939		789,412

Commitments and contingencies (note 9)
Member’s equity:
Common equity		178,547		184,111
Accumulated other comprehensive income		37,594		15,630

Total member’s equity		216,141		199,741

Total liabilities and member’s equity	$	1,019,080	$	989,153

See accompanying notes to consolidated financial statements.

Kraton Polymers LLC

Consolidated Statements of Operations

Three Months Ended September 30, 2007 and 2006
(in thousands of U.S. dollars)
(Unaudited)


	September 30,			September 30,
	2007			2006
Revenues
Sales	$	284,498		$	278,409
Other		5,652			9,745

Total revenues		290,150			288,154
Costs and expenses:
Costs of goods sold		243,699			225,820

Gross profit		46,451			62,334

Research and development expenses		5,452			6,084
Selling, general, and administrative expenses		15,594			18,884
Depreciation and amortization of identifiable intangibles		12,539			11,187
Loss (earnings) in joint venture		(189	)		208
Interest expense, net		12,375			10,932

Income before income taxes		680			15,039
Income tax provision		(1,434	)		(3,404	)

Net (loss) income	$	(754	)	$	11,635

See accompanying notes to consolidated financial statements.

Kraton Polymers LLC

Consolidated Statements of Operations

Nine Months Ended September 30, 2007 and 2006
(in thousands of U.S. dollars)
(Unaudited)


	September 30,			September 30,
	2007			2006
Revenues:
Sales	$	812,326		$	775,192
Other		19,546			27,639

Total revenue		831,872			802,831
Costs and expenses:
Costs of goods sold		701,660			635,552

Gross profit		130,212			167,279

Research and development expenses		18,504			19,150
Selling, general and administrative expenses		49,208			56,872
Depreciation and amortization		36,417			33,201
Earnings in joint venture		(514	)		(232	)
Interest expense, net		32,507			29,501

(Loss) income before income taxes		(5,910	)		28,787
Income tax provision		(1,822	)		(7,233	)

Net (loss) income	$	(7,732	)	$	21,554

See accompanying notes to the consolidated financial statements.

Kraton Polymers LLC

Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2007 and 2006
(in thousands of U.S. dollars)
(Unaudited)


	September 30,			September 30,
	2007			2006
Cash flows provided by (used in) operating activities:
Net (loss) income	$	(7,732	)	$	21,554
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of identifiable intangibles		36,417			33,201
Amortization of deferred financing costs		2,213			1,801
Loss on disposal of fixed assets		279			228
(Undistributed) distributed earnings in joint venture		(408	)		1,033
Deferred tax (benefit) provision		(3,937	)		1,239
Non-cash compensation related to equity awards		1,814			1,881
Gain on interest rate swaps		(1,553	)		—
Decrease (increase) in working capital:
Accounts receivable		(8,550	)		(38,949	)
Due to related party		11,048			(1,553	)
Inventories of products, materials and supplies		(16,217	)		(62,765	)
Other assets		(2,891	)		2,931
Accounts payable-trade, other payables and accruals, and other long-term liabilities		41,597			8,018

Net cash provided by (used in) operating activities		52,080			(31,381	)

Cash flows (used in) provided by investing activities:
Purchase of property, plant and equipment		(19,861	)		(28,049	)
Proceeds from sale of property, plant and equipment		43			54

Net cash used in investing activities		(19,818	)		(27,995	)

Cash flows provided by (used in) financing activities:
Proceeds from debt		—			123,008
Repayment of debt		(42,787	)		(2,596	)
Cash dividend to parent		—			(129,531	)
Deferred financing cost		—			(2,678	)
Net proceeds from insurance note payable		1,238			2,957

Net cash used in financing activities		(41,549	)		(8,840	)

Effect of exchange rate differences on cash		(1,997	)		(4,003	)

Net decrease in cash and cash equivalents		(11,284	)		(72,219	)
Cash and cash equivalents, beginning of period		43,601			100,934

Cash and cash equivalents, end of period	$	32,317		$	28,715

Supplemental disclosure cash flow information:
Cash paid during the period for income taxes, net of refunds received	$	8,105		$	3,856
Cash paid during the period for interest	$	30,320		$	33,364

See accompanying notes to consolidated financial statements.

Kraton Polymers LLC

Notes to Consolidated Financial Statements
(Unaudited)

(1) Summary of Significant Accounting Policies

(a) Organization and Description of Business

Kraton Polymers LLC, or Kraton, together with its subsidiaries, unless otherwise indicated, are collectively referred to as “we” “our,” “ours,” and “us” is the parent of Elastomers Holdings LLC (holding company of our United States operations), Kraton Polymers Holdings B.V. (holding company of the rest of the world operations) and Kraton Polymers Capital Corporation (a company with no obligations). Polymer Holdings LLC, or Polymer Holdings, own 100% of our equity interests. TJ Chemical Holdings LLC, or TJ Chemical, owns 100% of the equity interests of Polymers Holdings. TJ Chemical is indirectly owned by TPG Partners III, L.P., TPG Partners IV, L.P. and certain of their parallel investment entities, entities affiliated with or managed by J.P. Morgan Partners, LLC and affiliates and Kraton Management LLC, or Management LLC.

We manufacture styrenic block copolymers, or SBCs, at our manufacturing facilities in six countries: Belpre, Ohio; Wesseling, Germany; Berre, France; Pernis, The Netherlands; Paulinia, Brazil; and our joint venture in Kashima, Japan. SBCs are highly engineered synthetic elastomers which are used in a wide variety of products to impart flexibility, resilience, strength, durability, and processability. We generally sell our products to customers for use in industrial and consumer applications. Based on our management approach, we believe that all material operations revolve around the manufacturing and sales of SBCs and we currently report our operations, both internally and externally, as a single business segment.

(b) Basis of Presentation

The consolidated financial statements presented herein are for Kraton and its consolidated subsidiaries, each of which is a wholly-owned subsidiary.

The consolidated balance sheets, the consolidated statements of operations and the consolidated statements of cash flows for the periods presented are unaudited and reflect all adjustments, consisting of normal recurring items, which management considers necessary for a fair presentation. Operating results for the first nine months of 2007 are not necessarily indicative of results to be expected for the year ending December 31, 2007. All significant intercompany balances and transactions have been eliminated in consolidation. All dollar amounts in the tabulations in the notes to the consolidated financial statements are stated in thousands of dollars unless otherwise indicated. Certain amounts have been reclassified in the prior period to conform to the current period presentation.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires estimates and assumptions that affect the reported amounts as well as certain disclosures. Our financial statements include amounts that are based on management’s best estimates and judgments. Actual results could differ from those estimates.

These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto reported in Kraton’s Form 10-K for the year ended December 31, 2006. The accompanying consolidated financial statements have been prepared in accordance with the rules of the United States Securities and Exchange Commission (“SEC”) for interim financial statements and do not include all annual disclosures required by accounting principles generally accepted in the United States.

(c) Recently Issued Accounting Standards

In February 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 159,The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115(SFAS No. 159) which is effective for fiscal years beginning after November 15, 2007. This statement permits an entity to choose to measure many financial instruments and certain other items at fair value at specified election dates. Subsequent unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. We are currently evaluating the potential effect of SFAS No. 159 on the company’s financial position, results of operations and cash flows.

In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157,Fair Value Measurements(SFAS No. 157). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. It applies under other accounting pronouncements that require or permit fair value measurements, and does not require any new fair value measurements. SFAS No. 157 is effective for all fiscal years beginning after November 15, 2007, with earlier application encouraged. We are currently evaluating the potential effect of SFAS No. 157 on the Company’s financial position, results of operations and cash flows.

(2) Share-Based Compensation

In December 2004, the FASB issued SFAS No. 123(R),Share-Based Payment,which is a revision of FASB Statement No. 123. As required, we adopted the provisions of SFAS No. 123(R) effective January 1,2006, using the modified-prospective method. Upon adoption of SFAS No. 123(R), we elected to use the Black-Scholes option-pricing model to estimate the grant-date fair value of share based awards. SFAS No. 123(R) addresses all forms of share-based compensation including stock options and restricted stock. See footnote 10(a) for a description of T.J. Chemical Holdings LLC Membership Units Plan and footnote 10(b) for a description of T.J. Chemical Holdings LLC 2004 Option Plan.

Information pertaining to option activity for the nine months ended September 30, 2007 is as follows (number of options in thousands):


				Weighted
	Number			Average
	of			Exercise
	Options			Price
Outstanding at December 31, 2006		15,293		$	1.00
Granted		—			—
Exercised		—			—
Cancelled		(282	)		1.00

Outstanding at September 30, 2007		15,011		$	1.00

(3) Restructuring Activities

As part of our ongoing efforts to improve efficiencies and increase productivity, we have implemented a number of restructuring projects.

On September 20, 2007, Kraton decided to exit the SIS plant at our Pernis facility, which will result in a contractor workforce reduction. Notification of this decision and the exit plan was given to Shell Chemicals on November 9, 2007.

Kraton is undertaking the exit plan in connection with its decision to relocate SIS production to the Company’s other production facilities as part of its cost reduction efforts. We expect that the SIS grades can be manufactured successfully at alternative plant locations, and we expect to have sufficient capacity to meet current and near term demands. The plan is expected to begin in the fourth quarter of 2007 and is expected to be completed by early 2008. We recorded a liability associated with the exit plan of approximately $ 2.1 million, consisting of $1.8 million in contractor workforce reduction and $0.3 million in other associated costs. The entire amount of the charge consists of future cash expenditures. Kraton anticipates that substantially all of the cash expenditures will be incurred in the first and second quarters of 2008.

Restructuring projects implemented during the year ended December 31, 2006 included reducing the number of employees through a voluntary separation program at our Belpre, Ohio facility, the reorganization of our office in Tokyo, Japan and the closure of our office in London, United Kingdom. We shut down our research laboratory in Louvain-la-Neuve, Belgium and merged most of these activities into our research and development facility located in Amsterdam, The Netherlands. During the year ended December 31, 2006 we recorded approximately $5.0 million of employee severance costs related to our workforce reduction as part of our cost reduction program; recorded approximately $1.2 million of consulting costs related to our voluntary separation program at our Belpre, Ohio facility; recorded a charge of approximately $0.6 million associated with the closure of our office in London, United Kingdom; recorded a charge for additional pension and other postretirement benefits expense of approximately $2.3 million related to the voluntary separation program at our Belpre, Ohio facility; and recorded a charge of approximately $0.6 million associated with the planned shut down of our research laboratory in Louvain-la-Neuve, Belgium, related to the early lease termination penalty.

Certain of the restructuring charges discussed above were recorded in the September 30, 2007 and 2006 consolidated statements of operations as follows:


	Three Month Ended				Nine Month Ended
	September 30				September 30
	2007		2006		2007		2006
Cost of goods sold	$	1,850	$	1,459	$	1,850	$	6,468
Research and development	$	—	$	—	$	—	$	585
Selling, general and administrative	$	100	$	380	$	100	$	1,437

As of September 30, 2007 there was a net liability of approximately $0.1 million related to unpaid employee severance cost, which is estimated to be paid during the fourth quarter of the 2007. Of the remaining exit activity costs of approximately $2.4 million, $2.1 million is associated with the exit of the SIS plant at our Pernis facility, the Netherlands which are expected to be paid in 2008. The remaining $0.3 million associated with the closure of our office in London, United Kingdom is expected to be paid over the next several years ending in the second quarter of 2011.

The following table summarizes the activities related to the Company’s restructuring liability by component (in thousands):


	Severance			Exit Activity
	Costs (1)			Costs			Total
Reserve balance at December 31, 2006	$	2,042		$	935		$	2,977
Accruals		100			2,100			2,200
Cash payments		(2,000	)		(591	)		(2,591	)

Reserve balance at September 30, 2007	$	142		$	2,444		$	2,586


(1)		Excludes additional pension and other postretirement benefits expense of approximately $ 2.3 million.

(4) Detail of Certain Balance Sheet Accounts

The components of inventories of products and other payables and accruals included the following (in thousands):


	September 30,		December 31,
	2007		2006
Inventories of products, net:
Finished products	$	236,605	$	215,623
Work in progress		3,339		4,098
Raw materials		44,486		37,064

	$	284,430	$	256,785


Other payables and accruals:
Employee related	$	6,555	$	14,979
Interest		9,852		7,604
Property and other taxes		4,902		4,102
Customer rebates		6,888		3,089
Income taxes payable		6,637		8,504
Other		16,902		14,852

	$	51,736	$	53,130

(5) Comprehensive Income (Loss)

The components of comprehensive income include the following (in thousands):


	Three Month Ended						Nine Month Ended
	September 30						September 30
	2007			2006			2007			2006
Net income (loss)	$	(754	)	$	11,635		$	(7,732	)	$	21,554
Foreign currency adjustments		15,819			4,712			23,828			16,983
Unrealized (loss) gain on interest rate swaps		—			(699	)		(1,863	)		(532	)

Total comprehensive income	$	15,065		$	15,648		$	14,233		$	38,005

Accumulated other comprehensive income consisted of the following (in thousands):


	September 30, 2007			December 31, 2006
Foreign currency adjustments	$	38,789		$	14,962
Unrealized gain on interest rate swaps, net of tax		—			1,863
Pension adjustment, net of tax		(1,195	)		(1,195	)

Total accumulated other comprehensive income	$	37,594		$	15,630

(6) Long-Term Debt

Long-term debt consists of the following (in thousands):


	September 30,		December 31,
	2007		2006
Senior Secured Credit Facilities:
Term loans	$	339,326	$	382,113
Revolver		—		—
8.125% Notes		200,000		200,000

Total debt		539,326		582,113
Less current portion of long-term debt		3,445		3,850

Total long-term debt	$	535,881	$	578,263

(a) Senior Secured Credit Facilities

On May 12, 2006 Kraton entered into an amendment, which is referred to as the Amendment, to its senior secured credit agreement, or the Credit Agreement, dated as of December 23, 2003, as amended as of March 4, 2004, as further amended as of October 21, 2004 and as further amended as of February 16, 2006 among Kraton, various lenders, Goldman Sachs Credit Partners L.P., UBS AG, Stamford Branch, Credit Suisse First Boston, Morgan Stanley Senior Funding Inc., and General Electric Capital Corporation in order to provide a portion of the funds required in connection with the cash tender offer and consent solicitation commenced on April 24, 2006 by Polymer Holdings and Polymer Holdings Capital Corporation with respect to any and all of their outstanding 12.000% Discount Notes. On May 12, 2006 all of the 12.000% Discount Notes validly tendered and not withdrawn in the tender offer (representing approximately 99.8% of the aggregate amount of outstanding 12.000% Discount Notes) were accepted for payment and purchased for aggregate total consideration equal to $128,785,000.

The Amendment provided for, among other things, a new term facility, or the Term Facility, of $385 million, representing a $25 million increase over the original Term Facility, and extended the maturity of the Term Facility from December 23, 2010 to May 12, 2013. In addition, the Amendment extended the maturity of the revolving facility, or the Revolving Facility, from December 23, 2008 to May 12, 2011 and provided for the possibility of increasing the existing Revolving Facility from $60 million to $80 million, subject to new revolving lenders becoming parties to the Credit Agreement. On June 7, 2006 Kraton entered into a Joinder Agreement with a new revolving lender that increased the Revolving Facility to $75.5 million. In addition to the foregoing, the Amendment reduced the interest rate margin on the Term Facility, eliminated certain affirmative and negative covenants, including a covenant that limited Kraton’s ability to make capital expenditures, and modified the financial ratios we are required to maintain. On the effective date of the Amendment, Kraton borrowed the full $385 million available under the new Term Facility and used the proceeds to prepay in full existing borrowings under the original Term Facility, to make a distribution to Polymer Holdings to provide a portion of the funds necessary to consummate the tender offer for the 12.000% Discount Notes and pay fees and expenses related to the foregoing.

Polymer Holdings and three of Kraton’s subsidiaries, Kraton Polymers U.S. LLC, Elastomers Holdings LLC and Kraton Polymers Capital Corporation have guaranteed the Credit Agreement. The guarantors, together with Kraton, are referred to as the Loan Parties. The Credit Agreement is secured by a perfected first priority security interest in all of each Loan Party’s tangible and intangible assets, including intellectual property, real property, all of our capital stock and the capital stock of our domestic subsidiaries and 65% of the capital stock of the direct foreign subsidiaries of each Loan Party. As of September 30, 2007 and December 31, 2006, Kraton had no outstanding borrowings under the Revolving Facility. In these notes to the consolidated financial statements, the loans made under the Revolving Facility are referred to as the Revolving Loans, and the loans made under the Term Facility are referred to as the Term Loans.

Maturity

The Revolving Loans outstanding are payable in a single maturity on May 12, 2011. The Term Loans are payable in 24 consecutive equal quarterly installments, in an aggregate annual amount equal to 1.0% of the original principal amount of the Term Loans. The remaining balance is payable in four equal quarterly installments commencing on September 30, 2012 and ending on May 12, 2013.

On September 27, 2007 Kraton made a voluntary prepayment of $40,000,000 on the Term Facility pursuant to Section 2.13 (a) of the Credit Agreement. In connection with the prepayment, we amortized to interest expense approximately $0.6 million of deferred financing costs associated with the term loans.

Interest

The Term Loans bear interest at a rate equal to the adjusted Eurodollar rate plus 2.00% per annum or, at our option, the base rate plus 1.00% per annum. In general, interest is payable quarterly, subject to the interest period selected by us, per the Credit Agreement. The average effective interest rate on the Term Loans for the nine months ended September 30, 2007 was 7.3% compared to 7.0% for the nine months ended and 2006. The Revolving Loans bear interest at a rate equal to the adjusted Eurodollar rate plus a margin of between 2.00% and 2.50% per annum, depending on our leverage ratio, or at our option, the base rate plus a margin of between 1.00% and 1.50% per annum, depending on our leverage ratio. A commitment fee equal to 0.5% per annum times the daily average undrawn portion of the Revolving Facility accrues and is payable quarterly in arrears.

Scheduled Payments

The Term Facility is subject to mandatory prepayment with, in general: (1) 100% of the net cash proceeds of certain asset sales, subject to certain reinvestment rights; (2) 100% of the net cash proceeds of certain insurance and condemnation payments, subject to certain reinvestment rights; (3) 50% of the net cash proceeds of equity offerings (declining to 25%, if a leverage ratio is met); (4) 100% of the net cash proceeds of debt incurrences (other than debt incurrences permitted under the Credit Agreement); and (5) 50% of our excess cash flow, as defined in the Credit Agreement (declining to 25%, if a leverage ratio is met and to 0% if a further leverage ratio is met). Any such prepayment is applied first to the Term Facility and thereafter to the Revolving Facility.

Covenants

The Credit Agreement contains certain affirmative covenants including, among others, covenants to furnish the Lenders with financial statements and other financial information and to provide the Lenders notice of material events and information regarding collateral.

The Credit Agreement contains certain negative covenants that, among other things, restrict our ability, subject to certain exceptions, to: incur additional indebtedness, grant liens on our assets, undergo fundamental changes, make investments, sell assets, make acquisitions, engage in sale and leaseback transactions, make restricted payments, engage in transactions with our affiliates, amend or modify certain agreements and charter documents or change our fiscal year. In addition, we are required to maintain an interest coverage ratio of 2.25:1.00 through the first fiscal quarter of 2008, increasing to 2.50:1.00 through the fourth fiscal quarter of 2008 and becoming progressively more restrictive thereafter and to prevent our leverage ratio from exceeding 5.95:1.00 through the first two fiscal quarters of 2007, decreasing further to 5.45:1.00 in the last two fiscal quarters of 2007 through the first fiscal quarter of 2008 and becoming progressively more restrictive thereafter.

As of September 30, 2007, we were in compliance with all covenants under the Credit Agreement.

(b) Senior Subordinated Notes Due January 15, 2014

On December 23, 2003, Kraton and Kraton Polymers Capital Corporation issued the 8.125% Notes in an aggregate principal amount of $200.0 million. The 8.125% Notes are subject to the provisions for mandatory and optional prepayment and acceleration and are payable in full on January 15, 2014. The 8.125% Notes are guaranteed on a senior subordinated basis by all of Kraton’s exiting and future domestic subsidiaries that guarantee the indebtedness under Kraton’s senior secured credit facility described above. The amount of 8.125% Notes outstanding at September 30, 2007 and December 31, 2006, was $200.0 million.

Interest

The 8.125% Notes bear interest at a fixed rate of 8.125% per annum. Interest is payable (1) on January 15 and July 15 each year, with the first such payment made July 15, 2004, (2) upon any redemption or prepayment as described below, and (3) at maturity.

Optional Redemption

Generally, we cannot elect to redeem the 8.125% Notes until January 15, 2009. After such date, we may elect to redeem the 8.125% Notes at certain predetermined redemption prices, plus accrued and unpaid interest.

Prior to January 15, 2009, we may redeem up to a maximum of 35% of the 8.125% Notes with the proceeds of certain permitted equity offerings at a redemption price equal to 108.125% of the principal amount of the 8.125% Notes being redeemed, plus accrued and unpaid interest.

Covenants

The 8.125% Notes contain certain affirmative covenants including, among others, covenants to furnish the holders of the 8.125% Notes with financial statements and other financial information and to provide the holders of the 8.125% Notes notice of material events.

The 8.125% Notes contain certain negative covenants including limitation on indebtedness, limitation on restricted payments, limitation on restrictions on distributions from certain subsidiaries, limitation on lines of business, and mergers and consolidations.

As of September 30, 2007, we were in compliance with all covenants under the 8.125% Notes.

(7) Financial Instruments

(a) Interest Rate Swap Agreements

Prior to the Amendment of the Credit Agreement under the term loan portion of the senior secured credit facility, we were required to hedge, or otherwise protect against interest rate fluctuations, a portion of the variable rate debt. As a result, we entered into two interest rate swap agreements in the amount of $80.0 million effective June 11, 2004, and $80 million effective July 6, 2004. Both of these agreements terminated on June 24, 2007, had a fixed rate quarterly payment date on each of September 24, December 24, March 24 and June 24, commenced on June 24, 2004, and ended on the termination date. On November 1, 2004, both of these agreements were designated as cash flow hedges on the exposure of the variability of future cash flows subject to the variable quarterly interest rates on $160.0 million of the term loan portion of the credit facility. The agreements had an average fixed rate of 3.524%. The agreements had no fair market value as of September 30, 2007 due to the termination of the agreements on June 24, 2007. In June 2007, the Company recorded an adjustment to interest expense related to its accounting for interest rate swaps that resulted in an increase in pre-tax income of approximately $1.6 million for the nine months ended September 30, 2007. The adjustment reflects the additional income statement effects of the Company’s highly effective interest rate swaps that should have been reflected in prior periods. The Company evaluated the materiality of the adjustment, including both qualitative and quantitative considerations, and concluded that the adjustment was not material to current or prior periods.

(b) Fair Value of Financial Instruments

The following table presents the carrying values and approximate fair values of our long-term debt at September 30, 2007 and December 31, 2006 (in thousands):


	September 30, 2007
	Carrying Value		Fair Value
Term loans	$	339,326	$	339,326
8.125% Notes		200,000		194,250


	December 31, 2006
	Carrying Value		Fair Value
Term loans	$	382,113	$	382,113
8.125% Notes		200,000		200,000

Due to the Term Loans having variable interest rates, the fair value approximates their carrying value.

(8) Income Taxes

Income taxes are recorded utilizing an asset and liability approach. This method gives consideration to the future tax consequences associated with the differences between the financial accounting basis and tax basis of the assets and liabilities, and the ultimate realization of any deferred tax asset resulting from such differences. We consider the undistributed earnings of our foreign subsidiaries to be indefinitely reinvested, as we have no intention to repatriate these earnings. These foreign earnings could become subject to additional tax if remitted, or deemed remitted, as a dividend; however, it is not practicable to estimate the additional amount of taxes payable.

The effective tax rate for the nine months ended September 30, 2007 was approximately (30.8) % as compared to a rate of 25.1% in the nine months ended September 30, 2006. Our effective tax rate for the nine months ended September 30, 2007 was less than our statutory rate primarily due to not recording a tax benefit for certain net operating loss carryforwards generated during that period. Our effective tax rate for the nine months ended September 30, 2006 was less than our statutory rate primarily due to a different income mix between foreign and domestic tax jurisdictions.

Effective January 1, 2007, we adopted FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109(“FIN 48”). FIN 48 prescribes the minimum recognition threshold a tax position taken or expected to be taken in a tax return is required to meet before being recognized in the financial statements. It also provides guidance for derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. As a result of the implementation of FIN 48, we recognized no change in the liability for unrecognized tax benefits or accrued interest and penalties. The Company files income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. As of the January 1, 2007, our 2003 through 2006 U.S. federal income tax returns remain open to examination. In addition, open tax years to state and foreign jurisdictions remain subject to examination.

As of January 1, 2007, we had total unrecognized tax benefits of approximately $2.4 million. During the nine months ended September 30, 2007, we had a significant change in certain tax positions mainly related to prior tax periods. The decrease of $1.7 million in these tax positions was primarily due to settlements with overseas taxing authorities. As of September 30, 2007, we estimated $0.7 million in unrecognized tax benefits, that if recognized, would impact the effective tax rate. We recognize interest and penalties related to unrecognized tax benefits within the provision for income taxes in our consolidated statement of operations. As of September 30, 2007, we had accrued approximately $0.04 million in interest and penalties. During the three months ended September 30, 2007, we did not recognize any material interest and penalty charges related to the unrecognized tax benefits. As of January 1, 2007, we believe that no current tax positions that have resulted in unrecognized tax benefits will significantly increase or decrease within one year. As of the three and nine months ended September 30, 2007, no material changes, other than the settlements with taxing authorities mentioned above, have occurred in our estimates or expected events related to anticipated changes in our unrecognized tax benefits.

The following presents a rollforward of our unrecognized tax benefits and associated interest and penalties.


	Unrecognized			Interest
Millions of dollars	Tax Benefits			and Penalties

Balance at January 1, 2007	$	2.4		$	0.3
Increase (decrease) in prior year tax positions		(1.7	)		(0.3	)


Balance at September 30, 2007	$	0.7		$	0.0

(9) Commitments and Contingencies

Legal Proceedings

We, and certain of our subsidiaries, are parties to several legal proceedings that have arisen in the ordinary course of business. While the outcome of these proceedings cannot be predicted with certainty, management does not expect these matters to have a material adverse effect on our financial position, results of operations or cash flows.

(10) Employee Benefits

(a) Investment in Kraton Management LLC

We provided certain key employees who held interests in us prior to the acquisition the opportunity to roll over their interests into membership units of Management LLC, which owns a corresponding number of membership units in TJ Chemical. Additional employees have also been given the opportunity to purchase membership units in TJ Chemical through Management LLC at the original buy-in price and have been granted restricted and notional restricted membership units. The membership units are subject to customary tag-along and drag-along rights, as well as a Company call right in the event of termination of employment. As of September 30, 2007, there were 2,465,000 membership units of Management LLC issued and outstanding.

(b) TJ Chemical Holdings LLC 2004 Option Plan

On September 9, 2004, TJ Chemical adopted an option plan, or the Option Plan, which allows for the grant to key employees, consultants, members and service providers of TJ Chemical and its affiliates, including us, of non-qualified options to purchase TJ Chemical membership units in order to provide them with an appropriate incentive to encourage them to continue in the employ of or to perform services for, and to improve the growth and profitability of TJ Chemical and its affiliates. The aggregate number of membership units with respect to which options may be granted under the Option Plan shall not exceed an amount representing 8% of the outstanding membership units and profits units of TJ Chemical on March 31, 2004, on a fully diluted basis. As of September 30, 2007 there were 15,011,000 options granted and outstanding. There were no options granted during the three and nine months ended September 30, 2007. All options granted in fiscal 2004, fiscal 2005 and fiscal 2006 had an exercise price of $1 per membership unit, which is equal to or in excess of the fair value of the membership unit on the date of grant.

In general, the options vest and become exercisable in 20% increments annually on each of the first five anniversaries of the grant date, so long as the holder of the option is still an employee on the vesting date. With respect to directors, their options become exercisable in 50% increments annually on each of the first two anniversaries of the grant date, so long as the holder of the option is still a director on the vesting date. The exercise price per membership unit shall equal the fair market value of a membership unit on the date of grant. Upon a change in control, the options will become 100% vested if the participant’s employment is terminated without cause or by the participant for good reason (as each term is defined in the Option Plan) within the 2-year period immediately following such change in control.

A committee of TJ Chemical’s board of directors, or the Committee has been appointed to administer the Option Plan, including, without limitation, the determination of the individuals to whom grants will be made, the number of membership units subject to each grant and the various terms of such grants. The Committee will have the right to terminate all of the outstanding options at any time and pay the participants an amount equal to the excess, if any, of the fair market value of a membership unit as of such date over the exercise price with respect to such option, or the spread. Generally, in the event of a merger (except a merger where membership unit holders receive securities of another corporation), the options will pertain to and apply to the securities that the option holder would have received in the merger; and in the event of a dissolution, liquidation, sale of assets or any other merger, the Committee has the discretion to: (1) provide for an “exchange” of the options for new options on all or some of the property for which the membership

units are exchanged (as may be adjusted by the Committee); (2) cancel and cash out the options (whether or not then vested) at the spread; or (3) provide for a combination of both. Generally, the Committee may make appropriate adjustments with respect to the number of membership units covered by outstanding options and the exercise price in the event of any increase or decrease in the number of membership units or any other corporate transaction not described in the preceding sentence.

On a termination of a participant’s employment (other than without cause or by the participant for good reason within the 2-year period immediately following a change in control), unvested options automatically expire and vested options expire on the earlier of: (1) the commencement of business on the date the employment is terminated for cause; (2) 90 days after the date employment is terminated for any reason other than cause, death or disability; (3) 1-year after the date employment is terminated by reason of death or disability; or (4) the 10th anniversary of the grant date for such option.

Generally, pursuant to TJ Chemical’s operating agreement, membership units acquired pursuant to the Option Plan are subject to customary tag-along and drag-along rights for the 180-day period following the later of a termination of employment and 6 months and 1-day following the date that units were acquired pursuant to the exercise of the option, TJ Chemical has the right to repurchase each membership unit then owned by the participant at fair value, as determined in good faith by the board of directors of TJ Chemical.

(c) Other Equity Awards

We provided certain key employees with a grant of profits units (subject to the 8% pool limitation described above). Profits units are economically equivalent to an option, except that they provide the recipient/employee with an opportunity to recognize capital gains in the appreciation of TJ Chemicals and its affiliates and TJ Chemicals and its affiliates does not receive any deduction at the time of grant or disposition of the profits unit by the employee. Generally, pursuant to the applicable grant agreements, 50% of such profits units will vest when the fair value of TJ Chemical’s assets equals or exceeds two times the Threshold Amount, i.e., the first tranche, and the remaining 50% will vest when the fair value of TJ Chemical’s assets equals or exceeds three times the threshold amount, i.e., the second tranche, in each case, as determined by the Board of TJ Chemical, provided that the executive remains employed through the applicable vesting date. Additionally, 100% of the profits units shall vest upon the effective date of a disposition by the initial investors of 51% or more of their aggregate interests in Kraton. If at the time TJ Chemical makes a determination as to whether an individual is entitled to any appreciation with respect to the profits units, the value of the assets is more than two times, but less than three times the Threshold Amount, a pro rata portion of the second tranche will vest based on the appreciation above the two times Threshold Amount. Compensation expense will be recorded in our consolidated financial statements for this difference at the time it becomes probable the profits units will become vested. If an employees’ employment terminates prior to any applicable vesting date, such employee shall automatically forfeit all rights to any unvested profits units. As of September 30, 2007, there were 2,056,250 profits units granted and not yet vested.

(d) Kraton Polymers LLC Executive Deferred Compensation Plan

In 2006, certain employees participated in the Kraton Executive Deferred Compensation Plan, which was originally approved by the Board of Directors of Kraton on September 9, 2004. Participants in the plan are permitted to elect to defer a portion (generally, up to 50%) of their annual incentive bonus. Participating employees are credited with a number of phantom membership units based on the fair value of TJ Chemical membership units as of the date of deferral. Distributions from plan accounts may be made in TJ Chemical membership units, Management LLC membership units, or cash, at the discretion of the committee. Such distributions will occur upon termination of the participant’s employment subject to a call right or upon a change in control. We reserved 2 million membership units for issuance pursuant to the Kraton Deferred Compensation Plan and as of December 31, 2006. With respect to the 2006 accrued bonus liability, our executive officers in total elected to defer $351,250 during the three months ended March 31, 2007, and received 354,799 Notional Units. Pursuant to their participation in the Executive Deferred Compensation Plan (as described above), our executive officers in total hold 354,799 Notional Units in their plan accounts as of September 30, 2007. All such units are 100% vested and subject to the terms of the plan.

(e) 2007 Incentive Compensation Plan

On March 6, 2007, the Compensation Committee of the Board of Directors, or the Board, of Kraton approved and adopted the 2007 Incentive Compensation Plan including the performance-based criteria by which potential payouts to participants will be determined. The 2007 Incentive Compensation Plan is designed to attract, retain, motivate and reward officers and certain employees that have been deemed eligible to participate. For the bonus year which ends December 31, 2007, the Board established a common bonus pool proportional to the consolidated Adjusted Bank EBITDA (“Adjusted EBITDA”) which will be used in our Term Loan Covenants calculations for the year ended December 31, 2007. It is expected that the common bonus pool payout could be up to $4 million, depending on the performance of the Company. Once the common bonus pool is determined based on Adjusted EBITDA, the common bonus pool under the 2007 Incentive Compensation Plan may be increased or decreased up to $1 million based on a series of additional performance criteria as established by the Compensation Committee.

(f) Retirement Plans

The components of net periodic benefit cost related to pension benefits for the three and nine months ended September 30, 2007 and September 30, 2006, are as follows (in thousands):


	Three Months Ended						Nine Months Ended
	September 30						September 30
	2007			2006			2007			2006
Components of net periodic benefit cost:
Service cost	$	644		$	563		$	1,934		$	2,157
Interest cost		969			907			2,907			2,605
Expected return on plan assets		(908	)		(893	)		(2,726	)		(2,491	)
Restructuring costs (See Note 3)		—			(148	)		—			624

Net periodic benefit cost	$	705		$	429		$	2,115		$	2,895

The components of net periodic benefit cost related to other postretirement benefits for the three and nine months ended September 30, 2007 and September 30, 2006, are as follows (in thousands):


	Three Months Ended				Nine Months Ended
	September 30				September 30
	2007		2006		2007		2006
Components of net periodic benefit cost:
Service cost	$	88	$	90	$	264	$	296
Interest cost		187		187		561		461
Recognized actuarial gain		—		—		—		—
Restructuring costs (See Note 3)		—		499		—		1,900

Net periodic benefit cost	$	275	$	776	$	825	$	2,657

(11) Industry Segment and Foreign Operations

We operate in one segment for the manufacture and marketing of styrenic block copolymers. In accordance with SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information,” or SFAS 131, our chief operating decision-maker has been identified as the President and Chief Executive Officer, who reviews operating results to make decisions about allocating resources and assessing performance for the entire company. Since we operate in one segment and in one group of similar products, all financial segment and product line information required by SFAS 131 can be found in the consolidated financial statements.

For geographic reporting, revenues are attributed to the geographic location in which the customers’ facilities are located. Long-lived assets consist primarily of property, plant, and equipment, which are attributed to the geographic location in which they are located. Net revenues and long-lived assets by geographic region were as follows (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Net Revenues:
United States	$	97,397	$	104,887	$	285,417	$	295,886
Germany		37,558		36,096		112,491		90,491
Netherlands		11,382		15,235		38,824		43,898
Italy		12,601		13,083		38,152		41,587
Japan		12,830		14,175		37,434		45,323
China		11,457		13,645		31,059		34,767
United Kingdom		10,979		8,059		30,036		31,164
Brazil		10,143		8,961		26,851		23,283
Belgium		8,945		2,813		23,374		10,480
France		8,734		7,007		22,684		19,730
Poland		8,177		6,746		16,536		10,891
Canada		6,216		7,160		16,342		20,286
Taiwan		5,151		3,710		15,384		11,930
Thailand		4,498		3,148		12,054		11,530
Turkey		4,172		2,250		11,187		10,924
Argentina		3,836		3,738		10,601		9,881
Sweden		3,667		2,623		10,025		7,433
Austria		3,264		3,008		7,480		5,338
Mexico		2,214		2,481		6,932		6,981
Denmark		2,008		1,374		6,764		4,541
Australia		2,547		2,895		6,264		7,002
All other countries		22,374		25,060		65,981		59,485

	$	290,150	$	288,154	$	831,872	$	802,831


	September 30,		December 31,
	2007		2006
Long-lived Assets:
United States	$	293,878	$	283,171
Germany		38,511		32,506
Japan		3,589		3,225
Italy		27		25
France		108,388		100,476
Netherlands		32,141		29,436
Canada		—		—
Brazil		54,920		48,485
United Kingdom		182		133
China		1,970		54
All other countries		11,885		11,451


	$	545,491	$	508,962

(12) Supplemental Guarantor Information

Kraton and Kraton Polymers Capital Corporation, a financing subsidiary, collectively, the Issuers, are co-issuers of the 8.125% Notes. The Guarantor Subsidiaries fully and unconditionally guarantee, on a joint and several basis, the Issuers’ obligations under the 8.125% Notes. Kraton’s remaining subsidiaries are not guarantors of the 8.125% Notes. We do not believe that separate financial statements and other disclosures concerning the Guarantor Subsidiaries would provide any additional information that would be material to investors in making an investment decision.

Balance Sheet


	As of September 30, 2007
				Guarantor			Non-Guarantor
	Issuers (1)			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Assets
Current assets:
Cash and cash equivalents	$	—		$	358		$	31,959		$	—		$	32,317
Receivables, net		—			52,472			100,686			—			153,158
Due from related parties		(13	)		17,277			3,064			(20,328	)		—
Inventories of products, net		—			138,454			150,624			(4,648	)		284,430
Inventories of materials and supplies		—			6,804			5,410			—			12,214
Other current assets		3,613			1,078			9,526			—			14,217
Deferred income taxes		—			8,672			(6,734	)		—			1,938

Total current assets		3,600			225,115		$	294,535			(24,976	)		498,274
Property, plant and equipment, less accumulated depreciation		109,886			165,102			128,332			—			403,320
Identifiable intangible assets		32,399			—			48,811			—			81,210
Investment in unconsolidated joint venture		813			—			9,289			—			10,102
Deferred financing costs		10,825			—			—			—			10,825
Other long-term assets		97,391			397,096			21,447			(500,585	)		15,349

Total assets	$	254,914		$	787,313		$	502,414		$	(525,561	)	$	1,019,080

Liabilities and Member’s Equity
Current liabilities:
Current portion of long-term debt	$	3,445		$	—		$	—		$	—		$	3,445
Accounts payable-trade		2,700			52,987			61,701			—			117,388
Other payables and accruals		9,837			10,591			31,308			—			51,736
Due to (from) related parties		—			3,064			38,189			(20,328	)		20,925
Insurance note payable		1,977			—			—			—			1,977

Total current liabilities		17,959			66,642			131,198			(20,328	)		195,471
Long-term debt, net of current portion		535,881			—			—			—			535,881
Deferred income taxes		(47,589	)		71,882			10,928			—			35,221
Long-term liabilities		404,055			35,495			97,401			(500,585	)		36,366

Total liabilities		910,306			174,019			239,527			(520,913	)		802,939

Commitments and contingencies (note 9)		—			—			—			—			—
Member’s equity:
Common equity		(655,392	)		614,489			224,098			(4,648	)		178,547
Accumulated other comprehensive income		—			(1,195	)		38,789			—			37,594

Total member’s equity		(655,392	)		613,294			262,887			(4,648	)		216,141

Total liabilities and member’s equity	$	254,914		$	787,313		$	502,414		$	(525,561	)	$	1,019,080


(1)		Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be useful.

Balance Sheet


	As of December 31, 2006
				Guarantor			Non-Guarantor
	Issuers (1)			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Assets
Current assets:
Cash and cash equivalents	$	—		$	13,850		$	29,751		$	—		$	43,601
Receivables, net		3,509			47,194			97,259			(12,025	)		135,937
Inventories of products, net		—			141,164			119,514			(3,893	)		256,785
Inventories of materials and supplies		—			6,615			4,288			—			10,903
Other current assets		3,659			1,022			8,627			—			13,308
Deferred income taxes		—			8,665			(6,734	)		—			1,931

Total current assets		7,168			218,510			252,705			(15,918	)		462,465
Property, plant and equipment, less accumulated depreciation		117,519			169,727			116,497			—			403,743
Identifiable intangible assets		37,820			—			48,811			—			86,631
Investment in unconsolidated joint venture		813			—			8,563			—			9,376
Deferred financing costs		13,038			—			—			—			13,038
Other long-term assets		97,657			338,894			7,314			(429,965	)		13,900

Total assets	$	274,015		$	727,131		$	433,890		$	(445,883	)	$	989,153

Liabilities and Member’s Equity
Current liabilities:
Current portion of long-term debt	$	3,850		$	—		$	—		$	—		$	3,850
Accounts payable-trade		2,900			23,432			42,608			—			68,940
Other payables and accruals		7,605			16,415			29,110			—			53,130
Due to (from) related parties		—			704			20,672			(12,025	)		9,351
Insurance note payable		739			—			—			—			739

Total current liabilities		15,094			40,551			92,390			(12,025	)		136,010
Long-term debt, net of current portion		578,263			—			—			—			578,263
Deferred income taxes		(43,583	)		72,164			11,526			—			40,107
Long-term liabilities		333,435			34,158			97,404			(429,965	)		35,032

Total liabilities		883,209			146,873			201,320			(441,990	)		789,412

Commitments and contingencies (note 9)
Member’s equity:
Common equity		(611,057	)		581,453			217,608			(3,893	)		184,111
Accumulated other comprehensive income		1,863			(1,195	)		14,962			—			15,630

Total member’s equity		(609,194	)		580,258			232,570			(3,893	)		199,741

Total liabilities and member’s equity	$	274,015		$	727,131		$	433,890		$	(445,883	)	$	989,153


(1)		Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be useful.

Statement of Operations


	Three Months Ended September 30, 2007
				Guarantor			Non-Guarantor
	Issuers (1)			Subsidiaries			Subsidiaries			Eliminations				Consolidated
Revenues:
Sales	$	—		$	141,096		$	174,961		$	(31,559	)		$	284,498
Other		—			(108	)		5,760			—				5,652
													��
Total revenues		—			140,988			180,721			(31,559	)			290,150
Costs and expenses:
Cost of goods sold		787			114,486			159,985			(31,559	)			243,699

Gross profit (loss)		(787	)		26,502			20,736			—				46,451
Research and development expenses		—			2,205			3,247			—				5,452
Selling, general, and administrative expenses		(33	)		7,730			7,897			—				15,594
Depreciation and amortization		4,324			5,036			3,179			—				12,539
Earnings in joint venture		—			—			(189	)		—				(189	)
Interest expense (income), net		13,136			(2,495	)		1,734			—				12,375

Income (loss) before income taxes		(18,214	)		14,026			4,868			—				680
Income tax benefit (provision)		573			295			(2,302	)		—				(1,434	)

Net (loss) income	$	(17,641	)	$	14,321		$	2,566		$	—			$	(754	)


	Three Months Ended September 30, 2006
				Guarantor			Non-Guarantor
	Issuers (1)			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Revenues:
Sales	$	—		$	142,454		$	170,368		$	(34,413	)	$	278,409
Other		—			50			9,695			—			9,745

Total revenues		—			142,504			180,063			(34,413	)		288,154
Costs and expenses:
Cost of goods sold		(2,567	)		112,903			149,897			(34,413	)		225,820

Gross profit		2,567			29,601			30,166			—			62,334
Research and development expenses		—			3,980			2,104			—			6,084
Selling, general, and administrative expenses		—			10,718			8,166			—			18,884
Depreciation and amortization		4,479			4,739			1,969			—			11,187
Loss in joint venture		—			—			208			—			208
Interest expense (income)		11,917			(2,220	)		1,235			—			10,932

Income (loss) before income taxes		(13,829	)		12,384			16,484			—			15,039
Income tax (provision) benefit		2,609			(2,575	)		(3,438	)		—			(3,404	)

Net income (loss)	$	(11,220	)	$	9,809		$	13,046		$	—		$	11,635


(1)		Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be useful.

Statement of Operations


	Nine Months Ended September 30, 2007
				Guarantor			Non-Guarantor
	Issuers (1)			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Revenues:
Sales	$	—		$	416,149		$	511,132		$	(114,955	)	$	812,326
Other		—			—			19,546			—			19,546

Total revenues		—			416,149			530,678			(114,955	)		831,872
Costs and expenses:
Cost of goods sold		799			345,970			469,846			(114,955	)		701,660

Gross profit (loss)		(799	)		70,179			60,832			—			130,212
Research and development expenses		—			4,936			13,568			—			18,504
Selling, general, and administrative expenses		(33	)		26,778			22,463			—			49,208
Depreciation and amortization		12,972			15,023			8,422			—			36,417
Earnings in joint venture		—			—			(514	)		—			(514	)
Interest expense (income), net		34,203			(7,138	)		5,442			—			32,507

Income (loss) before income taxes		(47,941	)		30,580			11,451			—			(5,910	)
Income tax (provision) benefit		1,759			295			(3,876	)		—			(1,822	)

Net (loss) income	$	(46,182	)	$	30,875		$	7,575		$	—		$	(7,732	)


	Nine Months Ended September 30, 2006
				Guarantor			Non-Guarantor
	Issuers (1)			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Revenues:
Sales	$	—		$	408,199		$	496,817		$	(129,824	)	$	775,192
Other		—			185			27,454			—			27,639

Total revenues		—			408,384			524,271			(129,824	)		802,831
Costs and expenses:
Cost of goods sold		(461	)		326,794			439,043			(129,824	)		635,552

Gross profit		461			81,590			85,228			—			167,279
Research and development expenses		—			10,595			8,555			—			19,150
Selling, general, and administrative expenses		—			33,961			22,911			—			56,872
Depreciation and amortization		13,437			13,849			5,915			—			33,201
(Earnings) in joint venture		—			—			(232	)		—			(232	)
Interest expense (income)		32,624			(6,790	)		3,667			—			29,501

Income (loss) before income taxes		(45,600	)		29,975			44,412			—			28,787
Income tax (provision) benefit		10,963			(7,210	)		(10,986	)		—			(7,233	)

Net income (loss)	$	(34,637	)	$	22,765		$	33,426		$	—		$	21,554


(1)		Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be useful.

Statement of Cash Flows


	Nine Months Ended September 30, 2007
				Guarantor			Non-Guarantor
	Issuers (1)			Subsidiaries			Subsidiaries			Eliminations		Consolidated
Cash flows provided by (used in) operating activities	$	(29,070	)	$	68,593		$	12,557		$	—	$	52,080

Cash flows used in investing activities:
Purchase of plant and equipment, net of proceeds from sales of equipment		—			(11,466	)		(8,352	)		—		(19,818	)

Net cash used in investing activities		—			(11,466	)		(8,352	)		—		(19,818	)

Cash flows provided by (used in) financing activities:
Proceeds from (payments on) intercompany loans		—			—			—			—		—
Repayment of debt		(42,787	)		—			—			—		(42,787	)
Cash dividend to parent		—			—			—			—		—
Deferred Financing cost		—			—			—			—		—
Proceeds from (payments on) Inter Group Debt		70,619			(70,619	)		—			—		—
Net proceeds from insurance note payable		1,238			—			—			—		1,238


Net cash provided by (used in) financing activities		29,070			(70,619	)		—			—		(41,549	)

Effect of exchange rate difference on cash		—			—			(1,997	)		—		(1,997	)

Net decrease in cash and cash equivalents		—			(13,492	)		2,208			—		(11,284	)
Cash and cash equivalents at beginning of period		—			13,850			29,751			—		43,601

Cash and cash equivalents at end of period	$	—		$	358		$	31,959		$	—	$	32,317


	Nine Months Ended September 30, 2006
				Guarantor			Non-Guarantor
	Issuers (1)			Subsidiaries			Subsidiaries			Eliminations		Consolidated
Cash flows provided by (used in) operating activities	$	(47,273	)	$	6,713		$	9,179		$	—	$	(31,381	)
Cash flows used in investing activities:
Purchase of plant and equipment, net of proceeds from sales of equipment		—			(10,328	)		(17,667	)		—		(27,995	)

Net cash used in investing activities		—			(10,328	)		(17,667	)		—		(27,995	)

Cash flows provided by (used in) financing activities:
Proceeds from debt		123,008			—			—			—		123,008
Repayment of debt		(2,596	)		—			—			—		(2,596	)
Cash dividend to parent		(129,531	)		—			—			—		(129,531	)
Deferred financing costs		(2,678	)		—			—			—		(2,678	)
Net proceeds from insurance note payable		2,957			—			—			—		2,957
Proceeds from (payments on) intercompany loans		56,113			(51,897	)		(4,216	)		—		—

Net cash provided by (used in) financing activities		47,273			(51,897	)		(4,216	)		—		(8,840	)

Effect of exchange rate difference on cash		—			—			(4,003	)		—		(4,003	)

Net decrease in cash and cash equivalents		—			(55,512	)		(16,707	)		—		(72,219	)
Cash and cash equivalents at beginning of period		—			54,941			45,993			—		100,934

Cash and cash equivalents at end of period	$	—		$	(571	)	$	29,286		$	—	$	28,715


(1)		Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be useful.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our financial condition and results of operations with our audited consolidated financial statements and related notes thereto, included in Kraton’s Annual Report on Form 10-K as of and for the year ended December 31, 2006. This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to the risk factors discussed in the “Risk Factors” section of our From 10-K and in “Factors Affecting Our Results of Operations,” and elsewhere in this
Form 10-Q. Actual results may differ materially from those contained in any forward-looking statements.

Overview

Kraton is a leading supplier of engineered polymers worldwide. We believe we are the world’s leading producer (in terms of both sales and volume in 2006) of styrenic block copolymers (SBCs), a family of products whose chemistry we pioneered over 40 years ago. SBCs are highly engineered thermoplastic elastomers, which enhance the performance of numerous products by delivering a variety of attributes, including greater flexibility, resilience, strength, durability and processability. We also sell a high-end polyisoprene rubber (IR), polyisoprene latex, and SBC-based compounded materials. Our polymers typically modify other products and are frequently processed with other materials in a variety of applications. Our products are highly customized to each unique application and typically represent a key enabler of the performance to our customers’ products. We currently offer approximately 1,000 products to over 700 customers in over 60 countries worldwide. Our global manufacturing network includes six plants, which are located in the United States, The Netherlands, Germany, France, Brazil and Japan.

We have aligned our commercial activities to serve five core end-use markets: (1) Adhesives, Sealants and Coatings; (2) Paving and Roofing; (3) Compounding Channels; (4) Personal Care; and (5) Packaging and Films. We also have a business development group to manage our emerging businesses, including sales in polyisoprene latex.

We generate substantially all of our product sales and gross margin from our five primary product lines: (1) unhydrogenated SBCs, or USBCs; (2) hydrogenated SBCs or HSBCs; (3) Compounds; (4) IR; and (5) IR Latex.

Recent Developments

Pernis, The Netherlands

The agreement with Shell Chemicals providing isoprene to our Pernis, The Netherlands facility (“our Pernis facility”) will expire on December 31, 2009 and is renewed automatically unless twenty-four months prior written notice of termination is given. We understand that Shell Chemicals is considering the closure of its isoprene unit in Pernis, which we expect would cause Shell Chemicals to not renew its agreement to provide isoprene to our Pernis facility. We have not received a notice of termination as of the date of this report.

As previously disclosed, Shell Chemicals, the operator of our Pernis facility, provided us a preliminary study during 2003 and updated during 2004 which reviewed Kraton’s Pernis facilities operations and physical plant. The study identified both required maintenance and suggested near-term and long-term improvements to the plant, which could require considerable investment. This study, along with the possibility that Shell Chemicals may elect not to renew the isoprene supply agreement to our Pernis facility, caused us to review the long-term strategic and economic options for our Pernis assets.

On September 20, 2007, Kraton decided to exit the SIS plant at our Pernis facility, which will result in a contractor workforce reduction and is expected to provide annual cost savings in the range of $6 million to $9 million. Notification of this decision and the exit plan was given to Shell Chemicals on November 9, 2007. As a consequence of Kraton’s decision, the terms defined in the Agreement for Adjustment and Termination of Services under Kraton/SNC SUMFs and OMS Agreements at Pernis dated June 28, 2007 have come into effect.

Kraton is undertaking the plan in connection with its decision to relocate SIS production to the Company’s other production facilities as part of its cost reduction efforts. We expect that the SIS grades can be manufactured successfully at alternative plant locations, and we expect to have sufficient capacity to meet current and near term demands. The plan is expected to begin in the fourth quarter of 2007 and is expected to be completed by early 2008. Kraton recorded a liability associated with the plan of approximately $2.1 million, consisting of $1.8 million in contractor workforce reduction and $0.3 million in other associated costs. The entire

amount of the charge consists of future cash expenditures. We anticipate that substantially all of the cash expenditures will be incurred in the first and second quarters of 2008.

As of the date of this report, no final decision has yet been made on the future of the IR plant at our Pernis facility. We would expect to keep the IR plant operational at least until the end of calendar year 2009. If we should decide to close the plant we would expect to develop an alternative manufacturing facility for our IR grades, and we may build additional inventory to continue to supply our customers until the alternative manufacturing facility is in production.

Change in Board of Directors

On September 20, 2007, Mr. John Breckenridge, a principal of CCMP Capital Advisors, LLC, resigned as a member of the Board of Directors of Kraton Polymers LLC (the “Company”). Mr. Breckenridge also served as a member of the Audit, Compensation and Executive Committees of the Company. The Company does not intend to fill the vacancy created by the resignation of Mr. Breckenridge at this time.

Board Committee Membership Changes

On September 20, 2007, the Board of Directors of Kraton appointed the following as members of the three standing Board of Director committees, each to serve in accordance with the terms of the Amended and Restated Limited Liability Companies Agreement of Kraton and until their successors are appointed and qualified, or until their earlier resignation or removal:

Audit Committee:

James Ball – Chairman
Michael MacDougall
Timothy Walsh
Nathan Wright

Compensation Committee:

Timothy Walsh – Chairman
Kelvin Davis
Nathan Wright

Executive Committee:

Kelvin Davis – Chairman
George Gregory
Michael MacDougall
Timothy Walsh

Compensatory Arrangements of Certain Officers

As of September 20, 2007, Kraton Polymers LLC (“Kraton”) and Kraton’s Chief Financial Officer, Nicholas G. Dekker, have agreed to extend the term of Mr. Dekker’s employment beyond the expiration date of October 5, 2007, as set forth in his Employment Agreement with Kraton dated as of April 9, 2007 (previously filed as an exhibit to Form 10-K on April 12, 2007). Mr. Dekker and Kraton are currently negotiating the terms of such extension.

Critical Accounting Policies

Our significant accounting policies are more fully described in the notes to the December 31, 2006 consolidated financial statements included in Kraton’s Annual Report on Form 10-K as of and for the year then ended. The process of preparing financial statements, in accordance with generally accepted accounting principles in the United States requires management to make estimates and judgments regarding certain items and transactions. These judgments are based on historical experience, current economic and industry trends, information provided by outside sources, and management estimates. It is possible that materially different amounts could be recorded if these estimates and judgments change or if the actual results differ from these estimates and judgments. We consider the following to be our most significant critical accounting policies, which involve the judgment of management.

Revenue Recognition

We recognize revenue from sales when title transfers to the customer as products are shipped. In specific cases, we supply customers on a consignment basis and recognize revenue as the product is utilized. We classify amounts billed to customers for shipping and handling as revenues, with the related shipping and handling costs included in cost of goods sold. By-product sales (included in other revenue) are also recorded upon shipment.

Agreements have been entered into with some customers, whereby they earn rebates when the volume of their purchases of our product reaches certain agreed levels. We recognize the estimated rebate obligation under these agreements as a reduction of revenue to each of the underlying revenue transactions. These estimates are based on a combination of the forecast of customer sales and actual sales volumes and revenues against established goals, the customer’s current level of purchases, our knowledge of customer purchasing habits, and industry pricing practice. These rebates typically represent up to approximately 1% of our product sales.

Inventories

Our inventory is principally comprised of finished goods inventory. Inventories are stated at the lower of cost or market as determined on a first-in first-out, or FIFO basis. Inventory cost is comprised of raw materials, utilities and other manufacturing costs, including labor. On a quarterly basis, we evaluate the carrying cost of inventory to ensure that it is stated at the lower of cost or market. Our products are typically not subject to spoiling or obsolescence and consequently our reserves for slow moving and obsolete inventory have historically been immaterial. From time to time, the value of our inventory is re-evaluated to reflect customer demand for specific products.

Property, Plant and Equipment

One of the most critical accounting policies affecting our long-lived assets is the determination of the estimated useful lives of our property, plant and equipment. The estimated useful lives of our chemical assets, which range from three years to twenty years, are used to compute depreciation expense and are also used for impairment tests. The estimated useful lives used for the chemical facilities were based on the assumption that we would provide an appropriate level of annual capital expenditures while the plants are still in operation. Without these continued capital expenditures, the useful lives of these plants could significantly decrease. Changes to estimated useful lives would impact the amount of depreciation and amortization expense recorded in the statement of operations.

We are required to perform impairment tests on our assets whenever events or changes in circumstances lead to a reduction in the estimated useful lives or estimated future cash flows that would indicate that the carrying amount may not be recoverable. Under the provisions of Statement of Financial Accounting Standards No. 144, or SFAS No. 144, we must compare the undiscounted future cash flows of an asset to its carrying value. Key factors that could significantly affect future cash flows include international competition, environmental regulations, higher or lower product prices, feedstock costs, energy costs and remaining estimated useful life.

Pensions

Our United States pension benefit obligations and expenses are calculated using actuarial models and methods, in accordance with SFAS No. 87, “Employers’ Accounting for Pensions”, as amended by SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans.” Two of the more critical assumptions and estimates used in the actuarial calculations are the discount rate for determining the current value of plan benefits and the expected rate of return on plan assets. Other critical assumptions and estimates used in determining benefit obligations and plan expenses, including demographic factors such as retirement age, mortality and turnover, are also evaluated periodically and updated accordingly to reflect our actual experience. Discount rates are determined annually and are based on rates of return of high-quality fixed income investments currently available and expected to be available during the period to maturity of the pension benefits. Expected long-term rates of return on plan assets are determined annually and are based on an evaluation of our plan assets, historical trends and experience, taking into account current and expected market conditions. Plan assets are comprised primarily of equity and debt securities.

The actuarial assumptions used in determining our pension benefits may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates and longer or shorter life spans of participants. While we believe that the assumptions used are appropriate, differences in actual experience or changes in assumptions may materially affect our financial position or results of operations.

Income Taxes

We conduct all operations, including the U.S. operations, in separate legal entities and as a result, income tax amounts are reflected on a separate return basis. Deferred taxes result from differences between the financial and tax bases of our assets and liabilities and are adjusted for changes in tax rates and tax laws when changes are enacted. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.

Factors Affecting Our Results of Operations

Raw Materials

Our results of operations are directly affected by the cost of raw materials. We use three monomers as our primary raw materials in the manufacture of our products: styrene; butadiene; and isoprene. These monomers together represented approximately 81% of total raw material purchases volume and approximately 51% of cost of goods sold in 2006. Our financial performance for the year ended December 31, 2006 was affected by significant increases in raw material feedstock prices. We experienced significantly higher raw material feedstock prices in 2006. Prices for these key raw materials have increased between 8% and 37% during 2006 compared to 2005 and have generally been correlated to crude oil prices over the last three years. For the first nine months of 2007, financial performance has continued to be affected by the prevailing raw material pricing environment and global supply and demand conditions.

Styrene, butadiene and isoprene used by our U.S. and European facilities are primarily supplied by Shell Chemicals or its affiliates, Basell, and other suppliers under long-term supply contracts with various expiration dates. Prices under these contracts are typically determined by contractual formulas that reference both the suppliers cost of production as well as market prices. In Japan, butadiene and isoprene supplies for our joint venture plant are supplied under our joint venture agreement, where our partner supplies our necessary requirements. Styrene in Japan is sourced from local third-party suppliers. Our facility in Paulinia, Brazil generally purchases mostly of its raw materials from local third-party suppliers.

Styrene is used in the production of substantially all our products. Styrene is made from ethylene and benzene. Benzene is a derivative of crude oil and ethylene is a derivative of either crude oil or natural gas liquids. Prices for styrene are volatile. Styrene prices are primarily driven by worldwide supply and demand and the cost of ethylene, benzene, and natural gas. Market prices for styrene increased throughout most of 2004, 2005 and 2006. Our average acquisition costs of styrene increased approximately 9% during the nine months ended September 30, 2007, as compared to the comparable period in 2006.

Butadiene is used in the production of certain grades of both USBC and HSBC products. Prices for butadiene are also volatile, with prices reflecting worldwide supply and demand and prevailing crude oil and ethylene prices. Since 2004 we have generally experienced increasing market prices for butadiene. Our average acquisition costs of butadiene increased approximately 18% during the nine months ended September 30, 2007 as compared to the comparable period in 2006. These increases are the result of generally tight worldwide butadiene supply/demand and high energy costs. Butadiene is a by-product of the production of other petrochemicals and worldwide supply is some times less responsive to increased demand for the product versus other petrochemicals.

Isoprene is used in the production of certain grades of both USBC and HSBC and IR. Isoprene is primarily produced and consumed captively for the production of isoprene rubber, which is primarily used in the manufacture of rubber tires. As a result, there is limited non-captive isoprene produced in the market in which we operate and the market for isoprene is thin and prices are volatile. Prices for isoprene are determined by the supply and prices of natural and synthetic rubber, crude oil and natural gas prices and existing supply and demand in the market. Market prices for isoprene rose substantially throughout 2004, 2005 and most of 2006. A significant factor contributing to higher prices during the prior periods was the extreme tightness in the market caused by operational problems of some key producers. During the nine months ended September 30, 2007, however, our average acquisition costs for isoprene decreased 5% versus the comparable period in 2006, primarily due to changes in supply and demand conditions. While it is difficult to predict if additional operational problems of key isoprene producers are likely to recur, we believe it is unlikely that multiple key isoprene producers will experience operational problems in the future within the short period of time as occurred in early 2005. Nonetheless, due to the limited number of isoprene producers, any significant operational problems could potentially adversely affect available supply.

Changes in prices for raw materials will have an affect on our results of operations. In response to raw material feedstock cost increases, we have continued to increase prices for many of our products. We are continuing to evaluate our prices for all of our products, as market conditions change.

Seasonality

Sales of our products sold into the Paving and Roofing end-use market are affected by seasonal changes. Second and third quarters sales volumes in this end-use market are significantly higher than the first and fourth quarters because weather conditions reduce road and building construction in the winter seasons.

Economic and Market Conditions

Our results of operations are influenced by changes in general economic conditions. Our products are sold in markets that are sensitive to changes in general economic conditions, such as automotive and construction products. Downturns in general economic conditions can cause fluctuations in demand for our products, product prices, volumes and margins. A number of our products are sold into certain commercial and consumer end-use markets, such as the Compounding Channels and Personal Care end-use markets that are generally considered to be less affected by general economic conditions. However, our results of operations were negatively affected during 2006 in the Paving and Roofing end-use market due to the increased prices of asphalt, resulting in a decline in demand for our products. In addition, during 2007 we experienced lower than anticipated demand in the paving and roofing end use market in North America, which was primarily a result of unfavorable weather conditions.

A dramatic economic slowdown could adversely affect demand for our products. In addition, changes in interest rates may increase financing costs as our senior secured credit facility bears interest at a floating rate. Changes in inflation may increase the costs of raw materials and other costs, and we may not be able to pass such cost increases on to the consumers of our products.

International Operations and Currency Fluctuations

We operate a geographically diverse business, with 43% of net product sales generated from customers located in the Americas, 42% in Europe and 15% in the Asia Pacific region during the 2006 period. In 2006, we estimated that our products were sold to customers in more than 60 countries. We serve our customer base from 6 manufacturing plants in 6 countries. As described above, changes in general economic conditions in these countries will influence our results of operations.

Although we sell and manufacture our products in many countries, our sales and production costs are mainly denominated in U.S. dollars, Euros, Japanese Yen and Brazilian Real. The following table shows the U.S. dollar exchange rate for these currencies in the third quarter of 2007 and 2006. These average rates may differ from the actual rates used in the preparation of the consolidated financial statements.


	U.S. $ per Euro				U.S. $ per 10,000 Japanese Yen				U.S. $ per Brazilian Real
	Average		Period End		Average		Period End		Average		Period End
Quarter Ended September 30, 2006		1.275		1.269		86.10		84.82		0.459		0.460
Quarter Ended September 30, 2007		1.373		1.426		84.85		86.63		0.512		0.544
Nine months Ended September 30, 2006		1.243		1.269		86.30		84.82		0.459		0.460
Nine months Ended September 30, 2007		1.343		1.426		83.74		86.63		0.496		0.544

Our financial results are subject to gains and losses on currency transactions denominated in currencies other than the functional currency of the relevant operations. Any gains and losses are included in operating income, but have historically not been material. We have previously not engaged, and are not currently planning to engage in foreign currency hedging activities.

In addition, our financial results are subject to gains and losses on currency translations, which occur when the financial statements of foreign operations are translated into U.S. dollars. The financial statements of operations outside the U.S. where the local currency is considered to be the functional currency are translated into U.S. dollars using the exchange rate at each balance sheet date for assets and liabilities and the average exchange rate for each period for revenues, expenses, gains and losses and cash flows. The effect of translating the balance sheet into U.S. dollars is included as a component of other comprehensive income (loss) in member’s equity. Any appreciation of the functional currencies against the U.S. dollar will increase the U.S. dollar equivalent of amounts of revenues, expenses, gains and losses and cash flows, and any depreciation of the functional currencies will decrease the U.S. dollar amounts reported.

Results of Operations

Three Months Ended September 30, 2007, Compared to Three Months Ended September 30, 2006

The following table summarizes certain information relating to our operating results that have been derived from our financial statements (in thousands).


	Three Months Ended			Three Months Ended
	September 30, 2007			September 30, 2006
Revenues:
Sales	$	284,498		$	278,409
Other		5,652			9,745

Total revenues		290,150			288,154

Costs and expenses:
Cost of goods sold		243,699			225,820

Gross profit		46,451			62,334
Research and development expenses		5,452			6,084
Selling, general and administrative expenses		15,594			18,884
Depreciation and amortization of identifiable intangibles		12,539			11,187
Earnings in joint venture		(189	)		208
Interest expense, net		12,375			10,932

Income before income taxes		680			15,039
Income tax provision		(1,434	)		(3,404	)

Net income	$	(754	)	$	11,635

The following table summarizes certain information relating to our operating results as a percentage of total revenues and has been derived from the financial information presented above. We believe this presentation is useful to investors in comparing historical results. Certain amounts in the table may not sum due to the rounding of individual components.


	Three Months Ended			Three Months Ended
	September 30, 2007			September 30, 2006
Revenues:
Sales		98.0	%		96.6	%
Other		2.0			3.4

Total Revenues		100.0			100.0

Costs and expenses:
Cost of goods sold		84.0			78.4

Gross profit		16.0			21.6
Research and development expenses		1.9			2.1
Selling, general and administrative expenses		5.4			6.6
Depreciation and amortization of identifiable intangibles		4.3			3.8
Earnings in joint venture		(0.1	)		0.1
Interest expense, net		4.3			3.8

Income before income taxes		0.2			5.2
Income tax provision		(0.5	)		(1.2	)

Net income (loss)		(0.3	)%		4.0	%

Total Revenues

Total revenues increased by 0.7% to $290.2 million for the three months ended September 30, 2007, as compared to $288.2 million for the three months ended September 30, 2006. This increase was primarily due to an estimated increase of $7.7 million related to our product prices and an approximately $10.1 million due to the net strengthening of the functional currencies of our foreign operations against the U.S. dollar, partially offset by an approximate $4.1 million decrease associated with lower by-product sales and an estimated $11.7 million decrease related to lower sales volume. Prices for our products were increased primarily to help offset continued higher raw material costs. Functional currencies changed as follows: (1) the Euro strengthened approximately 7.7%; (2) the Brazilian Real appreciated approximately 11.5%; while (3) the Japanese Yen weakened approximately 1.5% during the three months ended September 30, 2007, as compared to the three months ended September 30, 2006.

Sales. Sales increased by 2.2% to $284.5 million for the three months ended September 30, 2007, as compared to $278.4 million for the three months ended September 30, 2006. The increase in sales was primarily due to an increase of approximately of $10.1

million related to the net strengthening of the functional currencies of our foreign operations against the U.S. dollar and an estimated $7.7 million increase due to product mix and product prices, which were partially offset by an estimated $11.7 million decrease due to lower sales volumes.

During the quarter, we implemented price increases in some of our product grades to help offset continued increased raw material costs. These price increases, however, were offset by lower sales volumes. The reduced sales volume was principally due to lower volume in the paving and roofing end use market in North America, which was primarily a result of unfavorable weather conditions, limited government paving budget and market response to our pricing strategy. All other core end use markets realized positive volume growth.

Other revenue. Other revenues decreased by 42.0% to $5.7 million for the three months ended September 30, 2007, as compared to $9.8 million for the three months ended September 30, 2006. Other revenue primarily consists of the sales of small quantities of residual products that is a by-product of the manufacturing process of Kraton IR, an isoprene rubber product produced at our Netherlands facility. The decrease in other revenues is primarily due to a decrease in sales volumes during the three months ended September 30, 2007 as compared to the three months ended September 30, 2006 and partially offset due to the strengthening of the Euro against the U.S. dollar during the 2007 period as compared to the 2006 period.

Cost of Goods Sold

Costs of goods sold increased by 7.9% to $243.7 million for the three months ended September 30, 2007, as compared to $225.8 million for the three months ended September 30, 2006. As a percentage of total revenues, cost of goods sold increased to 84.0% from 78.4%. Cost of goods sold for the three months ended September 30, 2007 when compared to the 2006 period increased $17.9 million due to an estimated $21.8 million related to increased raw material and other variable costs, and an approximate $9.3 million increase due to the net appreciation of functional currencies of our foreign operations against the U.S. dollar. These increases were partially offset by an approximate $9.1 million decrease due to reduced sales volume and a $4.1 million decrease associated with lower by-product sales. Average acquisition costs, per metric ton for butadiene increased more than 10%, in the comparable period equally due to industry supply demand and the weakening dollar to euro exchange rate, while the average price for styrene was stable. The average acquisition cost, per metric ton, for isoprene declined by 14% due to increased contract supply and the favorable impact of global supply and demand on spot pricing.

Gross Profit

Gross profit decreased by 25.5% to $46.5 million for the three months ended September 30, 2007, as compared to $62.3 million for the three months ended September 30, 2006. Gross profit as a percentage of total revenues decreased from 21.6% in the three months ended September 30, 2006 to 16.0% in the three months ended September 30, 2007, due to the factors noted above.

Operating Expenses

Research and development expenses.Research and development expenses decreased by 10.4% to $5.5 million for the three months ended September 30, 2007, as compared to $6.1 million for the three months ended September 30, 2006. Research and development expenses decreased primarily due lower personnel related costs and building lease expenses as a result of our restructuring activities implemented in 2006. This decrease was partially offset by an increase due to the net appreciation of functional currencies of our foreign operations against the U.S. dollar. As a percentage of total revenues, research and development expenses decreased from 2.1% in the three months ended September 30, 2006 to 1.9% in the three months ended September 30, 2007.

Selling, general and administrative expenses.Selling, general and administrative expenses decreased by 17.4% to $15.6 million for the three months ended September 30, 2007, as compared to $18.9 million for the three months ended September 30, 2006. Selling, general and administrative expenses decreased primarily due to lower incentive compensation and reduced personnel related costs during the 2007 period, and the 2006 period included some restructuring related expenses. These decreases were partially offset by an increase due to the appreciation of functional currencies of our foreign operations against the U.S. dollar and spending for the implementation of Sarbanes Oxley 404 (SOX) readiness activities. As a percentage of total revenues, selling, general and administrative expenses decreased to 5.4% in the three months ended September 30, 2007 from 6.6% in the 2006 period.

Depreciation and amortization of identifiable intangibles.Depreciation and amortization expense increased by 12.1% to $12.5 million for the three months ended September 30, 2007 as compared to $11.2 million for the three months ended September 30, 2006. The increase in depreciation and amortization expense was primarily due to assets that were under construction in prior periods that

were completed and placed in service during the and fourth quarter of 2006 and the first, second, and third quarters of 2007, including our new polyisoprene latex plant at our Paulinia, Brazil facility.

Earnings in joint venture.The Kashima plant is operated by a manufacturing joint venture with JSR Corporation under the name Kraton JSR Elastomers K.K. Earnings in the joint venture were $0.2 million for the three months ended September 30, 2007 as compared to losses of $0.2 million for the three months ended September 30, 2006. We use the equity method of accounting for our joint venture at the Kashima site.

Interest expense, net.Interest expense, net was $12.4 million for the three months ended September 30, 2007, as compared to $10.9 million for the three months ended September 30, 2006. This increase was primarily due to a higher effective interest rate for the three months ended September 30, 2007 as compared to the 2006 period. This increase was partially offset by somewhat lower debt balances during the quarter. During the three months ended September 30, 2007, and September 30, 2006, the average debt balances outstanding were approximately $580.2 million and $583.8 million, respectively. However, the effective interest rates on our debt during the same periods were 8.1% and 6.9%, respectively.

Income tax provision.Income tax provision was $1.4 million for the three months ended September 30, 2007, as compared to $3.4 million for the three months ended September 30, 2006. The effective tax rate for the three months ended September 30, 2007 was approximately 210.9% as compared to a rate of 22.6% in the three months ended September 30, 2006. Our effective tax rate for the three months ended September 30, 2007 was higher than our statutory rate primarily due to not recording a tax benefit for certain net operating loss carryforwards generated during that period. Our effective tax rate for the three months ended September 30, 2006 was less than our statutory rate primarily due to a different income mix between foreign and domestic tax jurisdictions.

Net income.Net loss was ($0.8) million for the three months ended September 30, 2007, as compared to net income of $11.6 million for the three months ended September 30, 2006, for the reasons discussed above.

Nine months Ended September 30, 2007, Compared to Nine Months Ended September 30, 2006

The following table summarizes certain information relating to our operating results that have been derived from our financial statements (in thousands).


	Nine Months Ended			Nine Months Ended
	September 30, 2007			September 30, 2006
Revenues:
Sales	$	812,326		$	775,192
Other		19,546			27,639

Total revenues		831,872			802,831

Costs and expenses:
Cost of goods sold		701,660			635,552

Gross profit		130,212			167,279
Research and development expenses		18,504			19,150
Selling, general and administrative expenses		49,208			56,872
Depreciation and amortization of identifiable intangibles		36,417			33,201
Earnings in joint venture		(514	)		(232	)
Interest expense, net		32,507			29,501

(Loss) income before income taxes		(5,910	)		28,787
Income tax provision		(1,822	)		(7,233	)

Net (loss) income	$	(7,732	)	$	21,554


	Nine months Ended			Nine months Ended
	September 30, 2007			September 30, 2006
Revenues:
Sales		97.6	%		96.6	%
Other		2.4			3.4

Total Revenues		100.0			100.0

Costs and expenses:
Cost of goods sold		84.4			79.2

Gross profit		15.6			20.8
Research and development expenses		2.2			2.4
Selling, general and administrative expenses		5.9			7.1
Depreciation and amortization of identifiable intangibles		4.4			4.1
Earnings in joint venture		(0.1	)		(0.0	)
Interest expense, net		3.9			3.7

(Loss) income before income taxes		(0.7	)		3.6
Income tax provision		(0.2	)		(0.9	)

Net (loss) income		(0.9	)%		2.7	%

Total Revenues

Total revenues increased by 3.6% to $831.9 million for the nine months ended September 30, 2007, as compared to $802.8 million for the nine months ended September 30, 2006. This increase was primarily due to: (1) an approximate $7.4 million increase in sales volume; (2) an estimated $27.8 million due to the net strengthening of the functional currencies of our foreign operations against the U.S. dollar; and (3) an estimated increase of $1.9 million due to product mix and higher product prices to help offset continued higher raw material costs. These increases were partially offset by an approximate $8.1 million decrease associated with lower by-product sales. Sales volume increased approximately 1.0%, from the comparable period in 2006. Functional currencies changed as follows: (1) the Euro strengthened approximately 8.0%; (2) the Brazilian Real appreciated approximately 8.5%; while (3) the Japanese Yen weakened approximately 3.0% during the nine months ended September 30, 2007, as compared to the nine months ended September 30, 2006.

Sales. Sales increased by 4.8% to $812.3 million for the nine months ended September 30, 2007, as compared to $775.2 million for the nine months ended September 30, 2006. The increase in sales was primarily due to: (1) an estimated $7.4 million increase in sales volume, (2) an approximate increase of $27.8 million due to the net strengthening of the functional currencies of our foreign operations against the U.S. dollar, and (3) a $1.9 million increase due to product mix and higher product prices.

The sales volume increase was primarily due to strong market growth in our Compounding Channels and Personal Care end-use markets. Compounding Channels growth was driven by HSBC innovation volumes, Personal Care growth was driven by continued USBC market growth in Europe. The Paving and Roofing end-use market experienced a sales volume decrease principally due to lower demand in North America, which was primarily a result of unfavorable weather conditions, limited government paving budget and market response to our pricing strategy. All other core end use markets realized positive volume growth, primarily driven by the sale of our new product developments.

Other revenue.Other revenues decreased by 29.3% to $19.5 million for the nine months ended September 30, 2007, as compared to $27.6 million for the nine months ended September 30, 2006. Other revenue primarily consists of the sales of small quantities of residual products that is a by-product of the manufacturing process of Kraton IR, an isoprene rubber product we produce at our Netherlands facility. The decrease in other revenues is primarily due to decreased sales volumes during the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006 and partially offset by the strengthening of the Euro against the U.S. dollar during the 2007 period as compared to the 2006 period.

Cost of Goods Sold

Costs of goods sold increased by 10.4% to $701.7 million for the nine months ended September 30, 2007, as compared to $635.6 million for the nine months ended September 30, 2006. As a percentage of total revenues, cost of goods sold increased to 84.4% from 79.2%. Cost of goods sold for the nine months ended September 30, 2007 when compared to the 2006 period increased $66.1 million due to: (1) an estimated $43.2 million increase related to higher raw material and other variable costs; (2) an approximate $25.2 million increase related

to the net appreciation of functional currencies of our foreign operations against the U.S. dollar; and (3) an estimated $5.8 million increase related to higher sales volume. These increases were partially offset by an approximate $8.1 million decrease associated with lower by-product sales. Average acquisition costs, per metric ton, for styrene and butadiene increased more than 9% and 18%, respectively, in the comparable periods due to the prevailing raw material pricing environment and the weakening dollar to euro exchange rate. The styrene variance also includes the favorable impact of an improved contract supply portfolio. The prices for isoprene declined by 5% due to increased contract supply and improved global supply and demand.

Gross Profit

Gross profit decreased by 22.2% to $130.2 million for the nine months ended September 30, 2007, as compared to $167.3 million for the nine months ended September 30, 2006. Gross profit as a percentage of total revenues decreased from 20.8% in the nine months ended September 30, 2006 to 15.6% in the nine months ended September 30, 2007, due to the factors noted above.

Operating Expenses

Research and development expenses.Research and development expenses decreased 3.4% from $19.2 million for the nine months ended September 30, 2006 to $18.5 million for the nine months ended September 30, 2007. Research and development expenses, as a percentage of total revenues decreased primarily due lower personnel related costs and building lease expenses as a result of our restructuring activities implemented in 2006. These decreases were partially offset by an increase due to the appreciation of functional currencies of our foreign operations against the U.S. dollar. As a percentage of total revenues, research and development expenses decreased from 2.4% to 2.2% during the current period.

Selling, general and administrative expenses.Selling, general and administrative expenses decreased by 13.5% to $49.2 million for the nine months ended September 301, 2007, as compared to $56.9 million for the nine months ended September 30, 2006. Selling, general and administrative expenses decreased primarily due to: (1) lower incentive compensation for the current period; (2) reduced personnel related costs due to restructuring activities implemented in 2006; and (3) costs associated with our restructuring activities and external consulting fees that were recorded in the 2006 period. These decreases were partially offset by an increase due to the appreciation of functional currencies of our foreign operations against the U.S. dollar. As a percentage of total revenues, selling, general and administrative expenses decreased to 5.9% from 7.1% in the 2007 period.

Depreciation and amortization of identifiable intangibles.Depreciation and amortization expense increased by 9.7% to $36.4 million for the nine months ended September 30, 2007 as compared to $33.2 million for the nine months ended September 30, 2006. The increase in depreciation and amortization expense was primarily due to assets that were under construction in 2006 periods that were completed and placed in service during the third and fourth quarters of 2006 and the first, second and third quarters of 2007, including our new polyisoprene latex plant at our Paulinia, Brazil facility.

Earnings in joint venture.The Kashima plant is operated by a manufacturing joint venture with JSR Corporation under the name Kraton JSR Elastomers K.K. Earnings in the joint venture were $0.5 million for the nine months ended September 30, 2007, as compared to $0.2 million for the nine months ended September 30, 2006. We use the equity method of accounting for our joint venture at the Kashima site.

Interest expense, net.Interest expense, net was $32.5 million for the nine months ended September 30, 2007, as compared to $29.5 million for the nine months ended September 30, 2006. This increase was primarily due to higher debt balances during the nine months ended September 30, 2007 as compared to the 2006 period and partially offset by the recognition of approximately $1.6 million of unrealized gain on interest rate swaps during the current year upon the termination of the interest rate swap agreements on June 24, 2007. In June 2007, the Company recorded an adjustment to interest expense related to its accounting for interest rate swaps that resulted in an increase in pre-tax income of approximately $1.6 million for the nine months ended September 30, 2007. The adjustment reflects the additional income statement effects of the Company’s highly effective interest rate swaps that should have been reflected in prior periods. The Company evaluated the materiality of the adjustment, including both qualitative and quantitative considerations, and concluded that the adjustment was not material to current or prior periods. During the nine months ended September 30, 2007, and September 30, 2006, the average debt balances outstanding were $580.1 million and $523.2 million, respectively. The effective interest rates on our debt during the same periods were 7.6% and 7.4%, respectively.

Income tax provision.Income tax provision was $1.8 million for the nine months ended September 30, 2007, as compared to $7.2 million for the nine months ended September 30, 2006. The effective tax rate for the nine months ended September 30, 2007 was approximately (30.8%) as compared to a rate of 25.1% in the nine months ended September 30, 2006. Our effective tax rate for the nine months ended September 30, 2007 was less than our statutory rate primarily due to not recording a tax benefit for certain net

operating loss carryforwards generated during that period. Our effective tax rate for the nine months ended September 30, 2006 was less than our statutory rate primarily due to a different income mix between foreign and domestic tax jurisdictions.

Net (loss) income.Net loss was ($7.7) million for the nine months ended September 30, 2007, as compared to net income of $21.6 million for the nine months ended September 30, 2006, for the reasons discussed above.

Liquidity and Capital Resources

Operating activities.Net cash provided by operating activities was $52.1 million for the nine months ended September 30, 2007, as compared to $31.4 million of cash used in operating activities for the nine months ended September 30, 2006. The increase in cash provided by operating activities during the nine months ended September 30, 2007 was primarily due to improved working capital management in the 2007 period as compared to the 2006 period. These increases were partially offset by an estimated $29.3 million decrease in net income.

Investing activities.Net cash used in investing activities was $19.8 million for the nine months ended September 30, 2007, as compared to $28.0 million used in investing for the nine months ended September 30, 2006. This decrease was primarily driven by the decrease in capital expenditures of $8.0 million during the nine months ended September 30, 2007, as compared to the prior period. This decrease was primarily related to the completion of the construction our new polyisoprene latex plant at our Paulinia, Brazil facility during the fourth quarter 2006.

Financing activities.Net cash used in financing activities was $41.5 million for the nine months ended September 30, 2007, as compared to $8.8 million for the nine months ended September 30, 2006. The change in net cash provided by financing activities for 2007 was primarily due to a voluntary prepayment of $40 million on the Term Facility made in the nine months ended September 30, 2007.

Sources of liquidity.We are a holding company without any operations or assets other than our subsidiaries. Our liquidity depends on distributions from our subsidiaries and we expect to continue to fund our liquidity requirements principally with cash derived from operations, existing cash balances and revolver credit facility. We believe during 2007 we will have sufficient liquidity to fund our operational needs. As of September 30, 2007 we had $32.3 million of cash and cash equivalents. We have available to us, upon compliance with customary conditions, the revolving portion of the senior secured credit facility in the amount of $75.5 million, which was fully available at September 30, 2007. The ability for us to pay principal and interest on our indebtedness, fund working capital and make anticipated capital expenditures depends on our future performance, which is subject to general economic conditions and other factors, some of which are beyond our control. There can be no assurance that our business will generate sufficient cash flow from operations or that future borrowings will be available under our senior secured revolving credit facility to fund liquidity needs in an amount sufficient to enable us to service our indebtedness. Furthermore, if we decide to undertake additional investments in existing or new facilities, this will likely require additional capital, and there can be no assurance that this capital will be available.

Under the terms of our senior secured credit facility, as amended May 12, 2006, we are subject to certain financial covenants, including maintenance of a minimum interest rate coverage ratio and a maximum leverage ratio. Currently, we are required to maintain an interest coverage ratio of 2.25:1.00 through the first fiscal quarter of 2008, increasing to 2.50:1.00 through the fourth fiscal quarter of 2008 and becoming progressively more restrictive thereafter, and to prevent our leverage ratio from exceeding 5.45:1.00 through the first fiscal quarter of 2008 and becoming progressively more restrictive thereafter. Our failure to comply with any of these financial covenants would give rise to a default under the senior secured credit facility.

As of September 30, 2007, we were in compliance with the applicable financial ratios in the senior secured credit facility and the other covenants contained in the senior secured credit facility and the indentures governing the notes.

Capital Expenditures.

Capital investments in property, plant and equipment account for the majority of our investing activities. For the nine months ended September 30, 2007, $19.9 million was spent on the purchase of property, plant and equipment as compared to $28.0 million for the nine months ended September 30, 2006. The decreased spending in the 2007 period was due to the construction of the new polyisoprene latex plant at our Paulinia, Brazil facility, which was completed during the fourth quarter of 2006.

Capital expenditures are expected to be between $28 and $33 million in 2007. These capital expenditures will primarily be for maintenance and infrastructure-related spending as well as expansionary and cost reduction projects. The 2007 expansionary capital expenditures are centered on growth areas including IR Latex, USBC and HSBC projects. Our minimum capital expenditure levels to

maintain and achieve incremental improvements in our facilities in each of the next three to five years are expected to be approximately $12 million to $16 million per year as a result of certain regulatory, environmental and other maintenance projects.

Description of Our Indebtedness

Senior Secured Credit Facility

Kraton entered into a new senior secured credit agreement, or Credit Agreement, dated as of December 23, 2003, as amended as of March 4, 2004, as further amended as of October 21, 2004 and as further amended as of February 16, 2006 with various lenders, Goldman Sachs Credit Partners L.P., UBS AG, Stamford Branch, Credit Suisse First Boston, Morgan Stanley Senior Funding Inc. and General Electric Capital Corporation. On May 12, 2006 we entered into an amendment, which we refer to as the Amendment, to the Credit Agreement to provide a portion of the funds required in connection with the cash tender offer and consent solicitation commenced on April 24, 2006 by Polymer Holdings and Polymer Holdings Capital Corporation with respect to any and all of their outstanding 12.000% Discount Notes. The following is a summary of the material terms of the Credit Agreement, as so amended. This description does not purport to be complete and is qualified in its entirety by reference to the provisions of the Credit Agreement.

The Amendment provided for, among other things, a new term facility, or Term Facility, of $385 million, representing a $25 million increase over the original Term Facility, and extended the maturity of the Term Facility from December 23, 2010 to May 12, 2013. In addition, the Amendment extended the maturity of the revolving facility, or Revolving Facility, from December 23, 2008 to May 12, 2011 and provided for the possibility of increasing the existing Revolving Facility from $60 million to $80 million, subject to new revolving lenders becoming parties to the Credit Agreement. On June 7, 2006 we entered into a Joinder Agreement with a new revolving lender that increased the Revolving Facility to $75.5 million. In addition to the foregoing, the Amendment reduced the interest rate margin on the Term Facility, eliminated certain affirmative and negative covenants, including a covenant that limited our ability to make capital expenditures, and modified the financial ratios we are required to maintain. On the effective date of the Amendment, Kraton borrowed the full $385 million available under the new Term Facility and used the proceeds to prepay in full existing borrowings under the original Term Facility, to make a distribution to Polymer Holdings to provide a portion of the funds necessary to consummate the tender offer for the 12.000% Discount Notes and pay fees and expenses related to the foregoing.

Polymer Holdings and three of our wholly-owned subsidiaries, Kraton Polymers U.S. LLC, Elastomers Holdings LLC and Kraton Polymers Capital Corporation have guaranteed the Credit Agreement and we refer in these notes to these guarantors, together with Kraton, as the Loan Parties. The Credit Agreement is secured by a perfected first priority security interest in all of each Loan Party’s tangible and intangible assets, including intellectual property, real property, all of our capital stock and the capital stock of our domestic subsidiaries and 65% of the capital stock of the direct foreign subsidiaries of each Loan Party. As of September 30, 2007 and December 31, 2006, we had no outstanding borrowings under the Revolving Facility. We refer to the loans made under the Revolving Facility as the Revolving Loans, and the loans made under the Term Facility as the Term Loans.

Maturity.The Revolving Loans outstanding are payable in a single maturity on May 12, 2011. The Term Loans are payable in 24 consecutive equal quarterly installments, in an aggregate annual amount equal to 1.0% of the original principal amount of the Term Loans. The remaining balance is payable in four equal quarterly installments commencing on September 30, 2012, and ending on May 12, 2013.

Interest.The Term Loans bear interest at a rate equal to the adjusted Eurodollar rate plus 2.00% per annum or, at our option, the base rate plus 1.00% per annum. In general, interest is payable quarterly, subject to the interest period selected by us, per the Credit Agreement. The average effective interest rates on the Term Loans for the nine months ended September 30, 2007 and 2006 were 7.3% and 7.0%, respectively. The Revolving Loans bear interest at a rate equal to the adjusted Eurodollar rate plus a margin of between 2.00% and 2.50% per annum, depending on our leverage ratio, or at our option, the base rate plus a margin of between 1.00% and 1.50% per annum, depending on our leverage ratio. A commitment fee equal to 0.5% per annum times the daily average undrawn portion of the Revolving Facility accrues and is payable quarterly in arrears.

Mandatory Prepayments.The Term Facility is subject to mandatory prepayment with, in general: (1) 100% of the net cash proceeds of certain asset sales, subject to certain reinvestment rights; (2) 100% of the net cash proceeds of certain insurance and condemnation payments, subject to certain reinvestment rights; (3) 50% of the net cash proceeds of equity offerings (declining to 25%, if a leverage ratio in met); (4) 100% of the net cash proceeds of debt incurrences (other than debt incurrences permitted under the Credit Agreement); and (5) 50% of our excess cash flow, as defined in the Credit Agreement (declining to 25%, if a leverage ratio is met and to 0% if a further leverage ratio is met). Any such prepayment is applied first to the Term Facility and thereafter to the Revolving Facility.

Covenants.The Credit Agreement contains certain affirmative covenants including, among others, covenants to furnish the Lenders with financial statements and other financial information and to provide the Lenders notice of material events and information regarding collateral.

The Credit Agreement contains certain negative covenants that, among other things, restrict our ability, subject to certain exceptions, to incur additional indebtedness, grant liens on our assets, undergo fundamental changes, make investments, sell assets, make acquisitions, engage in sale and leaseback transactions, make restricted payments, engage in transactions with our affiliates, amend or modify certain agreements and charter documents and change our fiscal year. In addition, we are required to maintain an interest rate coverage ratio of 2.25:1.00 through the first fiscal quarter of 2008, increasing to 2.50:1.00 through the fourth fiscal quarter of 2008 and becoming progressively more restrictive thereafter, and to prevent our leverage ratio from exceeding 5.45:1.00 through the first fiscal quarter of 2008, and becoming progressively more restrictive thereafter.

As of September 30, 2007, we were in compliance with all covenants under the Credit Agreement.

Kraton’s 8.125% Senior Subordinated Notes due 2014

On December 23, 2003, Kraton issued $200.0 million aggregate principal amount of Senior Subordinated Notes due 2014 that bear interest at a rate of 8.125% per annum. The following is a summary of the material terms of the 8.125% Notes. This description does not purport to be complete and is qualified, in its entirety, by reference to the provisions of the indenture governing the 8.125% Notes.

Maturity Date.The 8.125% Notes mature on January 15, 2014.

Interest Payment Dates.Interest on the 8.125% Notes is payable semi-annually on January 15 and July 15 each year, commencing July 15, 2004.

Guarantees.The 8.125% Notes are guaranteed on a senior subordinated basis by all of Kraton’s existing and future domestic subsidiaries that guarantee the indebtedness under Kraton’s senior secured credit facility described above.

Security and Ranking.The 8.125% Notes and the guarantees are Kraton’s and the guarantor subsidiaries’ general unsecured obligations are subordinate to Kraton’s and the guarantor subsidiaries’ existing and future senior indebtedness, including indebtedness under the senior secured credit facility, and rank equally with Kraton’s and the guarantor subsidiaries’ future senior subordinated indebtedness. The 8.125% Notes and the guarantees effectively rank junior to Kraton’s secured indebtedness and to the secured indebtedness of all of Kraton’s guarantor subsidiaries to the extent of the value of the assets securing the indebtedness and are structurally subordinated to all liabilities of Kraton’s subsidiaries that are not guarantors of the 8.125% Notes.

Optional Redemption.Generally, Kraton cannot elect to redeem the 8.125% Notes until January 15, 2009. After such date, Kraton may elect to redeem the 8.125% Notes at certain predetermined redemption prices, plus accrued and unpaid interest. Prior to January 15, 2009, Kraton may redeem up to 35% of the aggregate principal amount of the 8.125% Notes with the net cash proceeds of certain permitted equity offerings or contributions at a redemption price equal to 108.125% of the principal amount of the 8.125% Notes being redeemed, plus accrued and unpaid interest.

Covenants.The 8.125% Notes contain certain affirmative covenants including, among others, limitations on covenants to furnish the holders of 8.125% Notes with financial statements and other financial information and to provide the holders of 8.125% Notes notice of material events.

The 8.125% Notes contain certain negative covenants including limitations on indebtedness, limitations on restricted payments, and limitations on restrictions on distributions from certain subsidiaries, limitations on lines of business and merger and consolidations.

As of September 30, 2007, we were in compliance with all covenants under the 8.125% Notes.

Other Contingencies

As a chemicals manufacturer, our operations in the United States and abroad are subject to a wide range of environmental laws and regulations at both the national and local levels. These laws and regulations govern, among other things, air emissions, wastewater discharges, solid and hazardous waste management, site remediation programs and chemical use and management.

Pursuant to these laws and regulations, our facilities are required to obtain and comply with a wide variety of environmental permits for different aspects of their operations. Generally, many of these environmental laws and regulations are becoming increasingly stringent, and the cost of compliance with these various requirements can be expected to increase over time.

Management believes that we are in material compliance with all current environmental laws and regulations. We estimate that any expenses incurred in maintaining compliance with these requirements will not materially affect our results of operations or cause us to exceed our level of anticipated capital expenditures. However, we cannot give assurances that regulatory requirements or permit conditions will not change, and we cannot predict the aggregate costs of additional measures that may be required to maintain compliance as a result of such changes or expenses.

In the context of the separation in February 2001, Shell Chemicals agreed to indemnify us for specific categories of environmental claims brought with respect to matters occurring before the separation. However, the indemnity from Shell Chemicals is subject to dollar and time limitations. Coverage under the indemnity also varies depending upon the nature of the environmental claim, the location giving rise to the claim and the manner in which the claim is triggered. Therefore, if claims arise in the future related to past operations, we cannot give assurances that those claims will be covered by the Shell Chemicals’ indemnity and also cannot be certain that any amounts recoverable will be sufficient to satisfy claims against us.

In addition, we may in the future be subject to claims that arise solely from events or circumstances occurring after February 2001, which would not, in any event, be covered by the Shell Chemicals’ indemnity. While we recognize that we may in the future be held liable with respect for remediation activities beyond those identified to date, at present we are not aware of any circumstances that are reasonably expected to give rise to remediation claims that would have a material adverse effect on our results of operations or cause us to exceed our projected level of anticipated capital expenditures.

We had no material operating expenditures for environmental fines, penalties, government imposed remedial or corrective actions in the presented periods of 2007 and 2006.

Off-Balance Sheet Transactions

We are not involved in any material off-balance sheet transactions as of September 30, 2007.

Market Risk

We are exposed to market risk from changes in interest rates, foreign currency exchange rates, and commodity prices.

Interest rate risk.We have $339.3 million of variable rate debt outstanding under our senior secured credit facility as of September 30, 2007. The debt bears interest at the adjusted Eurodollar plus 2.00% per annum or at our option, the base rate plus 1.00% per annum. Prior to the Amendment of the Credit Agreement under the term loan portion of the senior secured credit facility, we were required to hedge, or otherwise protect against interest rate fluctuations, a portion of our variable rate debt. As a result, we entered into two interest rate swap agreements in the amount of $80.0 million each, effective June 11, 2004 and July 6, 2004, respectively. Both of these agreements terminated on June 24, 2007, had a fixed rate quarterly payment date on each of September 24, December 24, March 24 and June 24, commenced on June 24, 2004, and ended on the termination date. The agreements had an average fixed rate of 3.524%. The agreements had no fair market value as of September 30, 2007 due to the termination of the agreements on June 24, 2007.

Foreign currency risk.We conduct operations in many countries around the world. Our results of operations are subject to both currency transaction risk and currency translation risk. We incur currency transaction risk whenever we enter into either a purchase or sale transaction using a currency other than the local currency of the transacting entity. With respect to currency translation risk, our financial condition and results of operations are measured and recorded in the relevant domestic currency and then translated into U.S. dollars for inclusion in our historical combined financial statements. Exchange rates between these currencies and U.S. dollars in recent years have fluctuated significantly and may do so in the future. Approximately half of our revenue and costs are denominated in U.S. dollars; Euro and Euro-related currencies are also significant. The net appreciation of the Euro against the U.S. dollar and other

world currencies since 2001 has had a positive impact on our sales and a negative impact on our costs, as reported in U.S. dollars in our historical combined financial statements. Historically, we have not undertaken and we do not currently plan to undertake hedging strategies to minimize the effect of currency fluctuations.

Commodity price risk.We are subject to commodity price risk under agreements for the supply of our raw materials and energy. We have not hedged our commodity price exposure. We do not currently intend to hedge our commodity price exposure.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our variable rate debt consists of borrowings under the senior secured credit facility. The interest rates are a function of the bank prime rate or LIBOR. A 1% point change in the base interest rate on our $339.3 million of variable rate debt would result in an approximate $3.4 million change in annual income before taxes.

ITEM 4. CONTROLS AND PROCEDURES

We have carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based upon our evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2007, the disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports we are required to prepare pursuant to the indenture for the notes is recorded, processed, summarized and reported as and when required.

There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – Other Information

ITEM 1. LEGAL PROCEEDINGS

Pursuant to the sale agreements between us and Shell Chemicals relating to the separation from Shell Chemicals in 2001, Shell Chemicals has agreed to indemnify us for certain liabilities and obligations to third parties or claims against us by a third party relating to matters arising prior to the closing of the acquisition by Ripplewood Chemical, subject to certain time limitations. Shell Chemicals has been named in several lawsuits relating to the elastomers business that we have acquired. In particular, claims have been filed against Shell Chemicals alleging workplace asbestos exposure at the Belpre, Ohio facility. We are indemnified by Shell Chemicals with respect to these claims, subject to certain time limitations. In addition, we and Shell Chemicals have entered into a consent order relating to certain environmental remediation at the Belpre, Ohio facility.

While we are involved from time to time in litigation and governmental actions arising in the ordinary course of business, we are not aware of any actions which we believe would materially adversely affect our business, financial condition or results of operations.

ITEM 1A. RISK FACTORS

None.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Not Applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not Applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS

Not Applicable.

ITEM 5. OTHER INFORMATION

ITEM 6. EXHIBITS



10.1		Agreement for Adjustment and Termination of Services under Kraton/SNC SUMFs and OMS Agreements at Pernis dated as of June 28, 2017 by and among Shell Nederland Chemie B.V. and Kraton Polymers Nederland B.V.

31.1		Certification of Chief Executive Officer under Section 302 of Sarbanes—Oxley Act of 2002

31.2		Certification of Chief Financial Officer under Section 302 of Sarbanes—Oxley Act of 2002

32.1		Certification Pursuant to Section 906 of Sarbanes—Oxley Act of 2002

Signatures

The registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


	Kraton Polymers LLC
Date: November 13, 2007	/s/ George B. Gregory
	George B. Gregory
	Chief Executive Officer and President


	/s/ Nicholas G. Dekker
	Nicholas G. Dekker
	Chief Financial Officer and Vice President

Index to Exhibits


EXHIBITS
10.1		Agreement for Adjustment and Termination of Services under Kraton/SNC SUMFs and OMS Agreements at Pernis dated as of June 28, 2017 by and among Shell Nederland Chemie B.V. and Kraton Polymers Nederland B.V.

31.1		Certification of Chief Executive Officer under Section 302 of Sarbanes—Oxley Act of 2002

31.2		Certification of Chief Financial Officer under Section 302 of Sarbanes—Oxley Act of 2002

32.1		Certification Pursuant to Section 906 of Sarbanes—Oxley Act of 2002

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. sophomore Avg

Kraton Polymers Inactive 10-Q2007 Q3 Quarterly report

Content analysis