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United States

Securities and Exchange Commission

Washington, D.C. 20549

Form 10-K

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

For the fiscal year ended December 31, 2003

¨ 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 1-16091

PolyOne Corporation

(Exact name of registrant as specified in its charter)

Securities registered pursuant to Section 12(b) of the Act:

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x        No  ¨

The aggregate market value of the registrant’s outstanding voting common stock held by non-affiliates on June 30, 2003, determined using a per share closing price on that date of $4.45, as quoted on the New York Stock Exchange, was approximately $288,025,863.

The number of shares of common stock outstanding as of March 1, 2004 was 91,612,358.

DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates by reference certain information from the definitive Proxy Statement to be filed on or about March 31, 2004 with respect to the 2004 Annual Meeting of Shareholders.

POLYONE CORPORATION

PART I

PolyOne Corporation is an international polymer services company with continuing operations in thermoplastic compounds, specialty polymer formulations, color and additive systems, and thermoplastic resin distribution and equity investments in resin and intermediates. Headquartered in Avon Lake, Ohio, PolyOne has employees at manufacturing sites in North America, Europe and Asia, and joint ventures in North America, South America and Asia. We provide value to our customers through our ability to link polymer technology and formulation with our manufacturing and supply chain processes. For the fiscal year ended December 31, 2003, we had sales of $2.0 billion, approximately 24% of which were from markets outside of North America.

PolyOne was formed on August 31, 2000 as a result of the consolidation of The Geon Company (Geon) and M.A. Hanna Company (Hanna), and operates within three business segments: Performance Plastics, Distribution, and Resin and Intermediates.

As described in Note B to the Consolidated Financial Statements for the fiscal year ended December 31, 2003, PolyOne’s Elastomers & Performance Additives, Specialty Resins and Engineered Films businesses as of December 31, 2003 qualified for accounting as discontinued operations. PolyOne’s Italian operating subsidiary, So.F.teR S.p.A. (Softer), was sold in December 2002. All historical financial information for these business operations has been restated as discontinued operations. Unless otherwise noted, disclosure herein pertains to PolyOne’s continuing operations.

Polymer Industry Overview:

Polymers are a class of organic materials that are produced directly or indirectly through the conversion of natural gas or crude oil components into monomers such as ethylene, propylene, butane and styrene. These monomers are then polymerized into chains called polymers, or plastic resin, in its most basic form. Various additives are often combined with a base resin to create unique or enhanced properties necessary for end-use products. These combinations are generally referred to as plastic compounds. Plastic compounds have advantages over metals, wood, rubber and other traditional materials, which has and continues to result in the replacement of these traditional materials across a wide spectrum of applications ranging from automobile parts to construction materials due to the low cost and comparatively better performance of plastic. Plastics have a reputation for durability, aesthetics, ease of handling and high performance. We participate in the plastic compounding sector of the polymer industry through our Performance Plastics business segment.

Large petroleum companies produce a majority of the base resins because these commodity chemical manufacturers have direct access to the raw materials needed for production. Raw materials make up approximately 75% of the variable cost for the production of the base resin. Accordingly, the cost or material margin of a base resin fluctuates in tandem with the prices of raw materials used during production, primarily petroleum or natural gas and power or electricity. Through our equity interests in Oxy Vinyls, LP (OxyVinyls) and SunBelt Chlor-Alkali Partnership (SunBelt), we have the economic benefits of a base resin producer for one of our major raw materials: polyvinyl chloride resin.

There are two primary categories of polymers: thermoplastics and thermosets. Thermoplastics, which make up about 90% of the resin market, are characterized by their ability to be reshaped repeatedly into new forms after the application of heat and pressure. Thermoplastics offer versatility and a wide range of applications. There are five major types of thermoplastics: polyethylene, polyvinyl chloride, polypropylene, polystyrene and polyester. Each type of thermoplastic has unique qualities and characteristics that make it appropriate for use in a particular product. Our Performance Plastics business segment, which accounts for approximately 75% of our total sales, is primarily comprised of compounded thermoplastics. In addition, our Distribution business segment, which accounts for approximately 25% of our total sales, is a distributor of a wide range of thermoplastic resins and compounds.

Thermoplastic resins are found in numerous end-use products and in a variety of markets, including packaging, building and construction, transportation, furniture and furnishings, consumer and institutional products, electrical, adhesives, inks and coatings. Each category of thermoplastic resin has unique characteristics (such as flexibility, strength or durability) suitable for incorporation into a particular end-use product. For example, the packaging industry, which is the largest consumer of plastics, requires plastics that can help keep food fresh and free of contamination, while providing a variety of options for product display and offering advantages in terms of weight, energy and user-friendliness. In the building and construction industry, the second largest consumer of plastic, plastic has provided an economic and energy efficient replacement for traditional building materials in piping applications, building siding, flooring, insulation, windows and doors and a growing list of both structural

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and interior or decorative uses. In the transportation industry, plastic has proved to be durable, lightweight, and corrosion resistant while offering fuel savings, design flexibility and high performance to designers facing today’s complex transportation needs.

PolyOne Business Segments:

We operate within three business segments: Performance Plastics, Distribution, and Resin and Intermediates. Additional information regarding our business segments is discussed in Note S to the Consolidated Financial Statements for the fiscal year ended December 31, 2003.

Performance Plastics:

Our Performance Plastics business segment is a leading independent merchant compounder of plastics to the specifications of manufacturers of plastic products throughout North America and Europe, with a growing presence in Asia. We engage in the custom compounding of plastic materials to the specifications of manufacturers of molded and extruded plastic products. We are also a leading North American manufacturer of custom formulated colorants in the form of color concentrates, liquid dispersions, dry colorants and additives for customers in the plastic industry. Our Formulator operations process dispersion resins along with different additives to produce liquid or solid plastisol compounds. We also produce formulations using latex polymers.

For the fiscal year ended December 31, 2003, our Performance Plastics business segment had sales of $1.5 billion, representing 75% of our total sales. During 2003, we received $5.5 million of cash from dividends and distributions from all of our Performance Plastics business segment equity affiliates.

Included in the Performance Plastics business are three product groups: North American Plastic Compounds and Colors, International Plastic Compounds and Colors, and Formulators. Our Performance Plastics business segment has substantial and growing market positions in Europe and Asia.

North American and International Plastic Compounds and Colors:

North American and International Plastic Compounds and Colors consist of three product subgroups: vinyl compounds, colors and additives, and engineered materials.

Vinyl Compounds. Vinyl, or polyvinyl chloride, is an extremely versatile plastic. Vinyl is the only plastic that can be made thin and flexible enough for intravenous solution bags, yet rigid and tough enough for windows and computer housings. Because of this versatility, vinyl has become one of the most widely used plastics and is utilized in a wide range of applications. Our vinyl compounds combine polyvinyl chloride resins with a broad range of additives that offer product versatility, particularly when fire resistance, chemical resistance or weatherability is required. We believe we are the leading manufacturer of vinyl compounds in North America. In 2003, this product subgroup accounted for approximately 41% of our Performance Plastics business segment’s sales.

Colors and Additives. Color concentrates are plastic compounds that contain a high concentration of color pigments or additives predispersed in a polymer carrier medium and supplied in pellet, liquid, flake or powder form. Concentrates are designed for use in appropriate quantities with the base resin mix so that the correct color or additive performance is achieved. Additive concentrates include a wide variety of products, but are commonly categorized by the function performed, such as UV stabilizers, slip/antiblock, antistat, blowing agent, antioxidant, lubricant, and stabilizers.

Our color and additive concentrates provide flexibility to plastic processors who prefer to create multiple color effects or enhance the performance of their own base polymers. Our colors and additives for thermoplastics are used throughout the plastic industry, particularly in the packaging, automotive, consumer, pipe, and wire and cable industries. Our colors and additives are also incorporated into other end-use products such as stadium seating, toys, housewares, vinyl siding, pipe, food packaging, and medical packaging. In 2003, this product subgroup accounted for approximately 25% of our Performance Plastics business segment’s sales.

Engineered Materials. Our engineered materials consist of reinforced and filled compounds and thermoplastic elastomer compounds. With our compounding expertise, we have the ability to expand the performance range and structural properties of traditional engineered thermoplastics. We combine our knowledge of base polymers, lubricants, fillers and reinforcements as well as a wide range of functional additives to enable us to tailor our compounds to meet our customers’ unique application requirements. Our compounds incorporate commodity resins like polyethylene and polypropylene, engineering resins like nylon, polycarbonate and polyesters, and other high performance resins.

In addition, we have a broad product line of thermoplastic elastomer compounds, including thermoplastic olefins, thermoplastic vulcanizates and styrene block copolymers. In 2003, this product subgroup accounted for approximately 23% of our Performance Plastics business segment’s sales.

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Formulators:

Formulator products consist primarily of liquid systems with a base resin comprising of specialty polyvinyl chloride resins, or latex. We custom compound and manufacture PVC inks and powders, latex, specialty additives and colorants that meet the specific needs of our customers’ applications. Examples of applications for our formulator products include inks for textiles in the consumer industry; armrests, headrests and oil filters in the automotive industry; coil coatings, sheet vinyl and carpet backing in the construction industry; and decals, coatings and tool handles for general industry. In 2003, the Formulators product group accounted for approximately 11% of our Performance Plastics business segment’s sales.

Distribution:

PolyOne is a distributor of up to 3,500 grades of engineering and commodity resins and plastic compounds from approximately 13 major suppliers, including our own vinyl compounds. We purchase bulk quantities of plastic base resins, such as polyethylene, polypropylene, polystyrene, and polyvinyl chloride, and resell them in truckload and less-than-truckload amounts to more than 4,700 customers nationwide. Our supplier base includes several leaders in the resin business such as Atofina, Basell, BP Amoco, Bayer, Dow, DuPont, Eastman, Huntsman and Nova Chemicals. These products are sold to custom molders and extruders who convert them into plastic products sold to a number of different industries and end-use markets. We operate more than 30 stocking locations, including 10 repackaging plants, across North America that are strategically located in proximity to our customers, which provides us with a competitive advantage over other regional plastic distributors.

On January 12, 2004, the Distribution segment acquired the North American distribution business of ResinDirect LLC, a wholly owned subsidiary of Louis Dreyfus Energy Services L.P. ResinDirect North America distributes approximately 60 million pounds of commodity plastic resins annually. With this acquisition, the number of major suppliers has increased to approximately 18 and the number of customers has increased to more than 5,100.

For the fiscal year ended December 31, 2003, our Distribution business segment had sales of $529.2 million, representing 25% of our total sales.

Resin and Intermediates:

The results of our Resin and Intermediates business segment are reported on an equity income basis and consist primarily of our 24% equity interest in OxyVinyls and our 50% equity interest in SunBelt. OxyVinyls is a partnership with Occidental Chemical Corporation, and SunBelt is a partnership with Olin Corporation. OxyVinyls is North America’s second largest and the world’s third largest producer of PVC resin. In 2003, OxyVinyls had capacity of approximately 4.5 billion pounds of PVC resin, 5.0 billion pounds of vinyl chloride monomer (an intermediate chemical in the production of PVC), 580 thousand tons of chlorine and 638 thousand tons of caustic soda. Oxyvinyls’ capacities for chlorine and caustic soda exclude that of the idled Deer Park chlor-alkali plant. In 2003, SunBelt had capacity of approximately 278 thousand tons of chlorine and 305 thousand tons of caustic soda. Most of the chlorine manufactured at OxyVinyls and SunBelt is used for internal consumption by OxyVinyls in the production of PVC resin. Caustic soda is sold on the merchant market to customers in industries such as pulp and paper, chemical, construction and consumer products.

In addition to providing us with a secure and high quality supply of PVC resin, our Resin and Intermediates business segment provides us with backward integration for one of our major raw materials, PVC resin. First, our supply of PVC resin from OxyVinyls is at competitive prices based on long-term supply contracts between OxyVinyls and our businesses. Second, our equity investment in OxyVinyls provides a natural hedge against a portion of increased raw material prices to the extent OxyVinyls is able to pass on increased raw material costs to its other customers. Finally, the equity position in chlorine and caustic soda through both OxyVinyls and SunBelt provides economic integration to the chlorine chain.

For the fiscal year ended December 31, 2003, we received $23.1 million of cash from dividends, distributions and returns on investments net of new investments from all of our Resin and Intermediates business segment equity affiliates.

Competition:

The production of compounded plastics and the manufacture of custom formulated color and additives systems for the plastics industry is highly competitive, with product quality, service and price to customers being the principal factors affecting competition. PolyOne believes it is a leading independent compounder of plastics in North America and Europe and one of the leading producers of custom formulated color and additive systems in the United States and Europe.

The distribution of polymer resin is highly competitive, with product quality, service and price to customers being the principal

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factors affecting competition. In thermoplastic resin and compound distribution, we believe that we are the second largest independent thermoplastic resin distributor in North America. We compete against the General Polymers division of Ashland Distribution Company, which is the leading independent resin distributor in North America, and other smaller regional distributors. Growth in the thermoplastic resin and compound distribution market is directly correlated to growth in the market for base polymer resins.

International Operations:

Information regarding our international operations is discussed in Note S to the Consolidated Financial Statements for the fiscal year ended December 31, 2003.

Raw Materials:

In PolyOne’s Performance Plastics business segment, the primary raw materials are PVC resin, other resins, plasticizers, inorganic and organic pigments, and chemicals, all of which are in adequate supply. PolyOne is a party to long-term supply contracts with OxyVinyls, under which the majority of PolyOne’s PVC resin will be supplied. The supply contracts have initial terms that expire in 2013 and have provisions for renewal after the initial contract term. PolyOne believes the supply contracts should assure availability of PVC resin, technical development and support and competitively priced PVC resin. PolyOne further believes that the pricing under these supply contracts provides PVC resin at a competitive cost to PolyOne.

Patents and Trademarks:

PolyOne owns numerous patents and trademarks, which are important in that they protect inventions and product names against infringement by others and thereby enhance PolyOne’s position in the marketplace. The patents vary in duration up to 20 years, and the trademarks have an indefinite life that is based upon continued use.

Research and Development:

PolyOne has developed substantial research and development capability. PolyOne’s efforts are devoted to (1) developing new products to satisfy defined market needs, (2) providing quality technical services to assure the continued success of its products for its customers’ applications, (3) providing technology for improvements to its products, processes and applications, and (4) providing support to its manufacturing plants for cost reduction, productivity and quality improvement programs. PolyOne operates a research and development center that supports its compounding and specialty resins operations. The laboratory is equipped with state-of-the-art analytical, synthesis, polymer characterization and testing equipment and pilot plants and polymer compounding operations that simulate specific production processes for rapid translation of new technology into new products.

PolyOne incurred costs of $18.5 million in 2003, $15.9 million in 2002 and $15.1 million in 2001 for product research and product development. In 2004, PolyOne expects spending for product research and development to increase slightly over 2003.

Methods of Distribution:

PolyOne’s Performance Plastics and Distribution business segments sell products primarily through their direct sales personnel. The Performance Plastics business segment supplements its direct sales personnel with distributors, including PolyOne Distribution, and/or commissioned sales agents for various products and geographic areas. PolyOne’s products are transported to customers primarily via truck carriers, with some customer product pick-ups at its operating facilities in both of these business segments. In addition, PolyOne’s Performance Plastics business segment ships products to some customers via railroad cars.

Employees:

As of December 31, 2003, PolyOne had approximately 4,450 employees associated with the continuing operations. In addition, approximately 2,100 employees were associated with the discontinued operations.

Environmental, Health and Safety:

PolyOne is subject to various environmental laws and regulations concerning production, use and sale of chemicals, emissions to the air, discharges to waterways and other releases of materials into the environment; the generation, handling, storage, transportation, treatment and disposal of waste materials; or otherwise relating to the protection of the environment. PolyOne endeavors to ensure the safe and lawful operation of its facilities in manufacturing and distribution of products and believes it is in material compliance with applicable laws and regulations.

PolyOne maintains a disciplined environmental and occupational safety and health compliance program and conducts periodic internal and external regulatory audits at its domestic plants in order to identify and categorize potential environmental exposures, including compliance issues, and measures to address them. This is an effort that has required and may continue to

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require process or operational modifications and the installation of pollution control devices and cleanups. PolyOne believes it is in material compliance with applicable requirements. PolyOne incurred environmental expense of $4.1 million in 2003, $3.5 million in 2002 and $3.7 million in 2001.

PolyOne believes that compliance with current governmental regulations at all levels will not have a material adverse effect on its financial condition. However, the risk of additional costs and liabilities is inherent in certain plant operations and certain products produced at the plants, as is the case with other companies involved in the PVC industry. PolyOne cannot assure that it will not incur additional costs and liabilities in the future. Other developments, such as increasingly strict environmental, safety and health laws, regulations and related enforcement policies, discovery of unknown conditions, and claims for damages to property, persons or natural resources resulting from plant emissions or products could also result in additional costs and liabilities to PolyOne.

A number of foreign countries and domestic local communities have enacted, or have under consideration, laws and regulations relating to the use and disposal of plastic materials. Widespread adoption of these laws and regulations, along with public perception, may have an adverse impact on plastic materials. Although many of PolyOne’s major markets are in durable, longer-life applications that could reduce the impact of any such environmental regulation, PolyOne cannot assure that more stringent regulation of use and disposal of plastics would not have an adverse effect on its business.

PolyOne has been notified by federal and state environmental agencies and by private parties that it may be a potentially responsible party in connection with the investigation and remediation of several environmental waste disposal sites. While government agencies assert that potentially responsible parties are jointly and severally liable at these sites, in PolyOne’s experience, interim and final allocation of liability costs are generally made based on the relative contribution of waste. However, where such allocations of costs based on relative contribution of waste have been made, PolyOne cannot assure that its allocation will not be increased due to the failure of other relevant third parties to pay their share of such costs. In addition, PolyOne conducts investigations and remediation at several of its active and inactive facilities, and has assumed responsibility for environmental liabilities based on pre-1993 operations at sites formerly owned or operated by PolyOne or its predecessors. PolyOne believes that its potential continuing liability with respect to such sites will not have a material adverse effect on its consolidated financial position, results of operations or cash flows. In addition, PolyOne initiates corrective and preventive environmental projects of its own at its operations. Based on current information and estimates prepared by PolyOne’s environmental engineers and consultants, PolyOne, at December 31, 2003, had accruals on its Consolidated Balance Sheet totaling $54.7 million to cover probable future environmental expenditures relating to previously contaminated sites. This figure represents PolyOne’s best estimate within its range of estimated costs associated with probable remediation, based upon information and technology currently available and PolyOne’s view of the most likely remedy. Depending upon the results of future testing, the ultimate remediation alternatives undertaken, changes in regulations, new information, newly discovered conditions and other factors, it is reasonably possible that PolyOne could incur additional costs in excess of the accrued amount at December 31, 2003. However, such additional costs, if any, cannot be currently estimated. PolyOne’s estimate of the liability may be revised as new regulations or technologies are developed or additional information is obtained.

Available Information:

Our Internet address is http://www.polyone.com. PolyOne makes available, free of charge, on its Internet website its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after PolyOne electronically files such material with or furnishes it to the Securities and Exchange Commission.

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As of December 31, 2003, PolyOne, which is headquartered in Avon Lake, Ohio, operated facilities in the United States and foreign countries. Substantially all of PolyOne’s facilities are owned. During 2003, PolyOne generally made effective use of its productive capacity at its principal facilities. PolyOne believes that the quality and productive capacity of its facilities are sufficient to maintain its competitive position for the foreseeable future. The charts below list the principal facilities of PolyOne’s business segments.

Performance Plastics Facilities:

Distribution Facilities:

Resin and Intermediates Facilities:

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Discontinued operations:

Specialty Resins Facilities:

Engineered Films Facilities:

Elastomers & Performance Additives Facilities:

* Facility closed and held for sale or closure is in process.

In addition to the matters regarding the environment described in Item 1 under the heading “Environmental, Health and Safety,” PolyOne is involved in various pending or threatened claims, lawsuits and administrative proceedings, all arising from the ordinary course of business concerning commercial, product liability, employment and environmental matters, which seek remedies or damages. In addition, PolyOne has been named in several lawsuits involving multiple claimants and defendants relating to alleged asbestos exposure in the past by, among others, workers and their families at plants owned by PolyOne or its predecessors or on board ships owned or operated by PolyOne or its predecessors. PolyOne believes that any liability that may be finally determined should not have a material adverse effect on its financial condition, taken as a whole, results of operations or cash flows.

No matters were submitted to a vote of security holders during the fourth quarter of 2003.

(Included Pursuant to Instruction 3 to paragraph (b) of Item 401 of Regulation S-K)

The following table lists information, as of March 1, 2004, as to each executive officer of PolyOne, including his or her position with PolyOne as of that date and other positions held by him or her for at least the past five years. The executive officers are elected by the Board of Directors to serve one-year terms.

V. Lance Mitchell

Age: 44

Group Vice President, Global Plastics, January 2003 to date. Group Vice President, Plastic Compounds and Colors, September 1, 2000 to January 2003. Vice President and General Manager, Compounds, The Geon Company, May 1997 to August 31, 2000.

John E. Quinn

Age: 56

Vice President and General Manager, Elastomers & Performance Additives, September 1, 2000 to date. President, M.A. Hanna Rubber Compounding, May 1998 to August 31, 2000.

Michael L. Rademacher

Age: 53

Vice President and General Manager, Distribution, September 1, 2000 to date. Senior Vice President – Plastics Americas, M.A. Hanna Company, January 2000 to August 31, 2000. Vice President and General Manager, Industrial Chemical and Solvents Division, Ashland Chemical Company (chemical manufacturing and distribution), 1998 to January 2000.

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Robert M. Rosenau

Age: 49

Vice President and General Manager, North American Vinyl Compounds, January 2003 to date. General Manager, Extrusion Products, September 2000 to December 2002. General Manager, Custom Profile Compounds, The Geon Company, April 1998 to August 2000.

Wendy C. Shiba

Age: 53

Chief Legal Officer, November, 2001 to date and Vice President and Secretary, December 2001 to date. Vice President, Bowater Incorporated (pulp and paper), 1997 to November 2001, and Secretary and Assistant General Counsel, 1993 to November 2001.

Kenneth M. Smith

Age: 49

Chief Human Resources Officer, January 2003 to date and Vice President and Chief Information Officer, September 1, 2000 to date. Vice President, Information Technology, The Geon Company, May 1999 to August 31, 2000 and Chief Information Officer, August 1997 to May 1999.

Thomas A. Waltermire

Age: 54

President and Chief Executive Officer, November 6, 2003 to date. Chairman of the Board, President and Chief Executive Officer, September 1, 2000 to November 6, 2003. Chairman, The Geon Company, August 1999 to August 31, 2000, and Chief Executive Officer and President, May 1999 to August 31, 2000. President and Chief Operating Officer, The Geon Company, February 1998 to May 1999.

W. David Wilson

Age: 50

Vice President and Chief Financial Officer, September 1, 2000 to date. Vice President and Chief Financial Officer, The Geon Company, May 1997 to August 31, 2000.

PART II

The following table sets forth the amount of dividends paid and the range of the high and low sale prices for our common stock, $.01 par value per share, as reported by the New York Stock Exchange, where the shares traded under the symbol “POL” for the periods indicated.

As of March 1, 2004, there were approximately 3,350 holders of record of PolyOne’s common stock.

PolyOne paid consecutive quarterly dividends of $.0625 per share of common stock during 2002. Effective with the first quarter of 2003, PolyOne suspended payment of its quarterly dividend. Future declarations of dividends on common stock will be at the discretion of the Board of Directors, and the declaration of any dividends will depend upon, among other things, earnings, capital requirements and the Company’s financial condition. PolyOne does not anticipate paying any dividends on common stock in the foreseeable future. Additionally, the indenture governing our 10.625% senior notes due 2010 and the agreements governing our revolving credit facility and our receivables sale facility contain restrictions that limit our ability to pay dividends.

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Selected Financial Data

The historical results include the following business acquisitions from the acquisition date indicated forward: Acrol Holdings Limited from July 1, 1999; O’Sullivan Corporation from July 8, 1999; Dennis Chemical Company, Inc. from September 8, 1999; and M.A. Hanna Company from September 1, 2000. In addition, 1999 results of operations reflect the formation of Oxy Vinyls, LP on April 30, 1999, and the contribution of substantially all of Geon’s formerly consolidated Resin and Intermediates business segment operations to the partnership. In connection with this, PolyOne acquired businesses from Occidental Chemical Corporation and formed a powder compounding joint venture, all of which are included in PolyOne’s consolidated results of operations from May 1, 1999. In December 2002, PolyOne acquired Transcolor and sold its 70% ownership interest of Softer. With the sale of Softer, all its historical operating results have been reported separately as a discontinued operation. As of December 31, 2003, PolyOne’s Elastomers & Performance Additives, Specialty Resins and Engineered Films business operations qualified for accounting treatment as discontinued operations. As a result, all their historical operating results have been reported separately as discontinued operations.

Overview

PolyOne Corporation is an international polymer services company with continuing operations in thermoplastic compounds, specialty polymer formulations, color and additive systems, and thermoplastic resin distribution. Headquartered in Avon Lake, Ohio, PolyOne has employees at manufacturing sites in North America, Europe and Asia, and joint ventures in North America, South America and Asia. We provide value to our customers through our ability to link polymer technology and formulation with our manufacturing and supply chain processes. For the fiscal year ended December 31, 2003, we had sales of $2.0 billion, approximately 24% of which were from markets outside of North America.

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Discontinued Operations - As of December 31, 2003, PolyOne’s Elastomers & Performance Additives, Specialty Resins and Engineered Films businesses qualified for accounting treatment as discontinued operations. These three business operations are expected to be sold in 2004. As a result, all historical financial information of these businesses (revenues, costs and expenses, assets and liabilities, and cash flows) has been reported separately as discontinued operations. Elastomers & Performance Additives was previously reported as a separate business segment. Specialty Resins and Engineered Films were previously included in PolyOne’s Performance Plastics business segment. In December 2002, PolyOne sold its 70% interest in Softer, an Italian compounder of thermoplastic materials. As a result, all historical financial information of this business (revenues, costs and expenses, assets and liabilities, and cash flows) has been reported separately as a discontinued operation. Softer was previously included in PolyOne’s Performance Plastics business segment.

The following table summarizes the results for the businesses reported as discontinued operations:

In restating the operating results of the discontinued operations, estimated indirect costs previously allocated to the Elastomers & Performance Additives, Specialty Resins and Engineered Films business operations that are expected to be retained upon disposal of these businesses have now been included in the continuing businesses operating results. These costs, totaling $17.9 million in 2003, $22.6 million in 2002 and $20.9 million in 2001, have been allocated to the continuing business segments as follows: Performance Plastics 40%, Distribution 12% and Other 48%.

For more information regarding discontinued operations, see Note B to the Consolidated Financial Statements for the fiscal year ended December 31, 2003.

Restructuring and Consolidation Activities - Since our formation in August 2000, we have implemented several restructuring initiatives to streamline our manufacturing processes and reduce our overhead costs. As a result of such initiatives, we have incurred various employee separation and plant phaseout costs. These costs include severance, employee outplacement, external consulting, lease termination, facility closing and the writedown of the carrying value of plants and equipment. During 2003, employee separation and plant phaseout charges of $35.1 million were recorded. Of the 2003 expense, $17.7 million related to a January 2003 announcement to reduce approximately 400 staff personnel. The costs were for employee separation, which consisted of severance and other employee benefits. In June 2003, the decision was made to close the Fort Worth, Texas color additives plant, for which an expense of $3.6 million was recorded. During 2003, PolyOne adjusted its estimate for the remaining liabilities associated with restructuring initiatives announced in prior years. As a result of the adjustment, net reserves of $2.1 million were reversed and included in “employee separation and plant phase-out” on the Consolidated Statements of Operations. During the third and fourth quarters of 2003, PolyOne closed two leased Ohio administrative offices, closed a portion of the Mexico Distribution business, reduced manufacturing personnel in the North American plastics businesses and reduced additional administrative positions in North America. The impact of these closures and reductions was to reduce operating income by $15.9 million and terminate approximately 200 employees. Approximately 400 employees remain to be terminated in association with all restructuring initiatives announced in 2003. See Note S to the Consolidated Financial Statements for the fiscal year ended December 31, 2003 for the breakdown of these charges by segment for continuing operations.

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During 2002, employee separation and plant phaseout charges of $1.1 million were recorded for costs associated with the consolidation of certain activities related to the Formulator operations in the Performance Plastics segment. The costs were for employee separation, which consisted of severance and other employee benefits. All 43 employees were terminated in 2002.

During 2001, operating income for the Performance Plastics segment was reduced by charges of $30.4 million for costs associated with integration efforts and programs to update North American manufacturing. The costs included $19.1 million for employee separation, $2.1 million for cash plant closing and $9.2 million to write down the carrying value of plant and equipment. Employee separation consisted of severance and other related employee benefits, and included the projected termination of approximately 400 employees.

Status of Pension Plans - Our pension plans were generally under-funded at December 31, 2003 and 2002. At December 31, 2003, PolyOne had a minimum pension adjustment, net of tax, of $110.9 million. This balance will decrease in future periods if interest rates increase, investment results improve, or contributions cause the pension plans to return to fully-funded status.

As a result of the under-funded status of the pension plans at year-end 2003 and a reduction in the discount rate, non-cash pension expense is estimated to be approximately $1 million pre-tax higher in 2004 than in 2003. For 2004, total non-cash pension expense is expected to be approximately $24 million pre-tax.

Outlook – We anticipate improved market conditions in 2004 compared to 2003. U.S. industrial production is projected to increase approximately 4% versus 2003 as contrasted with the generally flat level seen in 2003 versus 2002. Housing starts are projected to remain strong at 1.7 million units, although down about 4% from 2003. North American automobile and light truck build rates are projected to increase moderately to 16.7 million units, but build rates at the “Big Three” domestic manufacturers are projected to decline 1% to 2%. As the economy recovers, we expect that the loss of North American business to Asia will become more evident and continue to be a factor. Our view is that plastics growth in North America will trend in the 2.5% to 3.5% level in 2004, whereas in the late 1990s the expectations were in the range of 3.5% to 5% per year.

Europe is currently witnessing a similar strengthening and projections are for industry growth rates recovering to 2% versus less than 1% in 2003. Asian business has largely recovered from the market activity-dampening SARS issues and is projecting industrial growth of 7% to 8% in 2004 compared to 2003. Plastics annual growth in China is expected to average 12% to 15% for the next five years.

The improvement we anticipate in 2004 market conditions is expected to be sequential by quarter, continuing the market-strengthening trend we saw from August through October, which provides a degree of optimism for positive momentum entering 2004. Fourth quarter 2003 shipment volumes increased 5% over the fourth quarter of 2002 in the Performance Plastics business segment and 1% in the Distribution business segment, with 6% growth in Distribution shipment volumes in the United States and Canada. After a normal seasonal year-end slowdown, demand in January 2004 returned to September and October 2003 levels for most businesses and geographic regions.

Price trends for key raw materials are mixed. Energy and derivative hydrocarbon feedstock pricing is expected to moderate compared to 2003. Chlorine and PVC resin, however, are projected to increase modestly, pressuring margins on our downstream vinyl compounding businesses. Resin and Intermediates, on the other hand, is expected to benefit from these trends and earnings are expected to increase in this business segment. Further pressure on vinyl compound margins is anticipated as a result of additional domestic production capacity. We also anticipate upward pressure on non-resin raw materials as market conditions improve. This resulting pressure on margins is expected to be offset by the full-year impact of 2003 cost reduction and restructuring initiatives, new initiatives in 2004 to continue simplifying processes and eliminating non-value added work and ongoing raw material savings programs.

Management actions in 2004 will also be focused on strengthening our market positions. We are targeting market share gains by helping customers be more competitive on a global basis through an expanded international presence and by commercializing new technologies.

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Results of Operations

Consolidated Results

Year to year changes in sales and segment operating income (loss) are discussed within the “Business Segment Information” section that follows.

Employee separation and plant phaseout - We recorded costs for severance, employee outplacement, external outplacement consulting, facility closing costs and the write-down of the carrying value of plants and equipment related to restructuring initiatives in each of the last three years. These costs are discussed in detail above and in Notes E and F to the Consolidated Financial Statements for the fiscal year ended December 31, 2003.

Period plant phaseout costs incurred - These are plant phaseout costs associated with the 2001 Geon restructuring initiatives that were recognized as period costs versus when the restructuring initiative was approved. In connection with the acquisition of Hanna and resulting formation of PolyOne, management developed several initiatives to capture the strategic value of the combined former Geon and former Hanna businesses. This resulted in several announcements in 2001 that former Geon plants and Hanna plants would be closed. The initiatives also included the termination of corporate and other positions at former Geon and Hanna locations. The 2003 charge is for the write-off of inventory and receivables as a result of the decision to exit a portion of the Mexico Distribution business.

Merger and integration costs - These costs primarily represented executive separation costs for two key former Geon executives incurred as a result of the change-in-control associated with the formation of PolyOne.

Asset impairments and loss on divestiture of equity investment - A non-cash impairment charge was recorded to adjust the 2003 year-end carrying value of deferred product technology, customer list, note receivable and internet investments to their estimated realizable future cash flows. For 2002, this charge included the first quarter loss of $1.5 million on our divestiture of our 37.4% investment in the PVC resin operations of Australian Vinyls Corporation and the fourth quarter impairment loss of $3.6 million on the sale of our equity investment in Techmer PM, LLC. For 2001, PolyOne recognized an investment impairment charge of $9.5 million, including a $4.9 million translation loss, in connection with the sale of Australian Vinyls Corporation.

Equity investment restructuring and plant idling costs and cumulative effect of a change in accounting - The 2003 expense relates to employee severance costs associated with personnel reductions undertaken by OxyVinyls in the second quarter. In addition, the 2003 expense includes a charge for the cumulative effect of a change in accounting upon OxyVinyls’ adoption of Statement of Financial Accounting Standards (SFAS) No. 143, “Accounting for Asset Retirement Obligations.” The 2002 costs include PolyOne’s share of OxyVinyls’ employee severance, plant phase-out costs and liabilities associated with the temporary idling of a plant in December 2001 and the asset write-off and decommissioning costs related to the permanent closure of a portion of a plant in 2002.

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Interest expense - Interest expense in 2003 of $66.6 million was $24.2 million higher than in 2002. This increase is primarily due to the issuance of $300 million of 10.625% unsecured senior notes in the second quarter of 2003 and the issuance of $200 million of 8.875% unsecured senior notes. Interest expense in 2002 of $42.4 million was $1.8 million higher than in 2001. Impacting 2002 interest expense was the second quarter issuance of $200 million of 8.875% unsecured senior notes in the second quarter of 2002. This was partially offset by the favorable impact of interest rate swap agreements and lower average borrowings outstanding under the revolving credit facility in 2002 compared to 2001.

Other expense, net - Other expense, net, includes finance costs associated with the receivables sale facility, foreign currency gains and losses and other miscellaneous expenses. The following table summarizes the major components of other expense, net for 2003, 2002 and 2001.

Income taxes - Income tax expense in 2003 was $12.3 million on a consolidated pre-tax loss from continuing operations of $83.0 million. The income tax expense was related to foreign earnings. Tax expense in 2003 related to continuing operations included a $24.0 million expense related to dividends from foreign subsidiaries and a $19.7 million tax allowance to reduce the U.S. net deferred income tax assets resulting from the 2003 operating loss carry-forwards. Excluding the above items, the effective income tax rate benefit for continuing operations was 37.8%. For 2002, the effective income tax rate benefit on comparable income from continuing operations was 43.1%. Income tax in 2002 was a benefit of $19.2 million on a consolidated pre-tax loss from continuing operations of $44.5 million. The effective income tax rate benefit in 2002 was 43.1% compared with a benefit of 39.4% in 2001. The income tax rate (benefit) for financial reporting purposes varied from the federal statutory rate as follows:

See Note Q to the Consolidated Financial Statements for the fiscal year ended December 31, 2003 for further detail.

Income (loss) from discontinued operations and loss on sale, net of income taxes - The loss from discontinued operations and loss on sale, net of income taxes, was $155.8 million in 2003 compared to income from discontinued operations and loss on sale, net of income taxes, of $20.1 million in 2002. Included in the 2003 loss was a $130.5 million pre-tax charge for impairment of net assets held for sale, a $30.6 million pre-tax charge for employee separation and plant phase-out costs primarily related to the closures of the Burlington, New Jersey, Wynne, Arkansas and DeForest, Wisconsin manufacturing plants and an income tax provision of $1.4 million. Included in 2002 income was a $0.6 million pre-tax charge for employee separation and plant phase-out costs and a $15.4 million income tax provision. Sales from the Elastomers & Performance Additives, Specialty Resins and Engineered Films businesses included in discontinued operations totaled $571.0 million in 2003 compared to $606.7 million in 2002. In addition, sales from the Softer business were $70.0 million in 2002.

Income from discontinued operations and loss on sale, net of income taxes, was $20.1 million in 2002 compared to $13.1 million in 2001. Included in 2002 income was a $0.6 million pre-tax charge for employee separation and plant phase-out costs and a $15.4 million income tax provision. Included in 2001 income was a $6.0 million pre-tax charge for employee separation and plant phase-out costs, merger and integration costs and period costs of closed facilities, $2.0 million of other income and a $13.0 million income tax provision. Sales from the Elastomers & Performance Additives, Specialty Resins and Engineered Films businesses included in discontinued operations totaled $606.7 million in 2002 compared to $647.4 million in 2001. In addition, sales from the

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Softer business were $70.0 million in 2002 compared to $73.5 million in 2001.

Cumulative effect of a change in accounting, net of income taxes - Effective January 1, 2002, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” In accordance with this statement, we ceased amortizing all goodwill and indefinite-lived intangible assets as of January 1, 2002. During the first quarter of 2002, we also completed the transitional review for goodwill impairment required under SFAS No. 142. The review indicated that goodwill related to the 1999 acquisition of our Engineered Films operation was impaired as of January 1, 2002. As a result we recognized a pre-tax charge of $54.7 million ($53.7 million after a tax benefit of $1.0 million) as a cumulative effect of a change in accounting principle.

Business Segment Information

Senior management uses segment operating income, which excludes special items, to assess performance and allocate resources to business segments. The following table reconciles operating income (loss) to segment operating income (loss). Senior management uses segment operating income when evaluating the results of operations of the business segments because senior management believes this measure is useful in understanding current profitability levels and how current levels may serve as a base for future performance. In addition, segment operating income is a component of the PolyOne Annual Incentive Plan at the corporate and business segment levels. Segment operating income may not be comparable to financial performance measures presented by other companies.

Special items include charges related to specific strategic initiatives such as the consolidation of operations, restructuring activities such as employee separation costs resulting from personnel reduction programs, plant closure and phase-out costs, merger and integration costs, asset impairments and gains and losses on the divestiture of joint ventures and equity investments.

2003 Compared with 2002

Performance Plastics had 2003 sales of $1,556.1 million, an increase of $80.2 million, or 5%, from 2002. A breakdown of 2003 segment sales, by primary product group, is as follows:

North American Vinyl Compounds’ volume decline was the result primarily of slower demand in the wire and cable, custom profile and packaging markets. Higher average selling prices, which were the result of efforts to recapture raw material cost increases, helped to offset the volume decline, bringing sales to

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slightly above 2002 levels. Although Colors and Additives volumes were flat compared to the prior year, sales were lower as a result of a shift in product mix towards more general-purpose products. Engineered Materials volumes and sales were down from lower demand in automotive end-market applications combined with a key customer taking its compounding production back in-house. International Plastic Compounds and Colors volumes were up due to the Transcolor acquisition and stronger demand in Asia. Favorable currency exchange rates increased sales by $50.7 million and the Transcolor acquisition added $45.0 million in sales. Formulators volume and sales declines were the result of the contribution of the former urethanes product line to the 50% BayOne equity joint venture formed in June 2003 for which PolyOne no longer separately reports sales, combined with a key customer having lost share in its end market.

Performance Plastic’s segment operating income was $34.5 million in 2003, an increase of $2.6 million from 2002. Even though volume was down by 1% from 2002, favorable currency translation added approximately $5.4 million to earnings. This was partially offset by higher raw material costs that were not fully recovered by higher selling prices. Margin compression was the most severe in the North American Vinyl Compounds product group, particularly in the first half of 2003. Also contributing to improved segment earnings were lower costs as a result of manufacturing, selling and administrative restructuring initiatives.

Distribution had 2003 sales of $529.2 million, an increase of $9.5 million, or 2% from 2002. Shipment volumes declined by 5% from 2002. Sales were up 6% in the United States and Canada due to stronger demand for engineering resins and PolyOne produced vinyl compounds. Mexico sales and volumes were down by approximately 50% due to a decision to exit a portion of the business and export from the United States.

Distribution’s segment operating income was $9.1 million in 2003, an increase of $4.8 million from 2002 due to increased sales and cost savings from the closure of a significant portion of the Mexico Distribution operation.

Resin and Intermediates operating income was $24.0 million, an increase of $13.4 million from 2002. The improvement resulted from higher SunBelt earnings of $15.0 million that were partially offset by lower OxyVinyls earnings of $2.2 million. For 2003 versus 2002, the average industry selling price for chlorine increased by approximately $69 per ton and caustic soda increased by approximately $50 per ton. OxyVinyls earnings decreased in 2003 from 2002 primarily due to higher average natural gas costs of approximately $1.90 per million BTU, largely offset by higher chlor-alkali earnings driven by the higher industry average selling prices of chlorine and caustic soda. Average industry spreads of PVC selling prices over ethylene and chlorine costs were marginally higher.

“Other” consisted primarily of corporate governance costs that are not allocated to business segments and inter-segment sales and profit eliminations. The loss in 2003 was $23.8 million compared with a loss of $28.4 million in 2002. The 2002 loss also includes the elimination of a $1.1 million pre-tax inter-segment profit in the Distribution business segment’s inventories related to PolyOne vinyl compounds.

2002 Compared with 2001

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Performance Plastics had 2002 sales of $1,475.9 million, a decrease of $43.5 million, or 3% from 2001. A breakdown of 2002 segment sales, by primary product group, is as follows:

The decline in total Performance Plastics sales was the result of lower sales in North American Plastic Compounds and Colors, partially offset by strong demand in Asia and a favorable Euro currency exchange impact, which increased U.S. dollar reported sales by $15.9 million. North American Plastic Compounds and Colors experienced softer demand in nearly all markets for vinyl, in addition to lower average selling prices compared to 2001. Vinyl compound volumes declined 5% while sales revenue declined 8% during 2002, with the most notable decline in wire and cable applications. Colors and Additives volumes declined 29% and sales revenues declined 19%, while Engineered Materials volumes improved 10% and sales revenues improved 4%. Contributing to lower 2002 sales in North American Plastic Compounds and Colors was some loss in market share in the North American color and additive concentrate and vinyl compound markets that resulted from competitors taking business at lower selling prices for which we chose not to compete, combined with some customers taking the production of these products in-house.

Performance Plastic’s segment operating income was $31.9 million in 2002, a decrease of $14.2 million from 2001, reflecting lower segment sales and lower vinyl compound margins, partially offset by the positive impact of cost reduction programs and restructuring initiatives, which included closing seven production facilities within the Performance Plastics business segment.

Distribution had 2002 sales of $519.7 million, an increase of $57.1 million, or 12%, from 2001. The improvement in sales resulted largely from using our Distribution business segment for smaller volume sales of PolyOne vinyl compounds instead of using a third-party distributor.

Distribution’s segment operating income was $4.3 million in 2002, an increase of $7.2 million from 2001 due to increased sales volumes and improved selling price spreads over material costs. In 2002, the Distribution segment began representing PolyOne’s vinyl compounds in the market place.

Resin and Intermediates operating income was $10.6 million, an increase of $23.2 million from 2001. This improvement was primarily the result of higher OxyVinyls earnings of $25.2 million. Average industry PVC resin market selling prices were approximately $0.015 per pound higher in 2002 compared to 2001, with the average industry resin spread over raw material costs increasing by a similar amount as lower ethylene costs offset higher chlorine costs. In addition, OxyVinyls’ earnings were reduced by lower average industry caustic soda selling prices of approximately $120 per ton, while lower average natural gas costs of approximately $1 per million BTU added to earnings.

“Other” consisted primarily of corporate governance costs that are not allocated to business segments and inter-segment sales and profit eliminations. The loss in 2002 was $28.4 million compared with a loss of $26.6 million in 2001.

Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires PolyOne’s management to make estimates, judgments and assumptions in certain circumstances that affect amounts reported in the accompanying Consolidated Financial Statements. PolyOne evaluates the accounting policies and estimates it uses to prepare financial statements on an ongoing basis. PolyOne bases its estimates on historical experience and assumptions believed to be reasonable under certain facts and circumstances. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements related to the accounting policies and estimates described in the text that follows. The application of these critical accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. For additional information regarding our accounting policies, see Note C to the Consolidated Financial Statements for the fiscal year ended December 31, 2003.

Environmental Accrued Liability - PolyOne has accrued $54.7 million to cover future environmental remediation expenditures, and believes that none of these matters, either in - -

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dividually or in the aggregate, will have a material adverse effect on its capital expenditures, consolidated financial condition, results of operations or cash flow. The accrual represents PolyOne’s best estimate of the remaining probable remediation costs, net of estimated insurance recoveries, based upon information and technology currently available. PolyOne’s estimate of the liability may be revised as new regulations or technologies are developed or additional information is obtained. For additional information regarding the environmental accrued liability, see Note O to the Consolidated Financial Statements for the fiscal year ended December 31, 2003.

Restructuring Accruals - PolyOne has recorded accruals in connection with restructuring its businesses, as well as the integration of acquired businesses. These accruals include estimates principally related to employee separation costs, the closure and/or consolidation of facilities, contractual obligations and the valuation of certain assets including property, plant and equipment, and inventories. Actual amounts could differ from the original estimates.

Restructuring-related accruals are reviewed on a quarterly basis and changes to the initial plans are appropriately recognized when identified. Changes to plans associated with the restructuring of existing businesses are generally recognized as employee separation and plant phaseout costs in the period the change occurs. Under EITF 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination,” changes to plans associated with the integration of an acquired business are recognized as an adjustment to the acquired business’ original purchase price (goodwill) if recorded within one year of the acquisition. After one year, a reduction of goodwill is recorded if the actual costs incurred are less than the original reserve. More than one year subsequent to an acquisition, if the actual costs incurred exceed the original reserve, the excess is recognized as an employee separation and plant phaseout cost. In January 2003, PolyOne refined the original 2001 plan and decided to continue operating one facility. Accordingly, in the first quarter of 2003, the related reserve of approximately $0.3 million associated with this facility, which related to an acquired business, was reversed and recognized as a reduction to goodwill of the acquired business. Also, during 2003, PolyOne adjusted its estimate of the remaining liabilities associated with the consolidation of Geon and Hanna. As a result of the adjustment, net expense of $2.1 million was recorded and included in “employee separation and plant phase-out” on the Consolidated Statements of Operations.

As of December 31, 2003, PolyOne had an accrued liability of $20.9 million for future estimated employee severance and plant closing costs. This liability related to remaining expected expenditures resulting from current year and prior year restructuring initiatives. During 2003, the liability was increased by $63.6 million, of which $28.5 million related to discontinued operations and was reported as a component of the total loss from discontinued operations. The liabilities for employee separation and plant phaseout for the businesses reported as discontinued operations will be retained by PolyOne upon the sale of these businesses. For additional discussion, refer to Notes E and F to the Consolidated Financial Statements for the fiscal year ended December 31, 2003.

Equity Investment - In December 2001, OxyVinyls, of which PolyOne owns a 24% interest, announced the temporary idling of its Deer Park, Texas, chlor-alkali plant due to low industry capacity utilization and low product market selling prices. As of December 31, 2001, OxyVinyls had accrued $13.8 million for future employee severance and liabilities associated with the temporary idling of the Deer Park plant. In 2002, OxyVinyls recognized an additional $2.2 million of expense associated with the temporary plant idling, plus an additional expense of $17.0 million in the third quarter related to the permanent closing of specific production assets included in the idled plant. The permanent closing costs included $14.5 million for the impairment of the fixed assets as well as $2.5 million for decommissioning costs. As of December 31, 2003, OxyVinyls had fully utilized the accrual for future employee severance liabilities and decommissioning costs. The plant had a net property carrying value by OxyVinyls at the end of 2003 of approximately $117.1 million, which is anticipated to be realized through future operations upon restarting the plant. OxyVinyls will maintain the Deer Park chlor-alkali plant in a standby mode pending further strengthening in overall economic conditions and improved demand for caustic soda resulting in improved margins.

Goodwill - As of December 31, 2003, PolyOne had $334.0 million of goodwill resulting from the acquisition of businesses. Effective January 1, 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” under which goodwill is no longer amortized but is tested for impairment annually (PolyOne has selected July 1), or more often, if an event or circumstance indicates that an impairment loss may have occurred. In making goodwill impairment assessments, we compare the fair value of each of our reporting units with the reporting unit’s carrying value. If the fair value of the reporting unit exceeds its carrying value, goodwill is considered not to be impaired. If the

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carrying value of a reporting unit exceeds its fair value, an impairment loss is measured and recognized.

PolyOne uses the combination of two valuation methodologies, a market approach and an income approach, to estimate the fair value of its reporting units. Absent fair value from a potential buyer or similar specific transactions, we believe the use of the two methodologies provides reasonable estimates of a reporting unit’s fair value. A reporting unit’s fair value computed by these two methodologies is derived using a number of factors such as projected future operating results and business plans, economic projections, anticipated future cash flows, marketplace data of comparable companies or near comparable companies from within a consistent industry grouping, and cost of capital. There are inherent uncertainties related to these factors and to management’s judgment when applied to the analysis of goodwill impairment. Accordingly, management believes the combination of these methodologies provides a reasonable approach by which to estimate the fair value of its reporting units. No assumptions or estimates differed between the two methodologies as of any valuation date for each reporting unit.

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. Management believes the use of this approach is appropriate because as it provides a fair value estimate using multiples from entities with operations and economic characteristics comparable to our reporting units. The key estimates and assumptions used in determining fair value under the market approach include (a) the use of projected future results and (b) a control premium applied to the market multiples to adjust the enterprise value upward for a 100% ownership interest. Projected future results for the next twelve months are utilized due to the forward-looking nature of the market-related multiples. Projected future results are based upon management’s estimates, which take into account projected economic and market conditions and the reporting unit’s business plans.

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. Management believes the use of this approach is appropriate because it provides a fair value estimate based upon the reporting unit’s expected long-term operating performance. This approach also mitigates most of the impact of cyclical downturns that occur in the reporting unit’s industry. The income approach is based on a reporting unit’s five to ten year projection of operating results and cash flows and is discounted using a weighted-average cost of capital calculated for the reporting unit’s industry. The projection is based upon management’s estimates of projected economic and market conditions over the five to ten year period including growth rates, estimates of future expected changes in operating margins and cash expenditures. Other significant estimates and assumptions used for the debt-free cash flow model include terminal value growth rates, terminal value margin rates, future capital expenditures and changes in future working capital requirements based on projected management plans.

We determined that goodwill was not impaired as of the annual assessment performed as of July 1, 2003 or the interim assessment performed as of December 31, 2003. However, the 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 performing another assessment prior to the required July 1, 2004 annual assessment. These types of events and the resulting analysis could result in future additional charges against earnings for goodwill write-offs or other asset impairments. Any future goodwill impairment would have no impact on PolyOne’s required financial ratios under the receivable sale facility and the revolving credit facility. However, the available borrowings under the revolving credit facility would effectively be reduced by 10% of any after-tax impairment write-off.

PolyOne performed a goodwill impairment assessment as of December 31, 2003 on its Plastic Compounds and Colors reporting unit and on its Formulators reporting unit. The average fair values of the market approach and the income approach exceeded the carrying value of these reporting units by 47% for the Plastic Compounds and Colors reporting unit and by 15% 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 13% for the Plastic Compounds and Colors reporting unit and by 8% for the Formulators reporting unit.

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The following is a summary of the key estimates used in preparing these valuations under the income and market approaches:

We did recognize an impairment charge at December 31, 2003 as a result of the determination to report three non-core businesses as discontinued operations as announced on January 15, 2004. The net assets of these businesses held for sale were reduced to their estimated future net proceeds. For additional details regarding these charges, see Note B to the Consolidated Financial Statements for the fiscal year ended December 31, 2003.

Income Taxes - Estimates of full year taxable income of the various legal entities and jurisdictions are used in the tax rate calculation, which change throughout the year. Management uses judgment in estimating what the income will be for the year. Because judgment is involved, there is risk that the tax rate may significantly increase or decrease in any period.

In determining income (loss) for financial statement purposes, we must make certain estimates and judgments. These estimates and judgments occur in the calculation of certain tax liabilities and in the determination of the recoverability of certain of the deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenue and expense. SFAS No. 109, “Accounting for Income Taxes,” also requires that the deferred tax assets be reduced by a valuation allowance, if based on the weight of available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods.

In evaluating our ability to recover our deferred tax assets we consider all available positive and negative evidence including our past operating results, the existence of cumulative losses in the most recent fiscal years and our forecast of future taxable income. In estimating future taxable income, we develop assumptions including the amount of future state, federal and international pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses.

We intend to maintain this valuation allowance until it is more likely than not the deferred tax assets will be realized. Our income tax expense recorded in the future will be reduced to the extent of offsetting decreases in our valuation allowance. The realization of our remaining deferred tax assets is primarily dependent on forecasted future taxable income. Any reduction in estimated forecasted future taxable income including but not limited to any future restructuring activities may require that we record an additional valuation allowance against our deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in such period and could have a significant impact on our future earnings.

In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations in a multitude of jurisdictions. We recognize potential liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. If payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary. If our estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result.

Pensions and Post-retirement Benefits - Included in our results of operations are significant pension and post-retirement benefit costs, which are measured using actuarial valuations. Inherent in these valuations are key assumptions, including

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assumptions about discount rates and expected returns on plan assets. These assumptions are updated at the beginning of each fiscal year. We are required to consider current market conditions, including changes in interest rates, in making these assumptions. Changes in the related pension and post-retirement benefit costs may occur in the future due to changes in the assumptions. Our net pension and post-retirement benefit cost was approximately $36 million, $25 million and $20 million during fiscal 2003, 2002 and 2001, respectively, excluding the impact of restructuring actions. The increase in net pension and post-retirement expense during fiscal 2003 was primarily a result of lower plan assets, a reduction in the discount rate from 7.25% to 6.75%, and a reduction in the expected return on plan assets from 9.0% to 8.75%.

To develop our discount rate, we considered the available yields on high-quality fixed-income investments with maturities corresponding to our benefit obligations. To develop our expected return on plan assets, we also considered the historical long-term asset return experience, the expected investment portfolio mix of plan assets and an estimate of long-term investment returns. To develop our expected portfolio mix of plan assets, we considered the duration of the plan liabilities and gave more weight to equity positions, including public and private equity investments and real estate, than to fixed-income securities. Holding all other assumptions constant, a 0.5 percentage point increase or decrease in the discount rate would have decreased or increased the fiscal 2003 net pension and post-retirement expense by approximately $2.8 million. Likewise, a 0.5 percentage point increase or decrease in the expected return on plan assets would have increased or decreased the fiscal 2003 net pension cost by approximately $1.3 million.

Market conditions and interest rates significantly affect the future assets and liabilities of our pension and post-retirement plans. It is difficult to predict these factors due to highly volatile market conditions. Holding all other assumptions constant, a 0.5 percentage point decrease or increase in the discount rate would have increased or decreased the minimum pension liability by approximately $25 million as of December 31, 2003.

The rate of increase in medical costs over the next five years was increased in 2003 to reflect both actual experience and projected expectations. The health care cost trend rate assumption has a significant effect on the amounts reported. Employees hired after December 31, 1999 are not eligible to participate in the post-retirement plan.

Contingencies - PolyOne is subject to various investigations, claims, and legal and administrative proceedings covering a wide range of matters that arise in the ordinary course of business activities. Any liability that may result from these proceedings, and any liability that is judged to be probable and estimable, has been accrued. Any potential liability not accrued is not currently expected to have a material adverse effect on PolyOne’s future financial position, results of operations or cash flows.

Stock Options Granted to Employees - In December 2002, SFAS No. 148, “Accounting for Stock-Based Compensation –  Transition and Disclosure,” was issued by the Financial Accounting Standards Board. SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition when a company voluntarily changes to the fair value based method of recognizing expense in the income statement for stock-based employee compensation, including stock options granted to the employees. As allowed by SFAS No. 123, PolyOne adopted the disclosure-only provisions of the standard and does not recognize expense for stock options granted to employees.

Cash Flows

Cash used by operating activities for continuing operations in 2003 was $176.0 million compared with $64.8 million in 2002. The loss from continuing operations was $95.3 million, of which $51.4 million represented depreciation and amortization compared with the loss from continuing operations of $25.3 million in 2002, of which $51.0 million represented depreciation and amortization. In 2003, the amount of receivables sold under the receivables sale facility declined by $89.2 million from 2002 compared with a decline of $57.6 million in 2002 from 2001. Additionally in 2003, accounts receivable declined $2.2 million, first-in, first-out (FIFO) inventories declined $24.3 million and accounts payable declined $31.3 million. For 2002, accounts receivable declined $8.5 million, FIFO inventories increased $5.6 million and accounts payable declined $47.6 million. Accrued expenses and other declined $20.0 million in 2003 compared with an increase of $38.1 million in 2002. Cash payments for employee separation and plant phase-out activities were $43.5 million in 2003 and $17.0 million in 2002.

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Cash used by investing activities for continuing operations was $12.9 million in 2003 and $68.5 million in 2002. Capital expenditures in 2003 totaled $28.7 million and were $65.0 million in 2002. Cash spent for businesses acquired, net of cash received, totaled $15.8 million in 2003 compared with $11.4 million in 2002. Cash proceeds from the sale of assets in 2003 were $27.7 million, primarily from the sale of our 51% interest in Techmer PM, LLC. Cash proceeds from the sale of assets in 2002 were $14.7 million, primarily from the sale of our 70% interest in Softer. In 2003, we received $3.9 million from an equity investment, compared with cash provided to the equity investment of $6.8 million in 2002.

Cash provided by financing activities for continuing operations was $189.0 million in 2003, primarily reflecting the issuance of $300 million of 10.625% unsecured notes, partially offset by the maturity of $87.8 million of 9.375% senior notes in September 2003. Cash provided by financing activities was $131.5 million in 2002 primarily reflecting the issuance of $200 million of 8.875% senior notes, partially offset by the funds used to repay a loan held by one of our German subsidiaries. Cash paid for financing costs in 2003 was $15.0 million compared with $4.9 million in 2002. Additionally, dividends of $22.7 million were paid in 2002 and net proceeds of $7.0 million were received from the exercise of stock options. In 2003, no dividends were paid and no stock options were exercised.

Cash provided by discontinued operations was $4.2 million in 2003 compared to $28.3 million in 2002. The main driver of the $24.1 million decline in 2003 compared to 2002 was lower profitability from a 6% decline in sales combined with higher material costs that were not fully recaptured in selling price increases. Net changes in assets, including accounts receivables, inventories, accounts payable and accrued expenses and other, were a use of cash of $13.4 million in 2003 compared with a use of cash of $4.6 million in 2002. Additionally, capital expenditures for discontinued operations were $6.1 million in 2003 compared with $10.1 million in 2002.

Capital Resources and Liquidity

As of December 31, 2003, PolyOne had existing facilities to access available capital resources (receivables sale facility, secured revolving credit facility, uncommitted short-term credit lines and senior unsecured notes and debentures) totaling approximately $950.7 million. As of December 31, 2003, PolyOne had utilized $855.2 million of these facilities and approximately $95.5 million was available to be drawn while remaining in compliance with all facilities. The following table summarizes available and outstanding facilities at December 31, 2003:

On May 6, 2003, PolyOne completed a debt refinancing. The refinancing provided liquidity and the funds to repay senior debt that matured in September 2003 and to support normal operations and fund restructuring initiatives intended to improve earnings. As part of this comprehensive refinancing, we issued $300 million of 10.625% unsecured senior notes, entered into a new three-year $225 million receivables sale facility, and amended and restated the revolving credit facility. The 10.625% unsecured senior notes rank equally with all other senior unsecured indebtedness. Proceeds from the issuance of the senior notes were used to repay the senior notes that matured in September 2003, to pay off the borrowings on the revolving credit facility and to pay down the amounts borrowed under the receivables sale facility. The new receivables sale facility replaced the former receivables sale facility. The security that had been extended in February 2003 to senior notes and debentures and our guarantee of the SunBelt notes terminated as part of the debt refinancing. Security was granted under the terms of the 2003 amended and restated revolving credit agreement. As of December 31, 2003, PolyOne’s secured borrowings were not at levels that would trigger the security on the indentures governing our notes and debentures or our guarantee of the SunBelt notes.

In connection with the formation of OxyVinyls, PolyOne had guaranteed $42.3 million of OxyVinyls’ borrowings from Occidental Petroleum Corporation. This guarantee terminated effective June 30, 2003.

Long-term Debt - At December 31, 2003, we had long-term debt of $783.4 million, with maturities ranging from 2004 to 2015. See Note H to the Consolidated Financial Statements for the fiscal year ended December 31, 2003 for further information on our debt. Current maturities of long-term debt at December 31, 2003 were $26.3 million.

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Revolving Credit Facility - As noted above, on May 6, 2003, PolyOne amended and restated its revolving credit facility. As amended and restated, it has a three-year term and provides for up to $50.0 million in borrowings. However, the maximum amount that may be borrowed under the revolving credit facility is limited to an amount equal to 95% of the amount that may be borrowed and secured without triggering the security provisions of the indentures governing the existing senior unsecured notes and debentures and our guarantee of the SunBelt notes. The revolving credit facility was further amended on September 25, 2003 to limit any additional borrowings under the facility unless, after giving effect to the borrowing, the interest coverage ratio as defined and calculated under the agreement would not be less than 1 and the borrowed debt-to-adjusted EBITDA ratio as defined and calculated under the agreement would be not more than 4.75. The revolving credit facility makes available up to $35.0 million for the issuance of standby letters of credit. Obligations under the revolving credit facility are secured by substantially all of the Company’s domestic intellectual property and inventory and some of the Company’s domestic real property.

As of December 31, 2003, PolyOne had not drawn on the revolving credit facility, although the facility served as a back-up facility for $16.8 million of outstanding letters of credit and for $7.1 million of loan guarantees, the majority of which related to its 50% Colombian equity joint venture.

PolyOne’s revolving credit facility requires PolyOne to, among other things, maintain certain interest coverage and borrowed debt-to-adjusted EBITDA earnings ratios. Further, the financing arrangements limit payments for purposes such as capital expenditures, acquisitions and dividends. On September 25, 2003, the required financial ratios in the financing arrangements were amended. The following table summarizes the current defined financial covenant ratios for the fourth quarter of 2003 and each quarter in 2004 under the revolving credit facility:

Receivables Sale Facility - On May 6, 2003, PolyOne terminated its former receivables sale facility and entered into a new receivables sale facility. Under the terms of the agreement governing the new facility, the Company is allowed to sell accounts receivable and realize proceeds of up to $225.0 million. However, the maximum amount of proceeds that may be received is limited to 85% of the amount of eligible domestic accounts receivable sold. The new receivables sale facility also makes available up to $50.0 million for the issuance of standby letters of credit, of which $9.0 million was used at December 31, 2003. Although the former receivables sale facility contained a provision that would allow the purchasers of the accounts receivable to terminate the facility if our senior debt ratings fell below specified levels, the new receivables sale facility does not contain any credit ratings provision. The amount of eligible receivables available to be sold under the receivables sale facility will be impacted upon divestment of any or all of the businesses currently held for sale as each of the businesses currently has accounts receivable sold under the receivables sale facility.

On September 25, 2003, PolyOne amended the receivables sale facility to adjust interest coverage ratio requirements. The interest coverage ratio requirements noted earlier for the revolving credit facility also apply to the receivables sale facility.

Of the capital resource facilities available to PolyOne as of December 31, 2003, the portion of the receivables sale facility that was actually sold provided security in connection with the transfer of ownership of these receivables. Each indenture governing our senior unsecured notes and debentures and our guarantee of the SunBelt notes allows for a specific level of secured debt, above which security must be provided on each such indenture and the guarantee of the SunBelt notes. The receivables sale facility does not constitute debt under the covenants associated with the senior unsecured notes and debentures. As of December 31, 2003, the Company sold accounts receivable of $70.7 million and had guaranteed unconsolidated equity affiliate debt of $85.3 million of SunBelt.

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The following table summarizes PolyOne’s obligations related to long-term debt, leases guarantees and purchase obligation as of December 31, 2003: