SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

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

For Quarterly Period Ended September 30, 2004. Commission file number 1-16091.

POLYONE CORPORATION

Registrant’s telephone number, including area code: (440) 930-1000

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 o

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

Yes x   No o

As of October 25, 2004, there were 91,616,135 common shares outstanding.

Table of Contents

Part I - Financial Information

Item 1. Financial Statements

PolyOne Corporation and Subsidiaries

See Accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.

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PolyOne Corporation and Subsidiaries

See Accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.

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PolyOne Corporation and Subsidiaries

See Accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.

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PolyOne Corporation and Subsidiaries

See Accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note A – Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Form 10-Q instructions and, in the opinion of management, contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position, results of operations and cash flows for the periods presented. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates. These interim statements should be read in conjunction with the financial statements and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2003 of PolyOne Corporation.

Operating results for the three and nine month periods ended September 30, 2004 are not necessarily indicative of the results expected in subsequent quarters or for the year ending December 31, 2004.

We have separately presented costs related to employee separation and plant phase-out, environmental remediation at inactive sites and loss on sale of assets in our Condensed Consolidated Statements of Operations. Employee separation and plant phase-out costs are discussed in Note H below. Environmental remediation at inactive sites represents environmental remediation costs for manufacturing facilities that we either no longer own, or that we closed in prior years. Loss on sale of assets includes a $0.3 million loss recorded upon the sale of our European vinyl compounding business in the second quarter of 2003 and a $5.9 million loss upon the sale of our Melos rubber granulates business in the second quarter of 2004. We completed the sale of the Melos business on June 9, 2004 to the Melos management team, which was supported by investors from a group of European banks and funds, to allow us to focus on our core plastic compounding and color additives businesses. The business, which we acquired in 1998, had 2003 sales of approximately $35 million and was previously included in the Performance Plastics business segment.

On October 21, 2003, we announced that our future focus would be on our global Plastics Compounding and Color & Additive Masterbatch businesses, and our Distribution business, as part of our drive to improve profitability and strengthen our balance sheet because we believe these businesses have the strongest market synergies and potential for success. As a result, our Elastomers and Performance Additives, Engineered Films and Specialty Resins businesses were targeted for divestment. The Elastomers and Performance Additives business had 2002 sales of $363.8 million and pre-tax income of $24.0 million. The Engineered Films and Specialty Resins businesses had 2002 sales of $242.9 million and pre-tax income of $8.7 million.

As a result, as of December 31, 2003, PolyOne’s Elastomers and Performance Additives, Specialty Resins and Engineered Films businesses qualified for accounting treatment as discontinued operations. The net assets held for sale of the discontinued operations were written down in the fourth quarter of 2003 to their projected net sale proceeds. These charges, totaling $92.6 million for the Elastomers and Performance Additives business and $37.9 million for the Engineered Films and Specialty Resins businesses, were included in “Income (loss) from discontinued operations and loss on sale, net of income taxes” on the Consolidated Statement of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2003.

On June 28, 2004, we entered into a definitive agreement with an entity formed by an investor group led by Lion Chemical Capital, LLC and ACI Capital Co., Inc. to sell our Elastomers and Performance Additives business. The sale, which was completed on August 5, 2004, provided gross proceeds before associated fees and costs of approximately $120 million, of which $106 million was paid in cash on that date and $14 million is in the form of a six-year note from the buyer. This price was within our previous range of estimates for the sale of this unit. Accordingly, through September 30, 2004, all historical financial information of these businesses (sales, costs and expenses, assets and liabilities and cash flows) has been reported separately as discontinued operations. Elastomers and Performance Additives was previously reported as a separate business segment. The Specialty Resins and Engineered Films businesses were previously included in PolyOne’s Performance Plastics business segment. In addition, in 2004, PolyOne recognized a $15.3 million non-cash pre-tax charge for impairment of net assets held for sale to adjust the net asset carrying value of the Elastomers and Performance Additives business to the net proceeds. The carrying amounts of the major classes of assets and liabilities of the Engineered Films and Specialty Resins businesses as of September 30, 2004 are reflected in “Discontinued operations” in the Condensed Consolidated Balance Sheets. The net carrying value of these businesses at September 30, 2004 was $71.4 million.

Note B – Accounting Policies

Stock-Based Compensation - As provided under Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock Based Compensation,” PolyOne has elected to account for stock-based compensation under the provisions of Accounting

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Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.” Compensation cost for stock options is measured as the excess, if any, of the quoted market price of the PolyOne stock at the date of the grant over the amount an employee must pay to acquire the stock. Compensation cost for stock appreciation rights (SARs) is recognized upon vesting, and is the amount by which the quoted market value of the shares of PolyOne stock covered by the grant exceeds the appreciation rights’ specified value. At September 30, 2004, approximately 1.6 million SARs were issued and outstanding, of which approximately 184,000 were vested and exercisable at share prices ranging from $6.00 to $12.22. The impact on compensation expense was less than $0.1 million for the three and nine month periods ended September 30, 2004.

The following table illustrates the effect on net income (loss) and income (loss) per share if PolyOne had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation, using the fair value estimate computed by the Black-Scholes option-pricing model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models use highly subjective assumptions, including expected share price volatility. Because PolyOne’s stock options have characteristics significantly different from traded options, and because changes in the subjective assumptions used can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our stock options.

New Accounting Pronouncements - In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities.” FIN 46 clarifies the application of accounting Research Bulletin No. 51, “Consolidated Financial Statements,” for certain entities which do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest (“variable interest entities”). Variable interest entities are required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected returns, or both, as a result of holding variable interests. These include ownership, contractual, or other pecuniary interests in an entity. FIN 46 was effective for all variable interest entities during PolyOne’s first quarter of fiscal 2004. The adoption of FIN 46 had no impact on our overall financial position, results of operations or cash flows.

On March 31, 2004, the FASB issued its Exposure Draft, “Share-Based Payment”, which is a proposed amendment to SFAS No. 123, “Accounting for Stock-Based Compensation.” The amendment would require all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. The FASB expects to issue a final standard late in 2004. On October 13, 2004, the FASB decided that the final amendment would be effective for public companies for any interim or annual period beginning after June 15, 2005, though early adoption would be encouraged, provided that financial statements for periods prior to the effective date have not been issued.

Reclassification - Certain amounts for prior periods have been reclassified to conform to the current period’s presentation.

Note C – Goodwill and Intangible Assets

Changes in the carrying amount of goodwill for the nine months ended September 30, 2004 by business segment are as follows:

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Information regarding PolyOne’s other intangible assets follows:

Amortization of other intangible assets follows:

Amortization expense for each of the five succeeding fiscal years is expected to be approximately $3 million per year.

As of September 30, 2004, we had $327.1 million of goodwill that resulted from acquiring businesses. SFAS No. 142, “Goodwill and Other Intangible Assets,” requires an annual assessment for potential impairment of goodwill and we have elected July 1 as our annual assessment date. During the third quarter of 2004, we completed the required “phase one” goodwill impairment assessment and determined that goodwill was not impaired as of July 1, 2004. We use the combination of two valuation methodologies, a market approach and an income approach, to estimate the fair value of our reporting units. The market approach estimates fair value by applying sales, earnings and cash flow multiples (derived from comparable publicly-traded companies with similar investment characteristics of the reporting unit) to the reporting unit’s operating performance adjusted for non-recurring items. The income approach is based on projected future debt-free cash flow that is discounted to present value using discount factors that consider the timing and risk associated with the forecasted debt-free cash flow. The average fair values of the market approach and income approach exceeded the carrying value by 92% for the Plastic Compounds and Colors reporting unit and by 9% for the Formulators reporting unit. Using the lowest fair value determined by these two methodologies would have resulted in a fair value that exceeded the carrying value by 92% for the Plastic Compounds and Colors reporting unit and by 7% for the Formulators reporting unit. While we determined that there was no additional goodwill impairment as of the annual assessment on July 1, 2004, the future occurrence of a potential indicator of impairment, such as a significant adverse change in legal factors or business climate, an adverse action or assessment by a regulator, unanticipated competition, loss of key personnel or a more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or disposed of, would result in our having to perform an interim assessment for some or all of our reporting units prior to the next required 2005 annual assessment.

Note D – Inventories

Components of inventories are as follows:

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Note E – Income Taxes

For the third quarter of 2004, PolyOne recorded tax expense of $2.2 million before discontinued operations, which was entirely for foreign taxes. A tax provision was not recorded on domestic income, as a result of the deferred tax valuation recorded in previous periods. PolyOne continues to maintain a full valuation allowance against its net deferred federal and state deferred tax assets. PolyOne intends to maintain a valuation allowance until positive evidence exists to support realization of some or all of the valuation allowance. During the same period in 2003, PolyOne recorded a deferred tax allowance in accordance with SFAS No. 109, “Accounting for Income Taxes.” In addition, PolyOne recorded tax expense of $24.0 million related to dividends from foreign subsidiaries and $2.3 million for foreign taxes.

For the nine months ended September 30, 2004, PolyOne recorded tax expense of $7.5 million before discontinued operations, which was entirely for foreign taxes. The tax expense for the nine months ended September 30, 2003 included a tax benefit of $32.1 million, offset by $24.0 million of tax expense related to dividends from foreign subsidiaries, a tax valuation allowance of $9.0 million and foreign tax expense of $10.3 million.

Note F – Investment in Equity Affiliates

PolyOne owns 24% of Oxy Vinyls LP (OxyVinyls), a manufacturer and marketer of PVC resins. OxyVinyls is a leading producer of PVC resins in North America. The following table presents OxyVinyls’ summarized results of operations for the three and nine months ended September 30, 2004 and 2003, and summarized balance sheet information as of September 30, 2004 and December 31, 2003.

OxyVinyls’ income during the first quarter of 2003 reported above includes a charge of $3.4 million, net of tax, in connection with a change in accounting from the adoption of SFAS No. 143, “Accounting for Asset Retirement Obligations.” Our proportionate share of the charge was $0.8 million.

PolyOne’s Resin and Intermediates segment also includes SunBelt Chlor-Alkali Partnership (SunBelt), which is 50% owned by PolyOne. The following table presents SunBelt’s summarized results of operations for the three and nine months ended September 30,

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2004 and 2003, and summarized balance sheet information as of September 30, 2004 and December 31, 2003.

The Performance Plastics segment includes DH Compounding Company (owned 50%), BayOne Urethane Systems, L.L.C (owned 50%) and Geon/Polimeros Andinos (owned 50%) equity affiliates. For the one-month period ended January 31, 2003, the Performance Plastics segment included results from Techmer PM, LLC, an equity affiliate (owned 51%). In January 2003, we sold our unconsolidated equity ownership interest in Techmer. For the eight-month period ended August 31, 2003, the Resin and Intermediates segment included results from Welvic Australia Pty Ltd (Welvic), an equity affiliate (owned 37.4%). As of September 1, 2003, Welvic sold substantially all of its net operating assets to Orica Ltd, the other partner in the joint venture with PolyOne. Combined summarized financial information for these equity affiliates is presented below.

Note G – Earnings Per Share Computation

Weighted average shares outstanding are computed as follows:

Basic earnings (loss) per common share is computed as net income (loss) available to common shareholders divided by weighted

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average basic shares outstanding. Diluted earnings (loss) per common share is computed as net income (loss) available to common shareholders divided by weighted average diluted shares outstanding.

PolyOne has excluded all outstanding options from the calculation of diluted earnings (loss) per share for the three and nine months ended September 30, 2003 because they would have had an anti-dilutive effect due to PolyOne’s net loss from continuing operations and exercise prices greater than the average market price of PolyOne’s common shares during these periods.

Note H – Employee Separation and Plant Phase-Out

During 2003 and 2004, we have undertaken several restructuring initiatives to improve profitability and, as a result, have incurred various employee separation and plant phase-out costs.

Employee separation costs include salary continuation benefits, medical coverage and outplacement assistance and are based upon a formula that takes into account each individual employee’s base compensation level and length of service. We maintain an employee severance plan that provides specific benefits to all employees (except those employed under collective bargaining agreements) who lose their jobs due to reduction in workforce or job elimination initiatives or from closing manufacturing facilities. Collective bargaining employees are covered under the terms of the specific agreement under which they are employed. The amount is determined separately for each affected employee and is recognized at the date the employee is notified if the actual termination date will be within 60 days of notification, or is accrued on a straight-line basis over the period from the notification date to the actual termination date if the termination date is greater than 60 days after the notification date. Of the 1,108 employees identified during 2003 and 40 employees identified in 2001 to be terminated, 405 remained to be terminated at December 31, 2003. As of September 30, 2004, all employees who were affected by these restructuring initiatives have been terminated.

Plant phase-out costs include the impairment of buildings, land, manufacturing equipment and office equipment at manufacturing facilities, and the resulting write-down of the carrying value of these assets to fair value, which represents our best estimate of the net proceeds to be received for the assets to be sold or scrapped, less cost to sell. Plant phase-out costs also include cash facility closing costs and lease termination costs. Assets transferred to other PolyOne facilities were transferred at net book value.

These costs associated with continuing operations are reflected on the Condensed Consolidated Statement of Operations on the line “Employee separation and plant phase-out.” These costs associated with discontinued operations are reflected on the Condensed Consolidated Statement of Operations on the line “Income (loss) from discontinued operations, net of income taxes.” Plant phase-out costs for continuing operations relate to the Performance Plastics business segment, and for discontinued operations relate to the Engineered Films business, formerly included in the Performance Plastics business segment, and the Elastomers and Performance Additives business, which was previously reported as a separate business segment. For further information, please refer to Note F to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2003.

2004 Charges — Operating income for the first nine months of 2004 includes a $1.5 million benefit and income from discontinued operations includes a $0.9 million expense relative to employee separation and plant phase-out costs as a result of adjusting our estimate for the remaining liabilities associated with restructuring initiatives announced in prior years. Charges recorded in 2004 totaling $6.7 million resulted from the announcement in the fourth quarter of 2003 and closure in the first quarter of 2004 of one of our Engineered Films’ manufacturing facilities and two of our Elastomers and Performance Additives’ manufacturing facilities. In addition, a gain of $0.3 million was recorded upon the sale of a previously closed Elastomers and Performance Additives’ manufacturing facility located in Tillsonburg, Ontario. As a result, income from discontinued operations for the same period was reduced by $6.4 million on a pre-tax basis for employee separation and plant phase-out costs. The liabilities for employee separation and plant phase-out for the businesses reported as discontinued operations will be retained by PolyOne upon the sale of these businesses and, as a result, are included in this discussion. All employees who were affected by the restructuring initiatives announced in prior years have been terminated as of September 30, 2004. The remaining employee separation costs accrued at September 30, 2004 totaling $4.2 million are expected to be paid out through the second quarter of 2005. The remaining plant phase-out cash closure costs accrued at September 30, 2004 totaling $2.9 million are expected to be paid out through the first quarter of 2007.

2003 Charges - Operating income for the first nine months of 2003 was reduced by $26.1 million, and income from discontinued operations for the same period was reduced by $9.2 million, on a pre-tax basis for employee separation and plant phase-out costs. A total of $21.4 million resulted from a January 2003 announcement to reduce approximately 400 staff personnel, of which $18.4 million related to continuing operations and $3.0 million related to discontinued operations. In June 2003, the decision was made to close the Fort Worth, Texas color additives plant, for which an expense of $3.5 million was recorded. During the second quarter of 2003, PolyOne adjusted its estimate for the remaining liabilities associated with restructuring initiatives announced in prior years. As a

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result of the adjustment, net reserves of $4.0 million were reversed and included in “employee separation and plant phase-out” on the Consolidated Statements of Operations. During the third quarter of 2003, PolyOne closed two leased Ohio administrative offices, closed a portion of the Mexico Distribution business and reduced manufacturing personnel in the North American plastics businesses. The impact of the third quarter closures and reductions was to reduce operating income by $8.2 million and to terminate 112 employees. The remaining $6.2 million of charges in discontinued operations resulted from an announcement in March 2003 to close an Engineered Films’ plant.

The following table summarizes the provisions, payments and remaining reserves associated with each of these initiatives from January 1, 2003 through September 30, 2004: