Results of Operations

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 ini tiatives 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 be tween 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 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.

POLYONE CORPORATION

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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: