Kraton Polymers 10-Q 2008 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2008

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

For the transition period from                     to                    

Commission File Number 333-123747

KRATON POLYMERS LLC

(Exact name of Register as specified in its Charter)

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

15710 John F. Kennedy Blvd. Suite 300, Houston, TX 77032

(Address of principal executive offices, including zip code)

281-504-4700

(Registrant’s telephone number, including area 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.    Yes  x    No  ¨

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 filer:  ¨  Accelerated filer:  ¨  Non-accelerated filer:  x  Smaller reporting company:  ¨  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

KRATON POLYMERS LLC

FORM 10-Q FOR THE QUARTER ENDED

September 30, 2008

TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)	4
	Condensed Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007	4
	Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2008 and 2007	5
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and 2007	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
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 1A.	Risk Factors	39
Item 2.	Unregistered Sales Of Equity Securities and Use of Proceeds	39
Item 3.	Defaults Upon Senior Securities	39
Item 4.	Submission of Matters to a Vote of Security Holders	39
Item 5.	Other Information	39
Item 6.	Exhibits	40
	Signatures	41

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

This Quarterly Report on Form 10-Q includes “forward-looking statements,” within the meaning of the Private Securities Litigation Reform Act of 1995. We may also make forward-looking statements in our Annual Reports 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. 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 “Condensed Consolidated Financial Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements are often characterized by the use of words such as “believes,” “estimates,” “expects,” “projects,” “may,” “will,” “intends,” “plans” or “anticipates,” or by discussions of strategy, plans or intentions. Such forward-looking statements involve known and unknown risks, uncertainties, and other important factors that could cause our actual results, performance or achievements, or industry results, to differ materially from historical results or any future results, performance or achievements expressed, suggested 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 or availability 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 and currency 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 sold, and

• other risks and uncertainties described in this report and Kraton’s other reports and documents.

These statements are based on current plans, estimates, beliefs 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 them publicly in light of new information or future events.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

KRATON POLYMERS LLC

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands)

	September 30, 2008		December 31, 2007
ASSETS
Current assets
Cash and cash equivalents	$	84,239	$	48,277
Receivables, net of allowances of $ 1,737 and $1,542		183,922		140,321
Inventories of products, net		285,974		256,323
Inventories of materials and supplies, net		11,888		12,170
Other current assets		10,251		12,404
Total current assets		576,274		469,495
Property, plant and equipment, less accumulated depreciation of $176,578 and $157,643		379,393		402,270
Identifiable intangible assets, less accumulated amortization of $34,428 and $29,205		71,133		76,356
Investment in unconsolidated joint venture		10,896		10,326
Deferred financing costs		8,675		10,323
Other long-term assets		17,803		16,124
Total assets	$	1,064,174	$	984,894
LIABILITIES AND MEMBER’S EQUITY
Current liabilities
Current portion of long-term debt	$	3,445	$	3,445
Accounts payable-trade		107,665		102,952
Other payables and accruals		58,740		55,816
Due to related party		21,046		24,505
Deferred income taxes		9,015		9,827
Insurance note payable		—		494
Total current liabilities		199,911		197,039
Long-term debt, net of current portion		572,462		535,020
Deferred income taxes		38,696		39,443
Long-term liabilities		25,996		30,682
Total liabilities		837,065		802,184
Commitments and contingencies
Member’s equity
Common equity		189,350		143,149
Accumulated other comprehensive income		37,759		39,561
Total member’s equity		227,109		182,710
Total liabilities and member’s equity	$	1,064,174	$	984,894

See Notes to Condensed Consolidated Financial Statements

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KRATON POLYMERS LLC

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands)

		Three Months Ended September 30,						Nine Months Ended September 30,
		2008			2007			2008			2007
Operating Revenues
Sales	��	$	363,275		$	284,498		$	947,925		$	812,326
Other			18,892			5,652			46,472			19,546
Total operating revenues			382,167			290,150			994,397			831,872
Cost of goods sold			287,719			243,699			788,618			701,660
Gross profit			94,448			46,451			205,779			130,212
Operating Expenses
Research and development			5,808			5,452			21,129			18,504
Selling, general, and administrative			28,214			15,594			73,578			49,208
Depreciation and amortization of identifiable intangibles			13,118			12,539			40,880			36,417
Total operating expenses			47,140			33,585			135,587			104,129
Equity in earnings of unconsolidated joint venture			(94	)		(189	)		(314	)		(514	)
Interest expense, net			7,875			12,375			27,678			32,507
Income (loss) before income taxes			39,527			680			42,828			(5,910	)
Income tax provision			(4,910	)		(1,434	)		(7,405	)		(1,822	)
Net income (loss)		$	34,617		$	(754	)	$	35,423		$	(7,732	)

See Notes to Condensed Consolidated Financial Statements

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KRATON POLYMERS LLC

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

	Nine Months Ended September 30,
	2008			2007
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	35,423		$	(7,732	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization of identifiable intangibles		40,880			36,417
Amortization of deferred financing costs		1,648			2,213
Loss on disposal of fixed assets		192			279
Distributed (undistributed) earnings in joint venture		727			(408	)
Deferred tax benefit		(2,813	)		(3,937	)
Non-cash compensation related to equity awards		778			1,814
Gain on interest rate swaps		(420	)		(1,553	)
Decrease (increase) in
Accounts receivable		(46,394	)		(8,550	)
Inventories of products, materials and supplies		(33,133	)		(16,217	)
Other assets		310			(2,891	)
Increase (decrease) in
Accounts payable-trade, other payables and accruals, and other long-term liabilities		7,879			41,597
Due to related party		(1,198	)		11,048
Net cash provided by operating activities		3,879			52,080
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, plant and equipment		(15,338	)		(19,861	)
Proceeds from sale of property, plant and equipment		17			43
Net cash used in investing activities		(15,321	)		(19,818	)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from debt		316,250			—
Repayment of debt obligations		(278,808	)		(42,787	)
Proceeds from cash contribution from member		10,000			—
Net (payment of) proceeds from insurance note payable		(494	)		1,238
Net cash provided by (used in) financing activities		46,948			(41,549	)
Effect of exchange rate differences on cash and cash equivalents		456			(1,997	)
Net increase (decrease) in cash and cash equivalents		35,962			(11,284	)
Cash and cash equivalents, beginning of period		48,277			43,601
Cash and cash equivalents, end of period	$	84,239		$	32,317
Supplemental Disclosures
Cash paid during the period for income taxes, net of refunds received	$	8,030		$	8,105
Cash paid during the period for interest	$	37,239		$	30,320

See Notes to Condensed Consolidated Financial Statements

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KRATON POLYMERS LLC

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. General

Organization and Description of Business. Kraton Polymers LLC, together with its direct and indirect subsidiaries, are, unless the context requires otherwise, collectively referred to herein as “we,” “our,” “ours,” “us” or “Kraton.” Kraton Polymers LLC is the parent of Elastomers Holdings LLC (holding company of Kraton’s United States (U.S.) operations), Kraton Polymers Global Holdings, C.V. (holding company of the remainder of our global operations) and Kraton Polymers Capital Corporation (a company with no obligations). Polymer Holdings LLC, or “Polymer Holdings,” owns 100% of the equity interests of Kraton, either directly or indirectly. TJ Chemical Holdings LLC, or “TJ Chemical,” owns 100% of the equity interests of Polymers Holdings. TJ Chemical is owned by TPG Partners III, L.P., TPG Partners IV, L.P. and certain entities affiliated with said parties, entities affiliated with or managed by J.P. Morgan Partners, LLC, and affiliates, and Kraton Management LLC.

We produce styrenic block copolymers (SBCs), a family of specialty chemical products whose chemistry we pioneered over 40 years ago. SBCs are highly engineered synthetic elastomers, which enhance the performance of numerous products by delivering a variety of performance characteristics, including greater flexibility, resilience, strength, durability and processability. Our specialty polymers are typically processed with other products to achieve customer specific performance characteristics in a variety of applications. The versatility of our portfolio of polymers is due to a wide range of distinctive molecular structures, which can be precisely controlled and tailored to unique design and performance characteristics. Each polymer requires a significant amount of testing and certification, which, combined with our proprietary chemistry, encourages strong customer loyalty.

We operate six plants globally, including our flagship Belpre, Ohio plant in the U.S., the largest SBC plant in the world, as well as plants in Germany, France, The Netherlands, Brazil and Japan. The plant in Japan is operated by a manufacturing joint venture.

Basis of Presentation.The accompanying Condensed Consolidated Financial Statements presented herein are for Kraton and its consolidated subsidiaries, each of which is a wholly-owned subsidiary.

These interim financial statements should be read in conjunction with the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2007, and reflect all normal recurring adjustments that are, in the opinion of management, necessary to fairly present Kraton’s results of operations and financial position. Amounts reported in the Condensed Consolidated Statements of Operations are not necessarily indicative of amounts expected for the respective annual periods.

Use of Estimates. To conform with generally accepted accounting principles (GAAP) in the U.S., management makes estimates and assumptions that affect the amounts reported in the Condensed Consolidated Financial Statements and Notes to Condensed Consolidated Financial Statements. Although these estimates are based on management’s best available knowledge at the time, actual results could differ.

2. Share-Based Compensation

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share-Based Payment,” which is a revision of FASB Statement No. 123. SFAS No. 123(R) addresses all forms of share-based compensation including stock options and restricted stock. SFAS No. 123R requires the benefit of tax deductions in excess of recognized compensation

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expense to be reported as a financing cash flow, rather than as an operating cash flow in the consolidated statements of cash flows. Kraton adopted the provisions of SFAS No. 123(R) effective January 1,2006, using the modified-prospective method and we elected to use the Black-Scholes Merton option-pricing model to estimate the grant-date fair value of share-based awards. We record non-cash compensation expense for the restricted membership units, notional membership units and option awards over the vesting period using the straight-line method. See Note 10(a) for further discussion.

Information pertaining to option activity for the nine months ended September 30, 2008 is as follows:

	Options		Weighted - Average Exercise Price
	(in thousands)
Outstanding at December 31, 2007	14,670		$	1.00
Granted	10,763			1.00
Exercised	—			—
Forfeited	(3,881	)		1.00
Outstanding at September 30, 2008	21,552		$	1.00

3. Restructuring Activities

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

As of September 30, 2008, there was a total liability for restructuring costs of approximately $1.4 million, of which $1.2 million is related to unpaid severance costs which are expected to be paid by the end of the first quarter of 2009. The exit activity cost of approximately $0.2 million is associated with the closure of our office in London, United Kingdom and 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 Kraton’s restructuring liability by component:

	Severance Costs			Exit Activity			Total
	(in thousands)
Accrued at December 31, 2007	$	294		$	2,402		$	2,696
Accruals		2,185			—			2,185
Cash payments		(1,257	)		(2,182	)		(3,439	)
Accrued at September 30, 2008	$	1,222		$	220		$	1,442

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4. Detail of Certain Balance Sheet Accounts

The components of inventories of products and other payables and accruals are as follows:

	September 30, 2008		December 31, 2007
	(in thousands)
Inventories of products, net:
Finished products	$	235,682	$	212,125
Work in progress		4,630		3,858
Raw materials		45,662		40,340
	$	285,974	$	256,323
Other payables and accruals:
Employee related	$	19,281	$	12,178
Interest		3,303		13,680
Property and other taxes		3,675		3,735
Customer rebates		6,804		6,561
Income taxes payable		6,786		4,643
Other		18,891		15,019
	$	58,740	$	55,816

5. Comprehensive Income

Comprehensive income includes net income and all other non-owner changes in equity. Components of comprehensive income are as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
	(in thousands)
Net income (loss)	$	34,617		$	(754	)	$	35,423		$	(7,732	)
Other comprehensive income
Foreign currency translation adjustments		(26,197	)		15,819			(4,316	)		23,828
Reclassification of interest rate swaps into earnings, net of tax		(421	)		—			(421	)		—
Unrealized gain on interest rate swaps, net of tax		—			—			2,935			(1,863	)
Total comprehensive income	$	7,999		$	15,065		$	33,621		$	14,233

Accumulated other comprehensive income consists of the following:

	September 30, 2008		December 31, 2007
	(in thousands)
Foreign currency adjustments	$	30,035	$	34,351
Unrealized gain on interest rate swaps, net of tax		2,514		—
Pension adjustment, net of tax		5,210		5,210
Total accumulated other comprehensive income	$	37,759	$	39,561

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6. Long-Term Debt

Long-term debt consists of the following:

	September 30, 2008		December 31, 2007
	(in thousands)
Senior Secured Credit Facilities:
Term loans	$	325,907	$	338,465
Revolving loans		50,000		—
8.125% Notes		200,000		200,000
Total debt		575,907		538,465
Less current portion of long-term debt		3,445		3,445
Total long-term debt	$	572,462	$	535,020

(a) Term Loans and Revolving Loans

We entered into a senior secured credit agreement dated as of December 23, 2003. The agreement and subsequent amendments to the agreement are defined herein as the Credit Agreement.

The Credit Agreement provides for a term facility, or Term Facility, of $385.0 million, and a revolving facility, or Revolving Facility, of up to $75.5 million (after entering into a Joinder Agreement on June 7, 2006). We refer to the loans made under the Revolving Facility collectively as the Revolving Loans, and the loans made under the Term Facility collectively as the Term Loans.

Three of our wholly-owned subsidiaries, Kraton Polymers U.S. LLC, Elastomers Holdings LLC, and Kraton Polymers Capital Corporation (collectively, the “Guarantor Subsidiaries”), along with Polymer Holdings, have guaranteed our obligations under the Credit Agreement and we refer 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, 2008, we had $50 million outstanding in Revolving Loans.

The following is a summary of the material terms of the Credit Agreement:

Maturity

The Revolving Loans 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, under the Credit Agreement. The average effective interest rate on the Term Loans for the nine months ended September 30, 2008 was 4.5% compared to 7.3% for the nine months ended September 30, 2007. 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. In

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February 2008, we entered into a $325 million notional amount interest rate swap agreement to protect against Eurodollar interest rate fluctuations, which we sold in June 2008. See Note 14(a) for a description of the swap agreement.

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 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 and change our fiscal year. We are required to maintain a fiscal quarter end interest coverage ratio of 2.50:1.00 through December 31, 2008, 2.75:1.00 beginning March 31, 2009 and 3.00:1.00 beginning March 31, 2010 and thereafter. In addition, we are required to maintain a fiscal quarter end leverage ratio not to exceed 4.95 through December 31, 2008, 4.45 beginning March 31, 2009 and 4.00 beginning December 31, 2009 and thereafter.

On January 14, 2008, we received an equity investment of $10.0 million, of which $9.6 million was included in the financial covenant calculation for the twelve-month period ending December 31, 2007 and will continue to be included in the fiscal quarter covenant calculations through the fiscal quarter ending September 30, 2008 pursuant to the equity cure provisions included in the Credit Agreement. As of September 30, 2008, we were in compliance with all covenants under the Credit Agreement.

(b) Senior Subordinated Notes Due January 15, 2014

On December 23, 2003, we issued $200.0 million aggregate principal amount of Senior Subordinated Notes. The following is a summary of the material terms of 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 our existing and future subsidiaries that guarantee the indebtedness under our senior secured credit facility described above.

Security and Ranking.The 8.125% Notes and the guarantees are general unsecured obligations and are subordinated to Kraton’s and its guarantor subsidiaries’ existing and future senior indebtedness, including indebtedness under the senior secured credit facility, and rank equally with Kraton’s and its guarantor

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subsidiaries’ future senior subordinated indebtedness. The 8.125% Notes and the guarantees effectively rank junior to our secured indebtedness and to the secured indebtedness of all of our 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, 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.

Covenants.The 8.125% Notes contain certain affirmative covenants including requirements 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, limitations on restrictions on distributions from certain subsidiaries, and limitations on lines of business and merger and consolidations. As of September 30, 2008, we were in compliance with all covenants under the 8.125% Notes.

7. Fair Value Measurements

Effective January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements,” for financial assets and liabilities. SFAS No. 157 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. SFAS No. 157 requires entities to, among other things, maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

SFAS No. 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

SFAS No. 157 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. In accordance with SFAS No. 157, these two types of inputs have created the following fair value hierarchy:

• Level 1—Quoted unadjusted prices for identical instruments in active markets.

• Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.

• Level 3—Model-derived valuations in which one or more significant inputs or significant value drivers are unobservable.

From time to time, we enter into derivative financial instruments that are measured at fair value. See Note 14 for further discussion.

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.

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The effective tax rate for the nine months ended September 30, 2008 was approximately 17.3% as compared to a rate of (30.8%) in the nine months ended September 30, 2007. Our effective tax rate for the nine months ended September 30, 2008 was lower than our statutory rate primarily due to recognition of net operating loss carryforwards on U.S. operations utilized during the period that were previously offset by valuation allowances, offset by not recording a tax benefit for certain foreign net operating loss carryforwards generated during the period and a different income mix between foreign and domestic tax jurisdictions. Our effective tax rate for the nine months ended September 30, 2007 was less than our statutory rate primarily due to a different income mix between foreign and domestic tax jurisdictions and due to not recording a tax benefit for certain net operating loss carryforwards generated during that period.

As of September 30, 2008, we had total unrecognized tax benefits of $0.7 million. During the nine months ended September 30, 2008, we had an increase of $0.3 million in these tax positions mainly due to expected tax audit settlements. As of September 30, 2008, we estimated $0.7 million in unrecognized tax benefits that, if recognized, would impact the effective tax rate. We recognized interest and penalties related to unrecognized tax benefits within the provision for income taxes in our Condensed Consolidated Statement of Operations. During nine months ended September 30, 2008, we recognized $0.2 million of interest charges related to unrecognized tax benefits, and at September 30, 2008, we had accrued $0.2 million for interest and penalties. As of September 30, 2008, we believe that no current tax positions that have resulted in unrecognized tax benefits will significantly increase or decrease within one year, and no material changes have occurred in our estimates or are expected to occur in events related to anticipated changes in our unrecognized tax benefits.

Kraton files income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. As of September 30, 2008, our 2005 through 2007 U.S. federal income tax returns remain open to examination. In addition, open tax years to state and foreign jurisdictions remain subject to examination.

9. Commitments and Contingencies

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, consolidated results of operations, financial position or cash flows.

10. Employee Benefits

(a) Investment in Kraton Management LLC (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. 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, 2008, there were 1,886,000 membership units of Management LLC issued and outstanding.

13

(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 Kraton, of non-qualified options (Options) to purchase TJ Chemical membership units. All Options granted in 2006, 2007 and 2008 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% or 33 1/3 % increments annually on each of the first five or three anniversaries of the grant date, respectively, so long as the holder of the Option is still an employee on the vesting date. With respect to directors, however, 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 or exceed 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 (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 has 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, the Options will pertain to and apply to the securities that the Option holder would have received in the merger. Generally, 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 value of 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, 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) one year after the date employment is terminated by reason of death or disability; or (4) the tenth anniversary of the grant date for such Option. In the event the participant’s employment is terminated by Kraton without cause or by the executive officer for good reason within two years following a change in control, all Options become vested as of such termination.

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 six months and one 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. See Note 10(e) for further discussion.

(c) Profits Units of Kraton Management, LLC (Management, LLC)

The Compensation Committee may grant Profits Units of Management LLC (subject to the 8% pool limitation described above) (Profits Units). Profits Units are economically equivalent to options, except that they provide the recipient with an opportunity to recognize capital gains in the appreciation of TJ Chemicals and its affiliates and TJ Chemicals and its affiliates are not entitled to receive any tax deductions at the time of grant or

14

disposition of the Profits Units by the employee. Generally, pursuant to the applicable grant agreements, 50% of the Profits Units will vest when the fair value of TJ Chemical’s assets equals or exceeds two times the Threshold Amount, which is defined as the initial value of TJ Chemical’s assets on the date of the grant, and 50% of the Profits Units will vest when the fair value of TJ Chemical’s assets equals or exceeds three times the threshold amount, provided that the participant is employed by Kraton or its subsidiaries on such vesting date and provided further, that 100% of the Profits Units shall become vested upon a change in control of TJ Chemical. 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. In the case of our President and Chief Executive Officer, if at the time TJ Chemical makes a determination as to whether he 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. If an employee’s employment terminates prior to any applicable vesting date, such employee shall automatically forfeit all rights to any unvested Profits Units. Upon the occurrence of any distributions received by Management LLC, the holders of the Profits Units will have a right to receive their pro rata share of the positive difference between initial value of the Profits Units, as determined by the profits unit award agreement, and the then current fair value of the Profits Units, as determined in accordance with the terms of the agreement governing TJ Chemical and Management LLC. See Note 10(e) for further discussion.

As of September 30, 2008, there were 900,000 Profits Units granted and not yet vested.

(d) Options and Profits Units Outstanding

The aggregate number of Options and Profits Units under the Option Plan shall not exceed 23,740,802 (the Aggregate Limit) representing 8.7% of the outstanding membership units and Profits Units of TJ Chemical on March 31, 2004, on a fully diluted basis. As of August 2008, the Option Plan was amended to provide for an increase in the number of Options and Profit Units from 21,740,802 to 23,740,802.

In the third quarter of 2008, no Options were granted and 421,000 Options were forfeited. As of September 30, 2008, the total Options granted under the Option Plan amounted to 21,552,118. In addition, as of September 30, 2008, there were 900,000 Profits Units granted under the Option Plan and not yet vested. See Note 10(c) for further discussion.

(e) Kraton Polymers LLC Executive Deferred Compensation Plan

The Named Executive Officers (as defined in the Annual Report on Form 10K filed with the Securities and Exchange Commission) have the option of deferring up to 50% of their annual bonus, if any, which is subsequently converted to notional membership units of TJ Chemical. Such Notional Units remain outstanding until either (1) a change in control or (2) termination of employment. The amount held pursuant to the plan may ultimately be paid in units of Management LLC.

In 2007, 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 2,000,000 membership units for issuance pursuant to the Kraton Deferred Compensation Plan.

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(f) 2008 Incentive Compensation Plan

On February 5, 2008, the Compensation Committee of the Board of Directors, or the Board, of Kraton approved and adopted the 2008 Incentive Compensation Plan including the performance-based criteria by which potential payouts to participants will be determined. The total award under the Incentive Compensation Plan ranges from $0 to $18.0 million, depending on the level of achievement against performance goals. As of September 30, 2008, we recorded a total liability for incentive compensation of approximately $12 million.

(g) Retirement Plans

The components of net periodic benefit cost related to pension benefits for the three and nine months ended September 30, 2008 and September 30, 2007, are as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
	(in thousands)
Components of net periodic benefit cost:
Service cost	$	603		$	644		$	1,809		$	1,932
Interest cost		1,059			969			3,177			2,907
Expected return on plan assets		(1,032	)		(908	)		(3,096	)		(2,724	)
Net periodic benefit cost	$	630		$	705		$	1,890		$	2,115

The components of net periodic benefit cost related to other postretirement benefits for the three and nine months ended September 30, 2008 and September 30, 2007, are as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
	(in thousands)
Components of net periodic benefit cost:
Service cost	$	88	$	88	$	264	$	264
Interest cost		212		187		636		561
Net periodic benefit cost	$	300	$	275	$	900	$	825

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, our chief operating decision-maker has been identified as the President and Chief Executive Officer, who regularly reviews financial information 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 condensed consolidated financial statements.

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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:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
	(in thousands)
Total operating revenues
United States	$	126,489	$	97,397	$	319,361	$	285,417
Germany		45,207		37,558		120,959		112,491
The Netherlands		25,930		11,382		68,589		38,824
Italy		13,819		12,601		39,622		38,152
Japan		19,367		12,830		50,922		37,434
China		9,165		11,457		27,895		31,059
United Kingdom		11,748		10,979		32,700		30,036
Brazil		13,823		10,143		32,430		26,851
Belgium		11,218		8,945		23,484		23,374
France		10,163		8,734		31,271		22,684
Poland		11,000		8,177		22,032		16,536
Canada		6,776		6,216		21,374		16,342
Taiwan		6,701		5,151		17,497		15,384
Thailand		8,103		4,498		17,372		12,054
Turkey		4,526		4,172		13,953		11,187
Argentina		4,589		3,836		12,055		10,601
Sweden		4,059		3,667		11,595		10,025
Austria		4,187		3,264		9,450		7,480
Mexico		5,082		2,214		11,349		6,932
Denmark		2,070		2,008		7,906		6,764
Australia		3,498		2,547		11,674		6,264
All other countries		34,647		22,374		90,907		65,981
	$	382,167	$	290,150	$	994,397	$	831,872

	September 30, 2008		December 31, 2007
	(in thousands)
Long-lived assets
United States	$	297,019	$	298,979
Germany		40,400		40,406
Japan		4,776		3,743
France		110,642		111,441
The Netherlands		34,302		34,454
Brazil		54,586		56,721
China		2,304		2,119
All other countries		11,942		12,050
	$	555,971	$	559,913

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.

17

Kraton Polymers LLC

Condensed Consolidating Balance Sheet

September 30, 2008

(In thousands)

	Issuers (1)			Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Eliminations			Consolidated
	(Unaudited)
Assets
Current assets
Cash and cash equivalents	$	—		$	64,063	$	20,176		$	—		$	84,239
Receivables, net		576			80,378		119,164			(16,196	)		183,922
Inventories of products, net		—			136,449		154,925			(5,400	)		285,974
Inventories of materials and supplies		—			6,932		4,956			—			11,888
Other current assets		4,062			728		5,461			—			10,251
Total current assets		4,638			288,550		304,682			(21,596	)		576,274
Property, plant and equipment, less accumulated depreciation		96,209			162,641		120,543			—			379,393
Identifiable intangible assets, less accumulated amortization		24,195			—		46,938			—			71,133
Investment in consolidated subsidiaries		897,364			—		—			(897,364	)		—
Investment in unconsolidated joint venture		813			—		10,083			—			10,896
Deferred financing costs		8,675			—		—			—			8,675
Other long-term assets		131,159			401,377		11,707			(526,440	)		17,803
Total assets	$	1,163,053		$	852,568	$	493,953		$	(1,445,400	)	$	1,064,174
Liabilities and Member’s Equity
Current liabilities
Current portion of long-term debt	$	3,445		$	—	$	—		$	—		$	3,445
Accounts payable-trade		2,700			54,729		50,236			—			107,665
Other payables and accruals		3,318			26,420		29,002			—			58,740
Due to related parties		—			5,030		32,212			(16,196	)		21,046
Deferred income taxes		(812	)		—		9,827						9,015
Total current liabilities		8,651			86,179		121,277			(16,196	)		199,911
Long-term debt, net of current portion		572,462			—		—			—			572,462
Deferred income taxes		(14,158	)		52,923		(69	)		—			38,696
Long-term liabilities		398,834			17,851		135,751			(526,440	)		25,996
Total liabilities		965,789			156,953		256,959			(542,636	)		837,065
Commitments and contingencies
Member’s equity
Common equity		194,750			690,405		206,959			(902,764	)		189,350
Accumulated other comprehensive income		2,514			5,210		30,035			—			37,759
Total member’s equity		197,264			695,615		236,994			(902,764	)		227,109
Total liabilities and member’s equity	$	1,163,053		$	852,568	$	493,953		$	(1,445,400	)	$	1,064,174

(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.

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Kraton Polymers LLC

Condensed Consolidating Balance Sheet

December 31, 2007

(In thousands)

	Issuers (1)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries		Eliminations			Consolidated
Assets
Current assets
Cash and cash equivalents	$	—		$	11,152		$	37,125	$	—		$	48,277
Receivables, net		—			50,134			90,187		—			140,321
Due from related parties		1,873			19,856			6,291		(28,020	)		—
Inventories of products, net		—			124,052			138,772		(6,501	)		256,323
Inventories of materials and supplies		—			6,817			5,353		—			12,170
Other current assets		2,172			1,671			8,561		—			12,404
Total current assets		4,045			213,682			286,289		(34,521	)		469,495
Property, plant and equipment, less accumulated depreciation		104,945			166,948			130,377		—			402,270
Identifiable intangible assets, less accumulated amortization		29,418			—			46,938		—			76,356
Investment in consolidated subsidiaries		807,543			—			—		(807,543	)		—
Investment in unconsolidated joint venture		813			—			9,513		—			10,326
Deferred financing costs		10,323			—			—		—			10,323
Other long-term assets		97,301			400,861			16,997		(499,035	)		16,124
Total assets	$	1,054,388		$	781,491		$	490,114	$	(1,341,099	)	$	984,894
Liabilities and Member’s Equity
Current liabilities
Current portion of long-term debt	$	3,445		$	—		$	—	$	—		$	3,445
Accounts payable-trade		2,700			48,030			52,222		—			102,952
Other payables and accruals		13,503			17,988			24,325		—			55,816
Due to related parties		—			6,291			46,234		(28,020	)		24,505
Deferred income taxes		—			—			9,827		—			9,827
Insurance note payable		494			—			—		—			494
Total current liabilities		20,142			72,309			132,608		(28,020	)		197,039
Long-term debt, net of current portion		535,020			—			—		—			535,020
Deferred income taxes		(52,048	)		84,417			7,074		—			39,443
Long-term liabilities		405,552			22,980			101,185		(499,035	)		30,682
Total liabilities		908,666			179,706			240,867		(527,055	)		802,184
Commitments and contingencies
Member’s equity
Common equity		145,722			621,110			190,361		(814,044	)		143,149
Accumulated other comprehensive income		—			(19,325	)		58,886		—			39,561
Total member’s equity		145,722			601,785			249,247		(814,044	)		182,710
Total liabilities and member’s equity	$	1,054,388		$	781,491		$	490,114	$	(1,341,099	)	$	984,894

(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.

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Kraton Polymers LLC

Condensed Consolidating Statement of Operations

Three Months Ended September 30, 2008

(In thousands)

	Issuers (1)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
	(Unaudited)
Operating Revenues
Sales	$	—		$	190,613		$	218,192		$	(45,530	)	$	363,275
Other		—			—			18,892			—			18,892
Total operating revenues		—			190,613			237,084			(45,530	)		382,167
Cost of goods sold		(1,034	)		134,803			199,480			(45,530	)		287,719
Gross profit		1,034			55,810			37,604			—			94,448
Operating Expenses
Research and development		—			3,285			2,523			—			5,808
Selling, general, and administrative		500			16,872			10,842			—			28,214
Depreciation and amortization of identifiable intangibles		4,169			5,426			3,523			—			13,118
Total operating expenses		4,669			25,583			16,888			—			47,140
Equity in earnings of consolidated subsidiaries		(46,631	)		—			—			46,631			—
Equity in earnings of unconsolidated joint venture		—			—			(94	)		—			(94	)
Interest expense, net		8,943			(2,715	)		1,647			—			7,875
Income (loss) before income taxes		34,053			32,942			19,163			(46,631	)		39,527
Income tax benefit (provision)		564			(36	)		(5,438	)		—			(4,910	)
Net income (loss)	$	34,617		$	32,906		$	13,725		$	(46,631	)	$	34,617

(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.

20

Kraton Polymers LLC

Condensed Consolidating Statement of Operations

Three Months Ended September 30, 2007

(In thousands)

	Issuers (1)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
	(Unaudited)
Operating Revenues
Sales	$	—		$	141,096		$	174,961		$	(31,559	)	$	284,498
Other		—			(108	)		5,760			—			5,652
Total operating revenues		—			140,988			180,721			(31,559	)		290,150
Cost of goods sold		787			114,486			159,985			(31,559			243,699
Gross profit		(787	)		26,502			20,736			—			46,451
Operating Expenses
Research and development		—			2,205			3,247			—			5,452
Selling, general, and administrative		(33	)		7,730			7,897			—			15,594
Depreciation and amortization of identifiable intangibles		4,324			5,036			3,179			—			12,539
Total operating expenses		4,291			14,971			14,323			—			33,585
Equity in earnings of consolidated subsidiaries		(16,887	)		—			—			16,887			—
Equity in earnings of unconsolidated joint venture		—			—			(189	)		—			(189	)
Interest expense, net		13,136			(2,495	)		1,734			—			12,375
Income (loss) before income taxes		(1,327	)		14,026			4,868			(16,887	)		680
Income tax benefit (provision)		573			295			(2,302	)		—			(1,434	)
Net income (loss)	$	(754	)	$	14,321		$	2,566		$	(16,887	)	$	(754	)

(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.

21

Kraton Polymers LLC

Condensed Consolidating Statement of Operations

Nine Months Ended September 30, 2008

(In thousands)

	Issuers (1)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
	(Unaudited)
Operating Revenues
Sales	$	—		$	494,733		$	588,379		$	(135,187	)	$	947,925
Other		—			—			46,472			—			46,472
Total operating revenues		—			494,733			634,851			(135,187	)		994,397
Cost of goods sold		(1,101	)		373,118			551,788			(135,187	)		788,618
Gross profit		1,101			121,615			83,063			—			205,779
Operating Expenses
Research and development		—			12,915			8,214			—			21,129
Selling, general, and administrative		752			41,062			31,764			—			73,578
Depreciation and amortization of identifiable intangibles		13,959			16,187			10,734			—			40,880
Total operating expenses		14,711			70,164			50,712			—			135,587
Equity in earnings of consolidated subsidiaries		(76,196	)		—			—			76,196			—
Equity in earnings of unconsolidated joint venture		—			—			(314	)		—			(314	)
Interest expense, net		29,963			(7,780	)		5,495			—			27,678
Income (loss) before income taxes		32,623			59,231			27,170			(76,196	)		42,828
Income tax benefit (provision)		2,800			(51	)		(10,154	)		—			(7,405	)
Net income (loss)	$	35,423		$	59,180		$	17,016		$	(76,196	)	$	35,423

(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.

22

Kraton Polymers LLC

Condensed Consolidating Statement of Operations

Nine Months Ended September 30, 2007

(In thousands)

	Issuers (1)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
	(Unaudited)
Operating Revenues
Sales	$	—		$	416,149		$	511,132		$	(114,955	)	$	812,326
Other		—			—			19,546			—			19,546
Total operating revenues		—			416,149			530,678			(114,955	)		831,872
Cost of goods sold		799			345,970			469,846			(114,955	)		701,660
Gross profit		(799	)		70,179			60,832			—			130,212
Operating Expenses
Research and development		—			4,936			13,568			—			18,504
Selling, general, and administrative		(33	)		26,778			22,463			—			49,208
Depreciation and amortization of identifiable intangibles		12,972			15,023			8,422			—			36,417
Total operating expenses		12,939			46,737			44,453			—			104,129
Equity in earnings of consolidated subsidiaries		(38,450	)		—			—			38,450			—
Equity in earnings of unconsolidated joint venture		—			—			(514	)		—			(514	)
Interest expense, net		34,203			(7,138	)		5,442			—			32,507
Income (loss) before income taxes		(9,491	)		30,580			11,451			(38,450	)		(5,910	)
Income tax benefit (provision)		1,759			295			(3,876	)		—			(1,822	)
Net income (loss)	$	(7,732	)	$	30,875		$	7,575		$	(38,450	)	$	(7,732	)

(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.

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Kraton Polymers LLC

Condensed Consolidating Statement of Cash Flows

Nine Months Ended September 30, 2008

(In thousands)

	Issuers (1)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations		Consolidated
	(Unaudited)
Cash flows provided by (used in) operating activities	$	(27,475	)	$	58,072		$	(26,718	)	$	—	$	3,879
Cash flows used in investing activities
Purchase of property, plant and equipment net of proceeds from sales of equipment		—			(11,880	)		(3,441	)		—		(15,321	)
Net cash used in investing activities		—			(11,880	)		(3,441	)		—		(15,321	)
Cash flows provided by (used in) financing activities
Borrowings under debt obligations		316,250			—			—			—		316,250
Repayment of debt obligations		(278,808	)		—			—			—		(278,808	)
Proceeds from cash contribution from member		10,000			—			—			—		10,000
Proceeds from (payments on) intercompany loans		(19,473	)		6,719			12,754			—		—
Net payment of insurance note payable		(494	)		—			—			—		(494	)
Net cash provided by financing activities		27,475			6,719			12,754			—		46,948
Effect of exchange rate difference on cash and cash equivalents		—			—			456			—		456
Net increase (decrease) in cash and cash equivalents		—			52,911			(16,949	)		—		35,962
Cash and cash equivalents at beginning of period		—			11,152			37,125			—		48,277
Cash and cash equivalents at end of period	$	—		$	64,063		$	20,176		$	—	$	84,239

(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.

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Kraton Polymers LLC

Condensed Consolidating Statement of Cash Flows

Nine Months Ended September 30, 2007

(In thousands)

	Issuers (1)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations		Consolidated
	(Unaudited)
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
Repayment of debt obligations		(42,787	)		—			—			—		(42,787	)
Proceeds from cash contribution from member		—			—			—			—		—
Proceeds from (payments on) intercompany loans		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 and cash equivalents		—			—			(1,997	)		—		(1,997	)
Net increase (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

(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.

13. New Accounting Pronouncements.

The following new accounting pronouncements were adopted during the nine months ended September 30, 2008:

SFAS No. 157, “Fair Value Measurements.” In September 2006, the FASB issued SFAS No. 157, which defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position (FSP) No. FAS 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13.” Also in February 2008, the FASB issued FSP No. 157-2, “Effective Date of FASB Statement No. 157,” which delays the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statement on a recurring basis (at least annually). The adoption of SFAS No. 157 and FSP No. FAS 157-1 by Kraton effective January 1, 2008 did not have a material impact on our consolidated results of operations, financial position or cash flows. See Note 7 for further discussion. Kraton has elected to defer the adoption of SFAS No. 157 for the measurement of asset retirement obligations until January 1, 2009 as permitted.

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In October 2008, the FASB issued FSP No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” which clarifies the application of SFAS No. 157 in determining the fair value of a financial asset when the market for that financial asset is not active. FSP No. FAS 157-3 was effective upon issuance, including prior periods for which financial statements have not been issued. Revisions in fair values resulting from a change in the valuation technique or its application would be accounted for as a change in accounting estimate. The adoption of FSP No. FAS 157-3 had no impact on Kraton’s consolidated results of operations, financial position or cash flows.

SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115.”In February 2007, the FASB issued SFAS No.159, which 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. The adoption of SFAS No. 159 by Kraton effective January 1, 2008 did not have a material impact on our consolidated results of operations, financial position or cash flows.

The following new accounting pronouncements have been issued, but have not yet been adopted as of September 30, 2008:

SFAS No. 141R, “Business Combinations.” In December 2007, the FASB issued SFAS No. 141R which replaces SFAS No. 141, “Business Combinations.” SFAS No. 141R requires the acquiring entity in a business combination to recognize all and only the assets acquired and liabilities assumed in the transaction, establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed, and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 and cannot be early adopted.

SFAS No. 161 “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133.”In March 2008, the FASB issued SFAS No. 161 which amends and expands the disclosure requirements for SFAS No. 133 with the intent to provide users of financial statements an enhanced understanding of how and why derivative instruments are used, how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for fiscal years and interim periods within those fiscal years, beginning on or after November 15, 2008.

FSP No. FAS 142-3, “Determination of the Useful Life of Intangible Assets.” In April 2008, the FASB issued FSP No. FAS 142-3 which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets.” FSP No. FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Kraton does not expect the adoption of FSP No. FAS 142-3 to have a material impact on our consolidated results of operations, financial position or cash flows.

14. Financial Instruments, Hedging Activities and Credit Risk

Financial Instruments

(a) Interest Rate Swap Agreements

In February 2008, we entered into a $325 million notional amount interest rate swap agreement to hedge or otherwise protect against Eurodollar interest rate fluctuations on a portion of our variable rate debt. The agreement had a fixed rate of 2.77%, which resulted in a total cost of 4.77%, and a term through April 1, 2010. This agreement was designated as a cash flow hedge on the exposure of the variability of future cash flows

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subject to the variable quarterly interest rates on $325 million of the Term Facility. We settled the swap early in June 2008 and realized cash proceeds of $4.6 million, resulting in a gain on the sale of $4.6 million. The gain is deferred in accumulated other comprehensive income at September 30, 2008 and is being reclassified as a reduction in interest expense through March 31, 2010 using the effective interest method, unless we determine that the forecasted interest payments under the Term Facility are probable not to occur, in which case the gain would then be reclassified immediately to interest expense.

(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, 2008 and December 31, 2007:

	September 30, 2008				December 31, 2007
	Carrying Value		Fair Value		Carrying Value		Fair Value
	(in thousands)
Term loans	$	325,907	$	325,907	$	338,465	$	338,465
Revolving loans		50,000		50,000		—		—
8.125% Notes		200,000		115,250		200,000		187,250

The Term Loans and Revolving Loans are variable interest rate securities, and as such, the fair value approximates their carrying value.

Foreign Currency Hedge

In July, 2008 we entered into a foreign currency option contract to reduce our exposure to fluctuations in the Euro to U.S. dollar exchange rate for a notional amount of €20 million. The option contract does not qualify for hedge accounting and is scheduled to expire on December 29, 2008. During the third quarter of 2008, we recorded a charge of $0.5 million, which represented the mark-to-market impact of the purchased option contract. The charge has been classified within selling, general, and administrative expense on the Condensed Consolidated Statements of Operations.

Credit Risk

Kraton’s customers are diversified by industry and geography with approximately 700 customers in approximately 60 countries worldwide. We do not have concentrations of receivables from these industry sectors throughout these countries. The recent global economic downturn may affect our overall credit risk. Where exposed to credit risk, Kraton analyzes the counterparties’ financial condition prior to entering into an agreement, establishes credit limits and monitors the appropriateness of those limits on an ongoing basis. We also obtain cash, letters of credit or other acceptable forms of security from customers to provide credit support, where appropriate, based on our financial analysis of the customer and the contractual terms and conditions applicable to each transaction.

15. Deferred Financing Costs

We capitalize financing fees and other related costs and amortize them to interest expense over the term of the related debt instrument. In the second and third quarters of 2008, we incurred fees of approximately $1.4 million associated with preliminary analysis of refinancing options associated with our Credit Agreement, of which $0.9 million was capitalized to Deferred financing costs on the Condensed Consolidated Balance Sheet as of June 2008. In the third quarter of 2008, we recorded a charge of $1.4 million to selling, general, and administrative expense in the Condensed Consolidated Statements of Operations as we determined our refinancing efforts were not probable due to current market conditions.

16. Subsequent Events

On October 15, 2008, we entered into a $320.0 million notional amount interest rate swap agreement to hedge or otherwise protect against Eurodollar interest rate fluctuations on a portion of our variable rate debt. This agreement was designated as a cash flow hedge on the exposure of the variability of future cash flows subject to the variable quarterly interest rates on $320.0 million of the term loan portion of the credit facility.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

INTRODUCTION

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, 2007. 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 most recent Form 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.

Executive Overview

We believe we are the world’s leading producer of styrenic block copolymers (SBCs), a family of specialty chemical products whose chemistry we pioneered over 40 years ago. SBCs are highly engineered synthetic elastomers which enhance the performance of numerous products by delivering a variety of performance characteristics, including greater flexibility, resilience, strength, durability and processability, and are a fast growing subset of the elastomers industry. Our specialty polymers are typically processed with other products to achieve customer specific performance characteristics in a variety of applications. Each polymer is highly customized to each application and is usually a critical component to the performance of our customer’s product, yet represents a small fraction of the overall cost of the customer’s finished product. The versatility of our portfolio of polymers is due to a wide range of distinctive molecular structures, which can be precisely controlled and tailored to unique design and performance characteristics. Each polymer requires a significant amount of testing and certification, which, combined with our proprietary chemistry encourages strong customer loyalty. We believe that our global scale, broad product offerings, superior technical expertise, strong customer relationships and well-recognized KRATON^® brand name have allowed us to maintain our leading global position in SBCs.

We currently offer over 800 products to over 700 customers in over 60 countries worldwide. We are the only SBC producer with manufacturing and service capabilities on four continents enabling our multinational customers to meet their global needs. We operate six plants globally, including our flagship Belpre, Ohio plant in the United States (U.S.), the largest SBC plant in the world, as well as plants in Germany, France, The Netherlands, and Brazil. The plant in Japan is operated by a manufacturing joint venture. We serve a large number of customers across a diverse set of end-use markets in many regions of the world. As a result, we believe our sales are less sensitive to conditions in any one particular end-use market or region.

We have aligned our commercial activities to serve three core end-uses with what we believe to be the highest growth and value potential: (i) Advanced Materials (32% of 2007 sales), which includes applications in compounding channels, packaging and films and personal care end-markets; (ii) Adhesives, Sealants & Coatings (31% of 2007 sales); and (iii) Paving & Roofing (30% of 2007 sales). Each of our end-uses constitutes a global profit center, and each has its own dedicated management, sales force and market development. In addition, each end-use is linked directly to the Research, Development and Technical Services (“RTS”) function and, via this link, sponsors the creation and commercialization of new products in addition to servicing its customers’ technical needs. We believe we hold the number one market position, based on 2007 sales, in each of our core end-use markets.

Recent Developments

Pricing

Through September 2008, Kraton continued to implement a series of global price increases which were generally broad-based across our end-use markets and in response to the continuing increase in raw material and energy costs. As of the date of this filing, the slowdown in the global economy is beginning to impact our global sales primarily in our Paving and Roofing and Advanced Materials end-use markets as a result of lower sales volumes. We will respond to these developments as they are better understood.

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Raw Materials

With Hurricanes Gustav and Ike causing unplanned outages at a number of U.S. Gulf Coast ethylene and butadiene extraction plants, even larger butadiene shortages initially developed in September and early October. More recently, Gulf Coast butadiene supply has improved significantly:

• Producers have returned to normal operations, while several large butadiene consumers have remained idled from hurricane damage. We believe these butadiene consumers will however return to normal operation during the fourth quarter.

• The financial market crisis has coincided with a rapid decline in crude oil prices during October.

• In November, the price of butadiene in North America declined 20% after 12 consecutive months of price increases.

As a result, we are currently able to acquire all the butadiene we need, and have therefore discontinued our allocation of selected Styrene-butadiene-styrene block copolymers. We cannot predict the extent, duration or ultimate market effect of these changes in energy and raw material costs, availability, or individual supply/demand constraints.

New Products

Our latest innovation product, MD6705, breaks the processing barrier of conventional styrenic block copolymers now allowing fabricators to make bicomponent elastic nonwovens on commercial production equipment at full speed. Materials like PP, PET and nylon can be used as sheath, while MD6705 is in the core of the bicomponent fibers. MD6705 brings significant system cost savings via processing simplification to our customers and also achieves excellent elastic recovery and a soft fabric-like feel.

Cost Reduction Initiative

We launched a global initiative aimed at further reducing Kraton’s annual fixed costs by approximately $10 million beginning in 2009. Though not final in scope, the initiative is expected to include purchasing savings, staffing reductions, and curtailing other expenditures. The initiative also includes a full review of planned capital expenditures in 2009, with the expectation that any growth-oriented discretionary spending would be postponed.

Customer Event

One of our major asphalt customers, SemMaterials L.P. (SEM), filed a petition for relief under Chapter 11 of Title 11 of the U.S. Code on July 22, 2008, along with several of SEM’s affiliated companies. Kraton has outstanding pre-petition receivables of approximately $0.4 million due from SEM, but does not believe that SEM’s bankruptcy case will have a material effect on our ongoing operations.

Kraton intends to seek payment on the pre-petition receivables due from SEM through the appropriate claim-filing procedures in SEM's bankruptcy cases.

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 49%, 52% and 54% of our total cost of goods sold for the twelve months ended December 31, 2007, and the nine months ended September 30, 2008 and 2007, respectively. The cost of these monomers has generally increased as crude oil prices have escalated. In addition to changes in crude oil prices, global supply and demand and economic conditions have resulted in increased costs for these monomers in 2008. Styrene, butadiene and isoprene used by our U.S. and European facilities are primarily supplied by Shell

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Chemicals or its affiliates, LyondellBasell, and other suppliers under long-term supply contracts with various expiration dates.

We have received Shell Chemicals’ termination notice for isoprene supply to Pernis, The Netherlands, effective December 31, 2009, and are in the process of reviewing the strategic and economic options for our Pernis assets. Upon termination of the isoprene supply agreement with Shell Chemicals on December 31, 2009, we may not be able to obtain the isoprene required for our operations at our Pernis, The Netherlands, facility on terms favorable to us or at all. On April 24, 2008, we received a notice of termination from Shell Chemicals for our U.S. butadiene supply contract effective April 30, 2009. We source butadiene in the U.S. pursuant to this contract. We expect to negotiate and enter into one or more replacement agreements with Shell Chemicals and/or other suppliers, although no assurances can be provided that any such replacement agreement will be entered into or as to the volumes or terms of any such replacement agreement(s). As of September 2008, we were unable to obtain the supply of butadiene to which we are entitled under all supply agreements. The significant factors causing the shortfall were the continued tight supply/demand balance for butadiene, especially in North America. The high cost of crude oil (relative to natural gas) led ethylene producers to crack lighter feedstocks which resulted in less Crude C4 production and butadiene extraction. As a result, we were unable to produce all products necessary to meet customer demand and, in turn, had to allocate certain available product supplies among our customers.

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 all 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. Styrene prices are primarily driven by worldwide supply and demand and the cost of ethylene, benzene, and natural gas.

Butadiene is used in the production of certain grades of both USBC and HSBC products. The price for butadiene is volatile and is determined by worldwide supply and demand and prevailing crude oil and ethylene prices. Butadiene is a by-product of the production of other petrochemicals and worldwide supply may be less responsive to increased demand for butadiene as compared to other petrochemicals. Isoprene is used in the production of certain grades of USBC, 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 as such the market for isoprene is tight. Since there are a limited number of isoprene producers, the price for isoprene can also be driven by the operating efficiency of some key producers. The cracking of light ethylene feedstocks that has limited butadiene supply has also restricted the production of Crude C5 and the extraction of isoprene.

Changes in price for and availability of raw materials will have an effect on our results of operations. In response to raw material feedstock cost increases, we have increased prices for many of our products. We are continuing to evaluate the prices for all of our products as market conditions change.

Economic and Market Conditions

Downturns in general economic conditions can cause fluctuations in demand for our products, product prices, volumes and margins. For example, our results of operations were negatively affected during 2007 in the North American Paving and Roofing end-use market due to poor weather conditions, limited government paving budgets and high asphalt prices, resulting in a decline in demand for our products. However, a number of our products are sold into certain commercial and consumer end-use markets, such as compounding and personal care products that are generally considered to be less affected by general economic conditions. 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.

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International Operations and Currency Fluctuations

We operate a geographically diverse business, with 40% of net product sales generated from customers located in the Americas, 46% in Europe and 14% in the Asia Pacific region during the nine months ended September 30, 2008. Our products are sold to customers in more than 60 countries. We serve our customer base from six manufacturing plants in six countries.

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.

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. In 2008, we entered into two foreign currency option contracts to reduce our exposure to fluctuations in the Euro to U.S. dollar exchange rate. The first option contract was entered into on April 3, 2008 and expired on June 26, 2008. The second option contract was entered into on July 1, 2008 and is scheduled to expire on December 29, 2008. See Note 14 of Notes to Condensed Consolidated Financial Statements for further discussion.

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.

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RESULTS OF OPERATIONS

	Three Months Ended September 30,									Nine Months Ended September 30,
	2008			2007			Increase (Decrease)			2008			2007			Increase (Decrease)
	(in thousands)
RESULTS OF OPERATIONS
Operating revenues	$	382,167		$	290,150		$	92,017		$	994,397		$	831,872		$	162,525
Cost of goods sold		287,719			243,699			44,020			788,618			701,660			86,958
Gross profit		94,448			46,451			47,997			205,779			130,212			75,567
Operating expenses		47,140			33,585			13,555			135,587			104,129			31,458
Interest expense, net		7,875			12,375			(4,500	)		27,678			32,507			(4,829	)
Income (loss) before income taxes		39,527			680			38,847			42,828			(5,910	)		48,738
Income tax provision		(4,910	)		(1,434	)		3,476			(7,405	)		(1,822	)		5,583
Net income (loss)	$	34,617		$	(754	)	$	35,371		$	35,423		$	(7,732	)	$	43,155

Three Months Ended September 30, 2008 as Compared to September 30, 2007

Operating Revenues.Operating revenues for the three months ended September 30, 2008 increased $92.0 million or 31.7% compared to the same period in 2007. The increase was driven primarily by:

• Sales increased $78.8 million or 27.7%. The increase in sales was the result of increases in global product sales prices and changes in product mix of $70.4 million and impact of changes in foreign currency exchange rates of $18.4 million, partially offset by a $9.9 million decrease related to a 6.0 kt, or 6.3 % decline in sales volume.

We implemented a series of global price increases in the first three quarters of 2008, which were generally broad-based across our end-use markets and in response to the continuing increase in raw material and energy costs. We experienced lower volume in our Paving and Roofing and Advanced Materials end-use market, largely due to constrained availability of butadiene. We continue to see lower sales volume in non-core end uses, such as footwear.

• Other revenue increased $13.2 million or 234.3%. The increase primarily consists of the sales of small quantities of residual products that are a by-product of the manufacturing process of isoprene rubber.

Cost of Goods Sold.Cost of goods sold for the three months ended September 30, 2008 increased $44.0 million or 18.1% compared to the same period in 2007. The increase was driven primarily by:

• a $13.4 million increase from changes in foreign currency exchange rates,

• a $24.6 million increase in monomer and other production costs,

• a $13.2 million increase in by-product cost, partially offset by,

• a $7.2 million decline in cost of goods sold directly related to the decline in sales volume.

As a percentage of operating revenues, cost of goods sold decreased to 75.3% for the three months ended September 30, 2008 from 84.0% for the same period in 2007.

Gross Profit.Gross profit for the three months ended September 30, 2008 increased $48.0 million or 103.3% compared to the same period in 2007. As a percentage of operating revenues, gross profit increased to 24.7% for the three months ended September 30, 2008 from 16.0% for the same period in 2007.

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Operating Expenses.Operating expenses for the three months ended September 30, 2008 increased $13.6 million or 40.4% compared to the same period in 2007. The increase was driven primarily by:

• Research and development increased $0.4 million or 6.5%. The increase was largely due to the costs associated with the realignment of our research, technical service and new business development organizations.

As a percentage of operating revenues, research and development decreased to 1.5% for the three months ended September 30, 2008 from 1.9% for the same period in 2007.

• Selling, general and administrative increased $12.6 million or 80.9%. The increase was primarily due to $9.7 million associated with Kraton’s incentive compensation plan, $1.4 million related to analysis of refinancing options and $1.1 million from changes in foreign currency exchange rates.

As a percentage of operating revenues, selling, general and administrative increased to 7.4% for the three months ended September 30, 2008 from 5.4% for the same period in 2007.

• Depreciation and amortization of identifiable intangibles increased $0.6 million or 4.6%. The increase in depreciation and amortization expense reflects assets that were under construction in prior periods that were completed and placed in service, including our polyisoprene latex plant at our Paulinia, Brazil facility and changes in foreign currency exchange rates.

Interest expense, net.Interest expense, net for the three months ended September 30, 2008 decreased $4.5 million or 36.4% compared to the same period in 2007. The decrease was primarily due to lower debt balances and lower interest rates, and the impact of the interest rate swap agreement. The average debt balances outstanding were $542.0 million and $580.2 million, in the three months ended September 30, 2008 and 2007, respectively. The effective interest rates on our debt during the same periods were 6.3% and 8.1%, respectively. We borrowed $50.0 million on our Revolver on September 23, 2008. See Note 14(a) for a description of the swap agreement.

Income tax provision.Income tax provision for the three months ended September 30, 2008 was $4.9 million compared to $1.4 million for the same period in 2007. The effective tax rate was approximately 12.4% for the three months ended September 30, 2008 as compared to 210.9% for the same period in 2007. Our effective tax rate for the three months ended September 30, 2008 was less than our statutory rate primarily due to not recording a tax benefit for certain net operating loss carryforwards generated during that period and recognition of deferred tax assets on US operations that were previously offset by valuation allowances, as well as a different income mix between foreign and domestic tax jurisdictions. 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 and a different income mix between foreign and domestic tax jurisdictions.

Nine Months Ended September 30, 2008 as Compared to September 30, 2007

Operating Revenues.Operating revenues for the nine months ended September 30, 2008 increased $162.5 million or 19.5% compared to the same period in 2007. The increases were driven primarily by:

• Sales increased $135.6 million or 16.7%. The increase in sales was the result of increases in global product sales prices and changes in product mix of $105.7 million and impact of changes in foreign currency exchange rates of $59.5 million, partially offset by a $29.5 million decrease related to a 14.6 kt, or 5.3 % decline in sales volume.

We experienced volume growth in our Adhesives, Sealants and Coatings end-use market which was more than offset by lower volume for our Paving and Roofing and Advanced Materials end-use market. Our volume in all end-use markets was constrained due to butadiene availability. We continue to see lower sales volume in non-core end uses, such as footwear.

• Other revenue increased $26.9 million or 137.8%. The increase primarily consists of the sales of small quantities of residual products that are a by-product of the manufacturing process of isoprene rubber.

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Cost of Goods Sold.Costs of goods sold for the nine months ended September 30, 2008 increased $86.9 million or 12.4 % compared to the same period in 2007. The increase was driven primarily by:

• a $45.7 million increase from changes in foreign currency exchange rates,

• a $26.9 million increase in by-product cost,

• a $37.1 million increase in monomer and other production costs, partially offset by,

• a $22.8 million decline in cost of goods sold directly related to the decline in sales volume.

As a percentage of operating revenues, cost of goods sold decreased to 79.3% for the nine months ended September 30, 2008 from 84.3% for the same period in 2007.

Gross Profit.Gross profit for the nine months ended September 30, 2008 increased $75.6 million or 58.0 % compared to the same period in 2007. As a percentage of operating revenues, gross profit increased to 20.7% for the nine months ended September 30, 2008 from 15.7% for the same period in 2007.

Operating Expenses.Operating expenses for the nine months ended September 30, 2008 increased $31.5 million or 30.2% compared to the same period in 2007. The increase was driven primarily by:

• Research and development increased $2.6 million or 14.2%. The increase was primarily due to the costs associated with the realignment of our research, technical service and new business development organizations.

As a percentage of operating revenues, research and development decreased to 2.1% from 2.2% compared to the same period in 2007.

• Selling, general and administrative increased $24.4 million or 49.5 %. The increase was primarily due to $5.5 million associated with the previously announced senior executive and other management changes, $4.6 million from changes in foreign currency exchange rates, $11.3 million associated with Kraton’s incentive compensation plan and $1.4 million related to analysis of refinancing options.

As a percentage of operating revenues, selling, general and administrative increased to 7.4% from 5.9% compared to the same period in 2007.

• Depreciation and amortization of identifiable intangibles increased $4.5 million or 12.3%. The increase in depreciation and amortization was due to timing of capital expenditures, including our polyisoprene latex plant at our Paulinia, Brazil facility, accelerated depreciation on the SIS plant assets at our Pernis facility beginning in September 2007, and changes in foreign currency exchange rates.

Interest expense, net.Interest expense, net for the nine months ended September 30, 2008 decreased $4.8 million or 14.9% compared to the same period in 2007. The decrease was primarily due to lower debt balances and lower interest rates, and the impact of the interest rate swap agreement. However, the decrease was partially offset by an adjustment to interest expense, net in 2007 related to the accounting for interest rate swaps that resulted in a decrease in interest expense and therefore an increase in pre-tax income of approximately $1.6 million for the nine months ended September 30, 2007. The average debt balances outstanding were $557.8 million and $580.1 million with effective interest rates of 6.6% and 7.6%, respectively. See Note 14(a) for a description of the swap agreement.

Income tax provision.Income tax provision was $7.4 million for the nine months ended September 30, 2008, as compared to $1.8 million for the nine months ended September 30, 2007. The effective tax rate for the nine months ended September 30, 2008 was approximately 17.3% as compared to a rate of (30.8)% for the nine months ended September 30, 2007. Our effective tax rate for the nine months ended September 30, 2008 was less than our statutory rate primarily due to not recording a tax benefit for certain net operating loss carryforwards generated during that period and recognition of deferred tax assets on U.S. operations that were previously offset by valuation allowances, as well as a different income mix between foreign and domestic tax jurisdictions. 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 and a different income mix between foreign and domestic tax jurisdictions.

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LIQUIDITY AND CAPITAL RESOURCES

We are a holding company without any operations or assets other than the operations of 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 and existing cash balances. We believe that, based on current and anticipated levels of operations, cash flow from operations of our subsidiaries and borrowings available to us will be adequate for the foreseeable future for us to fund our working capital and capital expenditure requirements and to make required payments of principal and interest on our 8.125% Notes and senior secured credit facility. Going forward 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 credit facility to fund liquidity needs in an amount sufficient to enable us to service our indebtedness. As of September 30, 2008, we had $84.2 million of cash and cash equivalents. We have available to us, upon compliance with customary conditions, the $75.5 million revolving portion of the senior secured credit facility of which we had borrowed $50.0 million on our Revolver at September 30, 2008. From time to time, on an ongoing basis, we continue to evaluate options with respect to our overall debt structure, including, without limitation, the possibility of purchases in the open market of Kraton indebtedness up to amounts permitted under our senior secured credit facility. 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.

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. We are required to maintain a fiscal quarter end interest coverage ratio of 2.50:1.00 through December 31,2008, 2.75:1.00 beginning March 31, 2009 and 3.00:1.00 beginning March 31, 2010 and thereafter. In addition, we are required to maintain a fiscal quarter end coverage ratio not to exceed 4.95 through December 31,2008 and 4.00 beginning December 31, 2009 and thereafter. Our failure to comply with any of these financial covenants would give rise to a default under the senior secured credit facility.

At September 30, 2008, 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.

Operating Cash Flows

Net cash provided by operating activities decreased $48.2 million for the nine months ended September 30, 2008 compared to the same period in 2007. This change was driven primarily by:

• Increased accounts receivable and inventory balances principally related to increases in global product pricing and increased cost of raw materials, partially offset by higher earnings.

Investing Cash Flows

Net cash used in investing activities totaled $15.3 million for the nine months ended September 30, 2008 compared to $19.8 million used in investing activities during the same period in 2007. This $4.5 million decrease was primarily driven by:

• a lower rate of capital expenditures.

Capital Expenditures.We are forecasting 2008 capital expenditures of approximately $30.0 million to $35.0 million. These capital expenditures will be for maintenance, infrastructure, expansion and cost reduction projects. Our minimum annual 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.

Belpre Plant Instrumentation Upgrade.In May, we entered into a contract with Invensys Systems Inc. pursuant to which certain systems and operating controls at the Belpre, Ohio facility will be upgraded in stages over the next several years. Pursuant to the contract, Invensys will provide detailed engineering design necessary

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to implement the new systems, as well as supply hardware and software for such systems. This project is designed to significantly improve the effectiveness, competitiveness and operating efficiency of the Belpre plant. The project will begin in the second-half of 2008 and will be completed in distinct phases extending into 2012, with the total spending currently estimated at $40.0 million.

Financing Cash Flows and Liquidity

Net cash provided by financing activities totaled $46.9 million in the first nine months of 2008 compared to $41.5 million net cash used in financing activities in the first nine months of 2007. This change was driven primarily by:

• a voluntary pre-payment of $40 million on the Term Facility in September 2007, and

• a $50 million draw on the Revolver in September 2008.

Description of Our Indebtedness.See Note 6 of Notes to Condensed Consolidated Financial Statements for a discussion of our debt facilities and related financial and other covenants. In September 2008, we borrowed $50 million on our Revolving Loans due to the uncertainties resulting from the recent and on-going global credit crisis. The proceeds are classified within Cash and cash equivalents on the Condensed Consolidated Balance Sheets.

Other Contingencies

As a chemicals manufacturer, our operations in the U.S. 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.

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We had no material operating expenditures for environmental fines, penalties, government imposed remedial or corrective actions in the presented periods of 2008 and 2007.

Contractual Commitments

We have contractual obligations for long-term debt, operating leases and purchase obligations that were summarized in a table of contractual commitments in our 2007 Annual Report on Form 10-K. There has been no material change other than the operating lease at Westhollow Technology Center since that date.

Off-Balance Sheet Transactions

We are not involved in any material off-balance sheet transactions as of September 30, 2008.

OTHER ISSUES

New Accounting Pronouncements

See Note 13 of Notes to Condensed Consolidated Financial Statements.

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Item 3. Quantitative and Qualitative Disclosures about 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 $325.9 million of variable rate debt outstanding under our senior secured credit facility as of September 30, 2008. 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. In addition, we have $50.0 million of variable rate debt outstanding under our Revolving Loans. 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. In February 2008, we entered into a $325.0 million notional amount interest rate swap agreement to hedge or otherwise protect against Eurodollar interest rate fluctuations on a portion of our variable debt. The agreement had a fixed rate of 2.77%, which resulted in a total cost of 4.77% and was scheduled to expire on April 1, 2010. We settled the swap early in June 2008 and realized cash proceeds of $4.6 million resulting in a gain on the sale of $4.6 million. The gain is deferred in accumulated other comprehensive income and is being reclassified as a reduction in interest expense through March 31, 2010 using the effective interest method, unless we determine that the forecasted interest payments under the Term Facility are probable not to occur, in which case the gain would then be reclassified immediately to interest expense.

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 consolidated financial statements. In recent years, exchange rates between these currencies and U.S. dollars have fluctuated significantly and may do so in the future. Approximately, one-half of our revenue and costs are denominated in U.S. dollars. Euro-related currencies are also significant. In July, 2008 we entered into a foreign currency option contract to reduce our exposure to fluctuations in the Euro to U.S. dollar exchange rate for a notional amount of €20 million. The option contract is scheduled to expire on December 29, 2008.

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 4. Controls and Procedures.

We have evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of September 30, 2008. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention of 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, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, are recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms, and that they are accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control reporting.

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

For information regarding legal proceedings, see Note 9 of Notes to Condensed Consolidated Financial Statements.

Item 1A. Risk Factors.

Readers of the Quarterly Report on Form 10-Q should carefully consider the risks described in our other reports filed with or furnished to the SEC, including our prior and subsequent reports on Forms 10-K, 10-Q, and 8-K, in connection with any evaluation of Kraton’s financial position, results of operations and cash flows.

The risks and uncertainties described in our most recent Annual Report on Form 10-K, filed with the SEC on March 31, 2008, are not the only ones facing us. Additional risks and uncertainties not presently known or those that are currently deemed immaterial may also affect our operations. Any of the risks, uncertainties, events or circumstances described therein could cause our future financial condition, results of operations or cash flows to be adversely affected.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Not Applicable.

Item 3. Defaults Upon Senior Securities

Not Applicable.

Item 4. Submission of Matters to a Vote of Security Holders.

Not Applicable.

Item 5. Other Information

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Item 6. Exhibits

Exhibit Number
*10.1	Amendment to TJ Chemical Holdings LLC 2004 Option Plan
*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

* Filed herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	KRATON POLYMERS LLC
Date: November 12, 2008	/S/    KEVIN M. FOGARTY
	Kevin M. Fogarty President and Chief Executive Officer
Date: November 12, 2008	/S/    STEPHEN E. TREMBLAY
	Stephen E. Tremblay Vice President and Chief Financial Officer

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