Avant Brands Annual Report 2006

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FY2006 Annual Report · Avant Brands

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Laying the Groundwork

Great Ideas Originate

Providing Customers

Our Playing Field

The Relentless Pursuit

For Growth

p 1

With Our Customers p 4

What They Need

p 6

Keeps Growing

p 8

Of Perfection

p 10

2006 ANNUAL REPORT

CLEAR
VISION

FOCUSED
STRATEGY

F I N A N C I A L H I G H L I G H T S

Dollars in millions, except per share data

Reported Results

(1)

Sales

Operating income

Year ended December 31,

2006

2005

$ 2,622.4 $ 2,450.6

$ 190.2 $

140.3

Income before income taxes and discontinued operations

$ 119.9 $

68.8

Loss from discontinued operations, net of income tax

Net income

Capital expenditures

Depreciation and amortization

Total long-term debt

Shareholders’ equity

Basic and diluted income, before discontinued operations, per share

Basic and diluted income per share

Weighted-average common shares used to compute:
Basic earnings per share (in millions)
Diluted earnings per share (in millions)

Number of employees,
including discontinued operations

Approximate number of shareholders

(2)

(2.7) $

(15.3)

$ 123.2 $

41.1 $

57.1 $

46.9

32.1

50.7

$ 567.7 $

638.7

$ 574.5 $

387.4

1.36 $

1.33 $

92.4
92.8

4,670

2,780

0.68

0.51

91.9
92.0

5,020

2,926

(1) See Management’s Discussion and Analysis of Financial Condition and Results of Operations, beginning on page 13 of Form 10-K,
for a description of the audited reported results.
(2) As of filing date

BUILDING
A NEW
POLYONE

At PolyOne Corporation, we are encouraging our stakeholders

to look at us in a fresh light. The theme of this annual report,

“Clear Vision, Focused Strategy,” frames a story of a rapidly

changing global company committed to generating long-

term, proﬁ table growth for shareholders by delivering the

specialized, value-creating solutions that increase customers’

competitiveness and help them succeed. Reviewing the

examples presented in these pages, you will see how this

story is unfolding every day, all over the world, as we shape

a new PolyOne.

In this annual report, statements that are not reported ﬁ nancial results or other historical information are “forward-looking

statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Factors that could cause our actual results

to differ materially from those implied by the forward-looking statements are described in detail on page 28 of the Form 10-K.

TO OUR SHAREHOLDERS

ast month marked my ﬁ rst year at PolyOne’s

L AY I N G T H E G R O U N D W O R K F O R G R O W T H

helm. On my ﬁ rst earnings conference call in

May 2006, I afﬁ rmed what I believed then,

and believe even more strongly now: This

company has tremendous opportunities to generate

Toward the end of 2006, weaker earnings from our

equity joint ventures underscored a fact of which we are

keenly aware: We must wean PolyOne from dependence

on these cyclical businesses and improve the mix of

proﬁ table growth in the long term.

our earnings.

Our challenge is to capture these opportunities.

We charted our course in the fall of 2006, with a clear

vision and focused strategy. Our vision is to be the

world’s premier provider of specialized polymer materi-

als, services and solutions. We intend to pursue this

vision relentlessly and achieve our strategic goals by

2010 – earlier, if possible – with scrupulous attention

to the needs of our customers. Growing with them,

we anticipate delivering the shareholder value that

you expect.

PolyOne is a changing company, as this annual re-

port attests. Paging through it, you will see how our

businesses are executing our strategy every day. An

anonymous sage wrote, “There is no elevator to suc-

cess. You have to take the stairs.” I would like to share

Our focus is consistent earnings growth in our core

operating businesses – those that can create sustain-

able value for our shareholders. Delivering on this prom-

ise should boost the market value of our stock, ensure

that future multiples are based on the performance of

these businesses and greatly reduce our exposure to the

inherent volatility of the chlor-vinyl commodity cycle.

This mandate reinforces the importance of the

new strategy we rolled out companywide last fall,

which comprises four core components: specialization,

commercial excellence, globalization and operational

excellence. This strategy is powering the drive to up-

grade the mix of our earnings base.

We didn’t wait for the rollout to commit to ongoing

investments and initiatives that align with our strategic

with you the steps we are taking.

goals.

2 0 0 6 F I N A N C I A L H I G H L I G H T S

• We added talent and relevant experience to our

We posted record ﬁ nancial results this past year,

though we have more to accomplish. In addition to sub-

stantial year-over-year gains in sales and earnings, we

reached other noteworthy ﬁ nancial milestones.

Including divestment of the Engineered Films busi-

ness, we generated more than $100 million in cash for

the ﬁ rst time in our history, due largely to more robust

earnings and continuing efﬁ ciency in our management

of working capital, a core competency of PolyOne. The

majority of this cash went to pay down our high-cost debt,

which we have reduced by approximately $320 million

since mid-2003.

Higher earnings and lower debt drove our debt-to-

EBITDA leverage ratio down to 2.6, the lowest and best

since PolyOne’s formation. We are gratiﬁ ed, but not sat-

isﬁ ed; our long-term target is 2.0 to 2.5. With a healthy

cash position and assured liquidity, we are ﬁ nancially

stable and strong.

leadership team. Michael Kahler joined us in the newly

created position of senior vice president, commercial

development, with responsibility for coordinating plans

and integrating strategies for the sales, marketing and

technology functions. Working closely with Mike is

another highly qualiﬁ ed newcomer, Randy Fortin, vice

president of marketing.

Two of our core operating businesses gained new

general managers. Joining us were John Van Hulle in

North American Color and Additives and Craig Nikrant

in North American Engineered Materials. Both are in-

dustry veterans with proven leadership skills.

Early in 2007, we welcomed Dr. Cecil Chappelow

as our new vice president of research and innovation

and chief innovation ofﬁ cer. Cecil will accelerate global

innovation of a differentiated, value-creating offering for

PolyOne’s customers.

• We began upgrading our sales, marketing and

technical talent. Placing good people in critical jobs is

essential to driving sustainable growth. We are on track

toward our goal of a minimum 100 commercial additions

POLYONE CORPORATI ON

OUR

STRATEGIC

GOALS

FOR 2010

(cid:129) Consistent,
double-digit income
growth in our
core businesses

(cid:129) Gross margins of
25 percent to
35 percent for
specialty business

(cid:129) 30 percent of
revenue from outside
North America

(cid:129) A vitality index of
25 percent – the
percentage of total
sales attributable
to new products,
services or markets
developed in the last
ﬁ ve years

in 18 months. Beyond recruitment, we are equipping

As we enlarged our global footprint outside North

all our commercial employees with the tools to suc-

America, we opened a state-of-the-art engineered mate-

ceed through value-based sales training and coaching

rials facility in Avon Lake, Ohio, to formulate and produce

programs. With our much-improved ﬁ nancial proﬁ le, we

primarily specialty products for our customers.

have the capability to fund this commitment to human

capital. We expect to achieve double-digit earnings

growth net of these investments.

• We listened and responded to customers – and

captured an early win. Customers told us we had to do

better with on-time delivery. We heard them and, as a

result, we raised our delivery performance by 7 percent-

age points from March 2006 to year’s end, to a level

where we are distinguishing PolyOne from competitors.

And we’re still improving as we strive to excel in this

area of primary importance to our customers.

• We launched Lean Six Sigma across PolyOne,

after a successful implementation in our Vinyl Busi-

ness unit. With proven processes, our employees are

addressing long-standing problems on the spot, and are

energized about helping our customers succeed. The

voice of our customers is guiding us to focus our initia-

tives on the areas of greatest value to them.

• The pace of our global expansion quickened.

Nowhere has our global growth strategy been more con-

vincingly validated than in Asia, where revenues grew

29 percent and earnings doubled in 2006 compared

with the prior year.

We announced our intent to begin producing vinyl

compounds in China by agreeing to acquire the assets

and operations of Ngai Hing PlastChem Company Ltd.,

including a vinyl compound plant in Guangdong prov-

ince. This facility will be our fourth manufacturing site

in China, where our Shenzhen plant is an unqualiﬁ ed

success. In 2007, we will add two lines in Shenzhen

and two more lines at our color compounding plant

in Thailand.

In another move to support our global customers

and explore opportunities in high-growth markets, we

opened a business development ofﬁ ce in Mumbai, India.

We also signed an agreement with a strong partner in

South Korea who will distribute high-value engineered

materials products and services for us.

In Kutno, Poland, we broke ground for a color manu-

facturing plant to meet burgeoning customer demand in

the Eastern European market. We expect this facility

will commence operations in the summer of 2007.

C L E A R V I S I O N , F O C U S E D S T R AT E G Y

Underpinning these tactics is a transformational

strategy comprising four key strategic pillars:

Specialization shifts the basis of competition to dif-

ferentiation from cost/commodity. PolyOne has the will

and capability to become a differentiated, high value-

added solutions provider to existing and prospective

customers. We possess an in-depth knowledge of poly-

mers, formulations and polymer processing that we can

leverage to create a unique value proposition based on

a clear understanding of how we can help our customers

become more competitive.

By innovating and redirecting our strategic focus

to the most attractive market segments, we will earn

a premium for the value we provide. Success will trans-

late to margin, proﬁ t and earnings improvements and

drive sustainable, proﬁ table growth.

Commercial excellence makes us more competitive

in the marketplace. It covers a full spectrum of market-

focused activities: adding sales, marketing and innova-

tion resources; developing their skills with the proper

training; revamping our internal process to develop and

bring to market value-added products and services that

provide unique beneﬁ ts to our customers.

At its heart, commercial excellence is a game

changer that positions us to offer our customers the

value and solutions that will help them achieve their

growth and proﬁ t improvement objectives. We will not

rest until we have the most satisﬁ ed customers in our

industry.

Globalization positions us to beneﬁ t from our geo-

graphic reach, a clear competitive advantage. Demand

for our products and knowledge is growing rapidly in

many regions of the world. As our customers migrate

to new geographies, they want leading global partners

who can ensure them a consistent standard of perform-

ance. PolyOne is uniquely positioned to capture the

globalization of its customer base.

We have proved that we know how to manage

global expansion. Our Shenzhen, China, facility turned

a proﬁ t in its ﬁ rst year, and we anticipate continuing

POLY ONE CORPORATION

double-digit sales and earnings increases from our in-

We have experienced people and a strengthened

ternational business. As we seize new opportunities in

management group that is leading this team as we

high-growth global markets, we are prioritizing our focus

execute our strategy.

on Asia and Eastern Europe.

And, we have something beyond the requisite skill

Operational excellence is a never-ending quest

sets: We have our hearts in this mission of proﬁ table

for improvement to answer the voice of our customers.

growth through customer focus. Such intensity can’t be

Although it sounds internally focused, operational ex-

taught – but it can make all the difference.

cellence is all about strengthening our capabilities to

In closing, I wish to acknowledge our Board of

deliver value ﬂ awlessly to our customers. It challenges

Directors, whose counsel and encouragement have

us to enhance productivity, proﬁ tability and efﬁ ciency

been vital to me. I also want to thank you, our share-

in all phases of our business, from safety to quality to

holders, and invite you to continue with us on this

waste elimination to environmental stewardship.

journey. We look forward to sharing the rewards with

It also assumes action: As soon as a ﬂ awed pro-

you as we take those steps toward success.

cess is identiﬁ ed, it is ﬁ xed. Our improved delivery

performance and effective management of working

capital are successful outcomes of the pursuit of

operational excellence. Through this initiative, we are

Stephen D. Newlin

shaping a results-oriented culture in which everyone at

Chairman, President and Chief Executive Ofﬁ cer

every level is empowered to make positive changes to

improve our business and serve customers better.

March 12, 2007

Linking all four of our strategic components is

a common theme: our steadfast commitment to

understanding what customers value, then tirelessly

deploying our resources to deliver advantage to them.

A Japanese proverb holds that “Vision without

action is a dream. Action without vision is a nightmare.”

I believe we have combined the best of both spheres:

Our strategy is straightforward and logical, and our

vision is attainable. We expect to generate long-term,

proﬁ table growth because we will deliver value to our

customers and out-hustle our competitors as we execute

our strategy and pursue our aspiration to be the world’s

premier provider of specialized polymer materials,

services and solutions.

P R O F I TA B L E G R O W T H

T H R O U G H C U S T O M E R F O C U S

With a clear new direction, we are transforming

PolyOne. It will take time, but already we have achieved

some early wins. Our progress will become increas-

ingly evident as higher-value new business growth rates

escalate and stronger earnings translate into increased

shareholder value. We are excited about our future

and the opportunity we are creating for PolyOne

shareholders.

POLYONE CORPORATI ON

C h a l l e n g e : Develop a polymer product family for high-heat applications such as piping and extruded vinyl windows.

S o l u t i o n : Polyone’s geon® Chlorinated Polyvinyl Chloride (CPVC) extrusion and molding compounds.

Va l u e : this cost-effective alternative to copper piping responds to customer demand; transparent pipe applications

are important to pharmaceutical, chemical and other customers who need to view and monitor fluid flow.

C h a l l e n g e : Create a high-performance alternative to lead and

other metals for multiple applications, from radiation shielding to

enhanced golf club weighting.

S o l u t i o n : Polyone’s gravi-tech™ polymer-metal composites:

high-density plastics with metallic fillers that mimic the look and

feel of metal, but offer the design flexibility and processing ease

of thermoplastics.

Va l u e : these composites reduce lead exposure for employees of

medical equipment manufacturers, offer significant environmental

benefits and create new market opportunities for molders.

“Whether it’s a customized product formulation,
a material substitution or a special service, these
tailored offerings create value
for customers because they
meet a need or solve a problem.”

Michael L. Rademacher

Senior Vice President and General Manager, Distribution

Specialization Champion

GREAT IDEAS ORIGINATE

WITH OUR CUSTOMERS

partner with them to help them succeed.

At PolyOne, the best customers are those who succeed because we

A specialized approach is more demanding than simply selling a commoditized

four core components of PolyOne’s new, customer-focused strategy.

One path to helping customers grow is specialization, one of

product because it challenges us to listen to people throughout our custom-

ers’ organizations, learning their business and markets as thoroughly as they

know them.

Guided by the voice of our customers, we then apply strengths such as

our formulation expertise to develop and market a differentiated, value-creat-

ing offering such as the products, services and technologies featured here. By

replacing a traditional material such as lead, for example, we take customers

into new markets. They, in turn, open new opportunities for us, as illustrated by

our color additives for biodegradable polymers.

Distinguishing PolyOne through innovation, we earn

our customers’ loyalty and a continuing role as their trusted

strategic partner, growing right along with them.

PATENT

APPLICATIONS

IT STARTS WITH A DIALOGUE

We talk with our customers,

who tell us what they need and

sow ideas, which our skilled

technical staff develops into

innovative solutions. In 2006,

we ﬁ led 25 patent applications

– double the 2005 total. The

true measure of our success,

however, is that customers ﬁ nd

value in unique, marketable

offerings inspired by their

own needs.

C h a l l e n g e : help customers meet european

regulatory requirements for biodegradable materials

and growing consumer demand for bio-derived,

eco-friendly alternatives to conventional plastic

polymers.

S o l u t i o n : Polyone’s onColor™ Bio, onCap™

Bio and SmartBatch™ Bio color and additive

systems for use with corn-based and other

biodegradable resins.

Va l u e : high-quality, ecologically compatible

colorants expedite acceptance of biopolymers

and allow customers to offer a broader range of

eco-friendly consumer products, in compliance

with evolving standards.

C H A L L E N G E : Design and build an Engineered Materials

manufacturing facility that advances PolyOne’s speciali-

zation goals and accommodates customer need for new

products, smaller quantities and speed to market.

S O L U T I O N : PolyOne’s new Engineered Materials plant

in Avon Lake, Ohio, with specialized new equipment that

includes a 40 mm twin-screw megacompounder.

VA L U E : Smaller, more ﬂ exible 40 mm line allows for

rapid product grade changeovers and quick turnaround

on small orders of specialty compounds, ensuring that

customers get to market faster and build competitive

advantage.

POLYONE CORPORATION

C H A L L E N G E : Help wire

and cable customers meet international

speciﬁ cations for highly ﬂ ame-retardant end

use applications that emit no corrosive gases and

very little smoke.

S O L U T I O N : PolyOne’s ECCOH® brand of low-smoke,

halogen-free specialized plastic compounds for wire

and cable.

VA L U E : This high-performance, cost-effective solution

to a critical customer need provides safety and

environmental beneﬁ ts and enables customers

to expand their product offering.

GREAT IDEAS ORIGINATE
WITH OUR CUSTOMERS

partner with them to help them succeed.

At PolyOne, the best customers are those who succeed because we

One path to helping customers grow is specialization, one of
four core components of PolyOne’s new, customer-focused strategy.
A specialized approach is more demanding than simply selling a commoditized
product because it challenges us to listen to people throughout our custom-
ers’ organizations, learning their business and markets as thoroughly as they
know them.

Guided by the voice of our customers, we then apply strengths such as
our formulation expertise to develop and market a differentiated, value-creat-
ing offering such as the products, services and technologies featured here. By
replacing a traditional material such as lead, for example, we take customers
into new markets. They, in turn, open new opportunities for us, as illustrated by
our color additives for biodegradable polymers.

Distinguishing PolyOne through innovation, we earn
our customers’ loyalty and a continuing role as their trusted
strategic partner, growing right along with them.

PATENT
APPLICATIONS

IT STARTS WITH A DIALOGUE

We talk with our customers,

who tell us what they need and

sow ideas, which our skilled

technical staff develops into

innovative solutions. In 2006,

we ﬁ led 25 patent applications

– double the 2005 total. The

true measure of our success,

however, is that customers ﬁ nd

value in unique, marketable

offerings inspired by their

own needs.

C H A L L E N G E : Design and build an Engineered Materials

manufacturing facility that advances PolyOne’s speciali-

zation goals and accommodates customer need for new

products, smaller quantities and speed to market.

S O L U T I O N : PolyOne’s new Engineered Materials plant

in Avon Lake, Ohio, with specialized new equipment that

includes a 40 mm twin-screw megacompounder.

VA L U E : Smaller, more ﬂ exible 40 mm line allows for

rapid product grade changeovers and quick turnaround

on small orders of specialty compounds, ensuring that

customers get to market faster and build competitive

advantage.

POLYONE CORPORATI ON

C H A L L E N G E : Help wire

and cable customers meet international

speciﬁ cations for highly ﬂ ame-retardant end

use applications that emit no corrosive gases and

very little smoke.

S O L U T I O N : PolyOne’s ECCOH® brand of low-smoke,

halogen-free specialized plastic compounds for wire

and cable.

VA L U E : This high-performance, cost-effective solution

to a critical customer need provides safety and

environmental beneﬁ ts and enables customers

to expand their product offering.

C H A L L E N G E : Improve the process of developing and commercializing new, high

value-added products, services and technologies that meet customers’ needs.

S O L U T I O N : “Technology and marketing joined at the hip”: PolyOne’s Innovation Stage & Gate

process to bring to market customer-focused products and solutions. This disciplined process

comprises ﬁ ve stages that new ideas must pass through before they launch in the marketplace.

To move up through stages, ideas must advance through a series of gates, or decision points,

where they are approved, terminated or put on hold.

VA L U E : Customers beneﬁ t from an innovative, value-added offering aligned with market needs,

which enables them to solve problems, expand into new markets and get to market faster.

C H A L L E N G E : Provide customers

the technical support they need to help

them move ideas from conception to

commercialization.

S O L U T I O N : The PolyOne Distribution

Design Center, an application-oriented,

customer-driven, high-tech facility unique

in the plastics industry, with capabilities

STAGE

I D

A
G

T I O

U I L
B

D
S I N
A

N
L I D

T A
A

Idea

GATE

INITIA
L
NIN

O T
OD
V
E

O T
TIN

O T

for complete product development and engineering of injection-

molded plastic parts.

New Product,
Technology,
Service

VA L U E : Customers who tap the expertise of PolyOne’s design

engineers at any stage in the product development cycle can

expect improved part quality and performance, faster cycle time,

less scrap, reduced tool sampling time, lower costs and more.

“Our future starts with our customers – genuinely
understanding what they value and our impact on
their value stream, then driving the
right products and services
to help them achieve their proﬁ t
improvement objectives.”

Michael Kahler

Senior Vice President, Commercial Development

Commercial Excellence Champion

CUSTOMERS

PROVIDING CUSTOMERS
WHAT THEY NEED

unique value we seek to deliver – but the one most relevant to our
daily interactions with customers is commercial excellence.

All four of PolyOne’s strategic components are fundamental to the

Commercial excellence commits us to strengthen our value
proposition so that it extends beyond products, to include services and solu-
tions for target market segments. Helping customers grow their revenues and
margins and reduce costs, we contribute to their proﬁ ts and become instru-
mental to their success.

With investments in sales, marketing and innovation resources, we
are laying the groundwork to win with our customers. We will know them and
their businesses inside and out. Our product development process will link
closely with marketing to effectively commercialize research advances that
meet customer needs. To build and maintain world-class relationships with
key customers, we are assembling dedicated account teams that combine
resources across PolyOne.

Commercial excellence is the outward face that PolyOne turns to the

marketplace. Here, you can see the shape of that face.

C H A L L E N G E : Align commercial practices to compete on the basis of a differentiated, value-creating strategy.

S O L U T I O N : PolyOne’s implementation of value-based pricing and selling.

VA L U E : A customer may want to improve product performance to increase sales. Or reduce manufacturing downtime or

product development costs. Placing the customer’s needs before a discussion of our product features and costs, we elevate

the dialogue to how we can deliver unique value that addresses a problem and brings a quantiﬁ able beneﬁ t.

C H A L L E N G E : Stay in front

of current and potential cus-

tomers to learn what they need

and to communicate PolyOne’s

strong focus on understanding

and responding.

S O L U T I O N : PolyOne’s

“We’re Listening” campaign,

introduced at the 2006

National Plastics Exposition,

largest North American trade

show of the plastics industry.

VA L U E : “We’re Listening” is

not a marketing ploy; rather, it

is a statement of our concern

and respect for our customers.

We have made it part of our

culture and we live it every

day, in every encounter, as we

strive to be our customers’

preferred partner.

VALUE

PRICES

COSTS

PRODUCTS

POLYONE CORPORATI ON

C h a l l e n g e : help customers meet consumer demand

in the apparel industry, where rapidly changing tastes

and trends make speed to market essential for success.

S o l u t i o n : Polyone’s Wilflex™ optima, part

of the Wilflex brand family of screen printing inks

that adorn clothing ranging from sports and leisure wear

to high fashion.

Va l u e : By manufacturing Wilflex optima in China with

locally sourced raw materials, Polyone gains the flexibil-

ity to respond quickly to customers who must be

attuned to the latest styles and colors. Designed for

automated manufacturing, Wilflex optima represents

a leap forward in China, which is swiftly transitioning

from manual production. Polyone sells Wilflex optima

throughout asia; the global Wilflex product line is

distributed in 52 countries.

C h a l l e n g e : Deliver products and services to global customers

consistently and seamlessly throughout the world.

S o l u t i o n : Polyone’s global manufacturing capability; global

key account teams staffed by account managers, sales teams,

technical and research managers, and others dedicated to building

and sustaining healthy customer relationships.

Va l u e : no matter where they do business, global customers

such as hewlett-Packard, itW and 3M can count on the same level

of value, quality and support they are accustomed to receiving in

their home countries from Polyone.

“Think about globalization as a service for our
customers: to bring them what they need – and what
they have in other places around
the world – with a short lead time.”

Bernard Baert

Senior Vice President and General Manager,

Colors and Engineered Materials, Europe and Asia

Globalization Champion

C h a l l e n g e : Develop a global network within

Polyone to enable functional managers in each

international business unit to exchange informa-

tion, coordinate and communicate activities, and

share best practices across geographies.

S o l u t i o n : Polyone’s global Councils, with

members from north america, europe and asia

Pacific who meet in person several times a year

to discuss areas of common interest.

Va l u e : a collaborative approach fosters a

global view of our business units and expedites

the flow of information on customers, contacts,

product platforms, technologies, etc., which

council members use for customers’ benefit.

OUR PLAYING FIELD
KEEPS GROWING

PolyOne’s customers are entering high-growth regions around the world

– and the globalization component of our strategy dictates that we go
with them. Being close enough to support them with consistency is
part of the service they expect from us. Whether they are doing busi-
ness in South China or South Carolina, our goal is to ensure them the same
high standards of quality, speed and reliability.

Proﬁ table growth is occurring rapidly in the developing world, where our
primary geographic targets are Asia and Eastern Europe. As our customers
migrate there, local producers of products for export also seek our support.
Consumer demand will likely fuel future growth in these markets as indigenous
populations aspire to higher living standards.

We are an experienced global partner, and we count this capability as a
core strength. As we expand, we distinguish PolyOne among regional competi-
tors. We also leverage economies of scale and apply our knowledge across a
broadening base of business, for the betterment of our customers.

C H A L L E N G E : Supply global

customers who have a growing

need for vinyl compounds.

S O L U T I O N : PolyOne’s pending

acquisition of the assets and op-

erations of Ngai Hing PlastChem

Company Ltd., which includes a

vinyl compound manufacturing

plant in Guangdong province.

VA L U E : This plant will provide

ready access to PolyOne’s vinyl

compound technology for North

American customers expanding

into the China/Asia Paciﬁ c mar-

ket and for Chinese companies

producing vinyl products for

export to developed markets.

C H A L L E N G E : Supply customers’ ever-increasing need for

plastic compounds and colors in South China.

S O L U T I O N : Expand capacity at PolyOne’s manufacturing plant

in Shenzhen, China, where the ﬁ rst lines were fully booked after

only one year in production. We plan to add one compounding

line in second-quarter 2007 to meet demand for engineered-

grade materials and a second new line in third-quarter 2007

for new product development.

VA L U E : PolyOne will be there for customers as they grow, and

our capacity to supply them should never be an issue.

C H A L L E N G E : Meet global customers’ need for support as they expand in India and

Southern Asia; develop new market opportunities in this fast-growing region.

S O L U T I O N : PolyOne’s sales and business development ofﬁ ce, opened in Mumbai, India,

in December 2006.

VA L U E : Maintaining a local presence improves customer access to PolyOne’s full of-

fering and speeds the customs process, ensuring lower prices for customers and faster

delivery of products imported from manufacturing sites outside India.

C H A L L E N G E : Serve the needs of a rapidly growing customer

base in Central and Eastern Europe.

S O L U T I O N : PolyOne’s planned manufacturing facility in Kutno,

Poland, slated to open in 2007 to produce colors and additives

for extrusion and molding processors.

VA L U E : With strong partnering support for existing European

customers establishing their own manufacturing sites in the

region, we help ensure them a smooth entry into new

geographic markets.

POLYONE CORPORATI ON

C H A L L E N G E : Address customer survey feedback that targeted on-time delivery as an

area of signiﬁ cance; mobilize the entire organization to take ownership of this key initiative.

S O L U T I O N : PolyOne’s ongoing drive to improve on-time delivery performance, starting with

a targeted gain of at least 5 percentage points between the ﬁ rst and fourth quarters of 2006;

actual improvement in this period was 7 percentage points.

For 2007, we are targeting an incremental improvement of 5 additional percentage

points in our delivery performance. We will also focus on reducing order lead times and working

with our suppliers to ensure that we have the raw materials to meet our customers’ delivery

expectations. We will continue to track our progress, and will conduct another survey to again

gauge customer views.

VA L U E : Ability to meet our delivery dates allows our customers to better manage their

inventory levels, control their working capital costs and honor their commitments to their

own customers – all of which encourages growth of their business.

t
n
e
m
e
v
o
r
p
m

t
n
o
P

e
g
a
t
n
e
c
r
e
P

Monthly On-time
Delivery Performance

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan
’07
’06

Graph shows trend line, not actual data

“The principles of operational excellence are elementary:
First, simplify, simplify, simplify. Second, always know
how even the smallest thing you
change, anywhere inside your
operation, impacts your customer.”

Robert M. Rosenau

Senior Vice President and General Manager, Vinyl Business

Operational Excellence Champion

C H A L L E N G E : Simplify and streamline work processes to minimize

steps, eliminate waste and bring sharper focus to activities that add

value for customers.

S O L U T I O N : PolyOne’s adoption of Lean operating principles, ﬁ rst in

Vinyl Business and then throughout the company; Six Sigma deploy-

ment to follow.

Throughout 2006, PolyOne’s Vinyl Business unit ran Lean kaizen

events, with a focus on improving order lead time and on-time delivery.

Kaizen events are anchored by cross-functional employee teams that

assemble for short periods to try to improve a speciﬁ c process.

Eight Vinyl Business plants hosted more than 50 kaizen events

in 2006. Due in large part to their efforts, the vinyl operations reduced

their lead time 40 percent and their late deliveries 66 percent.

VA L U E : Customers gained ﬂ exibility and the ability to more quickly

get to market with new products.

THE RELENTLESS PURSUIT
OF PERFECTION

a role. But this fourth component of PolyOne’s strategy is ultimately
about people: our customers and our employees.

Operational excellence sounds process driven – and process does play

Operational excellence is a continuous journey that engages
each employee at every level in a search for ways to maximize value to customers
and improve business performance. Far from a theoretical exercise, operational
excellence equips employees with the skills, tools and authority to identify
problems that impede ﬂ awless customer service, tackle them and solve them
without delay.

C H A L L E N G E : Establish a for-

mal feedback system to gather

information on customers’ needs

and monitor their perceptions

of PolyOne’s performance.

S O L U T I O N : Regular, compre-

hensive surveys of customers

across all PolyOne’s business

units.

VA L U E : These surveys provide

us with one more channel for

listening to our customers and

making changes to address their

concerns. In the process, we are

creating a differentiated offering

that serves their needs.

Examples on these pages illustrate how we are
applying operational excellence techniques throughout
PolyOne to pare waste and function more efﬁ ciently. As
our people become accustomed to looking at things in
this new light, they can see how strongly operational
excellence inﬂ uences customer issues such as order
lead times, on-time delivery and product consistency.

This strategic element is empowering all of
us to improve PolyOne for our customers’ beneﬁ t. A
shared commitment to positive change is at the heart
of every operational excellence initiative we pursue.

Which factors are most important to you in choosing
a supplier?

Responses

from one

business

unit’s

2006

customer

survey

Delivery

Customer Service

Quality

Availability

Technical Support

Meets Specifications

Consistency

Percentage of Respondents

Delivery
Improvements

Lean
Six Sigma

Customer

POLYONE CORPORATI ON

1 1

Voice of
the Customer

PRODUCTS
AND
APPLICATIONS

PolyOne Corporation (NYSE:

POL) is a leading global

provider of specialized

polymer materials, ser vices

and solutions that ser ve

industrial, commercial and

consumer markets. As

this chart shows, PolyOne

solutions are integral to

countless products that

people use daily at home, at

work, at play and in transit.

To bring our offering to

customers around the world,

we have operations in North

America, Europe, Asia and

Australia, and joint ventures

in North and South America.

Our corporate headquarters

is in northeast Ohio.

END USE MARKETS

POLYONE SOLUTIONS

A U T O M O T I V E

B U I L D I N G

M AT E R I A L S

C O N S U M E R

D U R A B L E S

E L E C T R I C A L /

E L E C T R O N I C

I N D U S T R I A L

M E D I C A L

N O N D U R A B L E

G O O D S

W I R E

A N D C A B L E

Color additives for interior and exterior automotive trim;

polymer coating systems for armrests, headrests and

ﬁ lters; specialty vinyl resins for door panels and protective

coatings; engineered materials for interior and exterior

structural applications; vinyl compounds for automotive

electrical applications.

Vinyl compounds for windows, pipe ﬁ ttings, decking and

fencing; color additives for outdoor decking, siding and

stadium seating; specialty vinyl resins for resilient ﬂ ooring,

sheet vinyl and carpet backing; polymer coating systems

for chain link fence coatings.

Engineered materials and vinyl compounds for household

appliance components and lawn care equipment; color

additives for power tool housings; specialty vinyl resins for

toys; polymer coating systems for outdoor furniture, fans,

dishwashers and closet racks.

Engineered materials for computer housings and printer

components; vinyl compounds for electrical surge

protectors and batter y jar housings; color additives for

consumer and business electronic products, including

computer and other housings.

Polymer coating systems for air ﬁ lters, metal coatings

and soft-touch tool handles; chlorinated vinyl compounds

for chemical process tubes and pipes; specialty vinyl resins

for ﬂ exible gasketing, adhesives, decals and signs on the

sides of trucks.

Vinyl compounds for tubing, connectors and intravenous

solution bags; engineered materials for X-ray shielding;

specialty vinyl resins for medical examination gloves;

color additives for medical packaging.

Vinyl compounds and color additives for packaging

applications such as cosmetic, beverage and food bottles

and caps; specialty vinyl resins for can coatings and

artiﬁ cial leather; polymer coating systems for ﬁ shing lures

and screen printing inks for consumer textiles, such as

sporting equipment.

Engineered materials, vinyl compounds and color additives

for wire and cable coatings used in telecommunication and

electrical applications.

For additional information on PolyOne products and ser vices and for contact information, please visit www. polyone.com.

United States
Securities and Exchange Commission

Washington, D.C. 20549

FORM 10-K

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

For the fiscal year ended December 31, 2006

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

For the transition period from

Commission file number 1-16091

PolyOne Corporation

(Exact name of registrant as specified in its charter)

OHIO

(State or other jurisdiction of

incorporation or organization)

33587 Walker Road,
Avon Lake, Ohio
(Address of principal executive offices)

34-1730488

(IRS Employer Identification No.)

44012
(Zip Code)

Registrant’s telephone number, including area code

(440) 930-1000

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

Title of each class

Name of each exchange on which registered

Common Stock, par value $.01 per share

New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:
None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes n

No ¥

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes n

No ¥

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 ¥

No n

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. n

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

Large accelerated filer ¥

Accelerated filer n

Non-accelerated filer n

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

No ¥

The aggregate market value of the registrant’s outstanding common stock held by non-affiliates on June 30, 2006,
determined using a per share closing price on that date of $8.78, as quoted on the New York Stock Exchange, was
$755,229,000.

The number of shares of common stock outstanding as of February 20, 2007 was 92,837,543.

DOCUMENTS INCORPORATED BY REFERENCE

Part III of this Annual Report on Form 10-K incorporates by reference certain information from the registrant’s definitive
Proxy Statement to be filed on or about March 26, 2007 with respect to the 2007 Annual Meeting of Shareholders.

P O L Y O N E C O R P O R A T I O N

Part I

ITEM 1. BUSINESS

Business Overview

PolyOne Corporation is a leading global provider of specialized
polymer materials, services and solutions with operations in
thermoplastic compounds, specialty polyvinyl chloride (PVC) vinyl
resins, specialty polymer formulations, color and additive systems,
and thermoplastic resin distribution, with equity investments in
manufacturers of PVC resin and its intermediates and in a formu-
lator of polyurethane compounds. When used in this Annual Report
on Form 10-K, the terms “we,” “us,” “our” and the “Company”
mean PolyOne Corporation and its subsidiaries.

We are incorporated in Ohio and our headquarters are in Avon
Lake, Ohio. We employ approximately 4,600 people and have 52
manufacturing sites and 11 distribution facilities in North America,
Europe, Asia and Australia, and joint ventures in North America and
South America. We sell more than 35,000 different specialty and
general purpose products to over 10,000 customers in 35 coun-
tries. In 2006, we had sales of $2.6 billion, 34% of which were to
customers outside the United States.

We provide value to our customers through our ability to link our
knowledge of polymers and formulation technology with our
manufacturing and supply chain processes to provide an essential
link between large chemical producers (our raw material suppliers)
and designers, assemblers and processors of plastics (our cus-
tomers). We believe that large chemical producers are increasingly
outsourcing less-than-railcar business; polymer and additive
producers need multiple channels to market; processors continue
to outsource compounding; and international companies need
suppliers with global reach. Our goal is to provide our customers
with specialized material and service solutions through our global
reach and product platforms, low-cost manufacturing operations, a
fully integrated information technology network, broad market
knowledge and raw material procurement leverage. Our end mar-
kets are primarily in the building materials, wire and cable, auto-
motive, durable goods, packaging, electrical and electronics,
medical and telecommunications markets, as well as many indus-
trial applications.

PolyOne was formed on August 31, 2000 from the consolida-
tion of The Geon Company (Geon) and M.A. Hanna (Hanna). Geon’s
roots date back to 1927 when BFGoodrich scientist Waldo Semon
produced the first usable vinyl polymer. In 1948, BFGoodrich cre-
ated a vinyl plastic division that was subsequently spun off through
a public offering in 1993, creating Geon, a separate publicly-held
company. Hanna was formed in 1885 as a privately-held company
and became publicly-held in 1927. In the mid-1980s, Hanna began
to divest its historic mining and shipping businesses to focus on
polymers. Hanna purchased its first polymer company in 1986 and
completed its 26th polymer company acquisition in 2000.

Recent Developments

Sale of businesses and discontinued operations

In February 2006, we sold 82% of our Engineered Films business for
$26.7 million. This business is presented in discontinued
operations in these financial statements. We maintain an 18%
ownership interest in this business and it is reflected in our financial
statements on the cost basis of accounting.

Purchase of businesses

In October 2006, we purchased the remaining 50% of our equity
investment in DH Compounding Company from a wholly-owned
subsidiary of The Dow Chemical Company for $10.2 million. This
equity investment was previously reflected in the Consolidated Bal-
ance Sheets on the line “Investment in equity affiliates.” DH Com-
pounding Company is now consolidated in our Consolidated Balance
Sheet as of December 31, 2006, and the results of operations are
included in our Consolidated Statement of Operations beginning
October 1, 2006. DH Compounding is included in our Producer
Services operating segment.

In October 2006, we announced that we had entered into a
definitive agreement to acquire the vinyl compounding business and
assets of Ngai Hing PlastChem Company Ltd., a subsidiary of Ngai
Hing Hong Company Limited (NHH), a publicly-held company listed
In connection with this
on the Hong Kong stock exchange.
acquisition, we initiated the purchase of certain assets at a
manufacturing facility in Dongguan, China with a deposit of
$2.7 million. This acquisition is expected to be completed during
the first half of 2007, subject to customar y closing conditions.

Board of Directors changes

In December 2006, our Board of Directors elected Edward J.
Mooney to be a director of PolyOne. Mr. Mooney has 35 years of
experience in the specialty chemicals industry and served as chair-
man and chief executive officer of Nalco Chemical Company from
1994 to 2000. Mr. Mooney presently serves on the boards of FMC
Corporation, FMC Technologies, Inc., Northern Trust Corporation
and Cabot Microelectronics Corporation.

Restructuring initiatives and facility closures

During the first quarter of 2006, we completed the closure of our
Manchester, England color additives manufacturing facility to
reduce costs and align capacity with market demand. Key customer
product demand requirements were transitioned to other company
facilities.

During the fourth quarter of 2006, we announced the reloca-
tion of our Commerce, California latex business to our Massillon,
Ohio facility to better support the growth occurring in the latex
business east of the Mississippi River. This transition will be com-
pleted in the first quarter of 2007 and resulted in charges related to
employee separation and plant phaseout of approximately
$0.5 million.

P O L Y O N E C O R P O R A T I O N

Sale of assets

During 2006, we sold previously closed facilities as part of our
restructuring initiatives and cost reduction plans for a total of
$8.7 million.

Polymer Industry Overview

Polymers are a class of organic materials that are generally pro-
duced by converting natural gas or crude oil derivatives into mono-
mers, such as ethylene, propylene, vinyl chloride and styrene. These
monomers are then polymerized into chains called polymers, or
plastic resin, in its most basic form. Large petrochemical compa-
nies, including some in the petroleum industry, produce a majority
of the monomers and base resins because they have direct access
to the raw materials needed for production. Monomers make up the
majority of the variable cost of manufacturing the base resin. As a
result, the cost of a base resin tends to move in tandem with the
industry market prices for monomers and the cost of raw materials
and energy used during production. Resin selling prices can move in
tandem with costs, but are largely driven by supply and demand
balances. Through our equity interests in Oxy Vinyls, LP (OxyVinyls)
and SunBelt Chlor-Alkali Partnership (SunBelt), we realize a portion
of the economic benefits of a base resin producer for PVC resin, one
of our major raw materials.

Thermoplastic polymers make up a substantial majority of the
resin market and are characterized by their ability to be reshaped
repeatedly into new forms after heat and pressure are applied.
Thermoplastics offer versatility and a wide range of applications.
The major types of thermoplastics include polyethylene, polyvinyl
chloride, polypropylene, polystyrene, polyester and a range of
specialized engineering resins. Each type of thermoplastic has
unique qualities and characteristics that make it appropriate for
use in a particular product.

Thermoplastic resins are found in a number of end-use prod-
ucts and in a variety of markets, including packaging, building and
construction, wire and cable, automotive, medical, furniture and
furnishings, durable goods, institutional products, electrical and
electronics, adhesives, inks and coatings. Each type of thermoplas-
tic resin has unique characteristics (such as flexibility, strength or
durability) suitable for use in a particular end-use application. The
packaging industry, the largest consumer of plastics, requires
plastics that help keep food fresh and free of contamination while
providing a variety of options for product display, and offering
advantages in terms of weight and user-friendliness. In the building
and construction industry, plastic provides an economical and
energy efficient replacement for other traditional materials in piping
applications, siding, flooring, insulation, windows and doors, as well
as structural and interior or decorative uses. In the wire and cable
industry, thermoplastics serve to protect by providing electrical
insulation, flame resistance, durability, water resistance, and color
coding to wire coatings and connectors. In the automotive industry,
plastic has proved to be durable, lightweight and corrosion resistant
while offering fuel savings, design flexibility and high performance.
In the medical industry, plastics help save lives by safely providing a

range of transparent and opaque thermoplastics that are used for a
vast array of devices including blood and intravenous bags, medical
tubing, masks, clamps and connectors to bed frames, curtains and
sheeting, and electronic enclosures. In the electronics industry,
plastic enclosures and connectors not only enhance safety through
electrical insulation, but thermally and electrically conductive plas-
tics provide heat transferring, cooling, antistatic, electostatic dis-
charge, and electromagnetic shielding per formance for critical
applications including integrated circuit chip packaging.

Various additives can be combined with a base resin to provide
it with greater versatility and per formance. These combinations are
known as plastic compounds. Plastic compounds have advantages
over metals, wood, rubber and other traditional materials, which
have resulted in the replacement of these materials across a wide
spectrum of applications that range from automobile parts to
construction materials. Plastic compounds offer advantages
compared to traditional materials that include processability, weight
reduction, chemical resistance, flame retardance and lower cost.
Plastics have a reputation for durability, aesthetics, ease of han-
dling and recyclability.

PolyOne Segments

We operate within four reportable segments: Vinyl Business, Inter-
national Color and Engineered Materials, PolyOne Distribution, and
Resin and Intermediates. The All Other segment includes our North
American Color and Additives, North American Engineered Materi-
als, Producer Services and Polymer Coating Systems operating
segments. For more information about our segments, see Note R
to the Consolidated Financial Statements, which is incorporated by
reference into this Item 1.

Vinyl Business:

Our Vinyl Business operating segment is a global leader offering an
extensive array of products and services for vinyl coating, molding
and extrusion processors. Our product offerings include rigid, flex-
ible and dry blend vinyl compounds as well as industry-leading
dispersion, blending and specialty suspension grade vinyl resins
to a wide variety of manufacturers of plastic parts and consumer-
oriented products. We also offer a wide range of polymer services to
meet the ever changing needs of our multi-market customer base.
These services include materials testing and component analysis,
color management, custom compound development, colorant and
additive services, design assistance, structural analyses, process
simulations, extruder screw design and specialty products.

Vinyl is one of the most widely used plastics, utilized in a wide
range of applications in building and construction, wire and cable,
consumer and recreation markets, automotive, packaging and
healthcare. Vinyl resin can be combined with a broad range of
additives, resulting in per formance versatility, particularly when fire
resistance, chemical resistance or weatherability is required. We
are well-positioned to meet the stringent quality, service and inno-
vation requirements of
this diverse and highly competitive
marketplace.

P O L Y O N E C O R P O R A T I O N

Our Vinyl Business segment had total sales of $925.8 million,
of which sales to external customers were $788.3 million, with
operating income of $65.3 million in 2006 and total assets of
$412.3 million as of December 31, 2006.

International Color and Engineered Materials:

Our International Color and Engineered Materials operating seg-
ment combines the strong regional heritage of our color additive
masterbatches and engineered materials operations to create glo-
bal capabilities with plants, sales and service facilities located
throughout Europe and Asia.

Working in conjunction with our North American Color and
Additives and North American Engineered Materials segments,
we provide solutions that meet our
international customers’
demands for both global and local manufacturing, service and
technical support.

Our International Color and Engineered Materials segment had
sales to external customers of $539.9 million, with operating
income of $22.3 million in 2006 and total assets of $379.6 million
as of December 31, 2006.

PolyOne Distribution:

Our PolyOne Distribution operating segment distributes more than
3,500 grades of engineering and commodity grade resins, including
PolyOne-produced compounds, to the North American market.
These products are sold to over 5,000 custom injection molders
and extruders who, in turn, convert them into plastic parts that are
sold to end-users in a wide range of industries. Representing over
20 major suppliers, we offer our customers a broad product port-
folio, just-in-time delivery from multiple stocking locations, and local
technical support.

Our PolyOne Distribution segment had total sales of $732.8 mil-
lion, of which sales to external customers were $724.1 million, with
operating income of $19.2 million in 2006 and total assets of
$164.6 million as of December 31, 2006.

Resin and Intermediates:

We report the results of our Resin and Intermediates segment on
the equity method. This segment consists almost entirely of our
24% equity interest in OxyVinyls and our 50% equity interest in
SunBelt. OxyVinyls, a producer of PVC resins, vinyl chloride mono-
mer (VCM), and chlorine and caustic soda, is a partnership with
Occidental Chemical Corporation and is our principal supplier of PVC
resin. SunBelt, a producer of chlorine and caustic soda, is a part-
nership with Olin Corporation. OxyVinyls is North America’s second
largest and the world’s third largest producer of PVC resin. In 2006,
OxyVinyls had production capacity of approximately 4.3 billion
pounds of PVC resin, 6.2 billion pounds of VCM (an intermediate
chemical in the production of PVC), 580 thousand tons of chlorine
and 667 thousand tons of caustic soda. The 6.2 billion pounds of
VCM capacity includes approximately 2.4 billion pounds owned by
OxyMar, a partnership that is 50% owned by OxyVinyls. In 2006,
SunBelt had production capacity of approximately 320 thousand

tons of chlorine and 358 thousand tons of caustic soda. Most of the
chlorine manufactured by OxyVinyls and SunBelt is consumed by
OxyVinyls to produce PVC resin. Caustic soda is sold on the mer-
chant market to customers in the pulp and paper, chemical, con-
struction and consumer products industries.

In addition to providing us with a secure and high-quality supply
of PVC resin, our Resin and Intermediates segment provides us with
some of the economic and technology development benefits of
backward integration through our ownership position and contrac-
tual arrangements. First, our purchases of PVC resin and VCM from
OxyVinyls are at competitive prices based on long-term supply
contracts. The PVC resin is used to make our vinyl compounds,
and the VCM is used to make our specialty vinyl resins. Second, our
equity investment in OxyVinyls provides a hedge against a portion of
raw material price increases to the extent that OxyVinyls can pass
on increased raw material costs to its other customers. Finally, our
equity position in chlorine and caustic soda through OxyVinyls and
SunBelt provides partial economic integration with the chlorine
chain.

Our Resin and Intermediates segment had operating income of
$102.5 million in 2006 and had total assets of $270.9 as of
December 31, 2006. We also received $92.6 million of cash from
dividends and distributions from our Resin and Intermediates seg-
ment equity affiliates in 2006.

All Other:

Our All Other segment includes our North American Color and
Additives, North American Engineered Materials, Producer Services
and Polymer Coating Systems operating segments.

Our North American Color and Additives operating segment is a
leading provider of specialized colorants and additive concentrates
that offers an innovative array of colors, special effects and per-
formance-enhancing solutions. Our color masterbatches contain a
high concentration of color pigments and/or additives that are
dispersed in a polymer carrier medium and are sold in pellet, liquid,
flake or powder form. When combined with non pre-colored base
resins, our colorants help our customers achieve a wide array of
specialized colors and effects that are targeted at the demands of
today’s highly design-oriented consumer and industrial end mar-
kets. Our additive masterbatches encompass a wide variety of
per formance enhancing characteristics and are commonly catego-
rized by the function that they per form, such as UV stabilization,
anti-static, chemical blowing, antioxidant and lubricant, and pro-
cessing enhancement.

Our colorant and additives masterbatches are used in most
plastics manufacturing processes,
including injection molding,
extrusion, sheet, film, rotational molding and blow molding through-
out the plastics industry, particularly in the packaging, automotive,
consumer, outdoor decking, pipe, and wire and cable markets. They
are also incorporated into such end-use products as stadium seat-
ing, toys, housewares, vinyl siding, pipe, food packaging and med-
ical packaging.

P O L Y O N E C O R P O R A T I O N

Our North American Engineered Materials operating segment is
a leading provider of custom plastic compounding services and
solutions for processors of thermoplastic materials across a wide
variety of markets and end-use applications. Our product portfolio,
one of the broadest in our industry, includes standard and custom
formulated high-per formance polymer compounds that we manu-
facture using a full range of thermoplastic compounds and elas-
tomers, which are then combined with advanced polymer additive,
reinforcement, filler and colorant technologies.

Our depth of compounding expertise helps us expand the
per formance range and structural properties of traditional engi-
neering-grade thermoplastic resins that meet our customers’
unique per formance requirements. Our product development and
application reach is further enhanced by the capabilities of our
Solutions Center, which produces and evaluates prototype and
sample parts to help assess end-use performance and guide prod-
uct development. Our manufacturing capabilities, which include a
new facility located in Avon Lake, Ohio, are targeted at meeting our
customers’ demand for speed, flexibility and critical quality.

Our Producer Services operating segment offers custom com-
pounding services to resin producers and processors that design
and develop their own compound recipes. We also offer a complete
product line of custom black masterbatch products for use in the
pressure pipe industry. Customers often require high quality, cost
effective and confidential services. As a strategic and integrated
supply chain partner, Producer Services offers resin producers a
way to develop custom products for niche markets by using our
compounding expertise and multiple manufacturing platforms.

Our Polymer Coating Systems operating segment provides
custom-formulated liquid systems that meet a variety of customer
needs and chemistries, including vinyl, natural rubber and latex,
polyurethane, and silicone. Our products and services are designed
to meet the specific requirements of our customers’ applications by
providing unique solutions to their market needs. Products also
include proprietar y fabric screen-printing inks, powders, latexes,
specialty additives and colorants. We serve diversified markets that
include recreational and athletic apparel, automotive, construction,
flooring, material handling, filtration, outdoor furniture and medi-
cal/health care. We also have a 50% interest in BayOne, a joint
venture between PolyOne and Bayer Corporation, which sells poly-
urethane systems into many of the same markets.

Our All Other segment had total sales of $598.6 million, of
which sales to external customers were $570.1 million, with an
operating loss of $0.2 million in 2006 and total assets of
$374.5 million as of December 31, 2006.

Competition

The production of compounded plastics and the manufacture of
custom and proprietary formulated color and additives systems for
the plastics industry is highly competitive. Competition is based on
speed, delivery, service, per formance, product innovation, product
recognition, quality and price. The relative importance of these
factors varies among our products and services. We believe that

we are the largest independent compounder of plastics and pro-
ducer of custom and proprietar y formulated color and additive
masterbatch systems in the United States and Europe, with a
growing presence in Asia. Our competitors range from large inter-
national companies with broad product offerings to local indepen-
dent custom compounders whose focus is a specific market niche
or product offering.

The distribution of polymer resin is also highly competitive.
Speed, delivery, service, brand recognition, quality and price are the
principal factors affecting competition. In less-than-truckload ther-
moplastic resin and compound distribution, we believe that we are
the second largest independent thermoplastic resin distributor in
North America. We compete against other national independent
resin distributors in North America, along with other regional dis-
tributors. Growth in the thermoplastic resin and compound distri-
bution market is directly correlated with growth in the base polymer
resins market.

We believe that the strength of our company name and repu-
tation, the broad range of product offerings from our suppliers and
our speed and responsiveness, coupled with the quality of products
and flexibility of our distribution network, allow us to compete
effectively.

Raw Materials

The primary raw materials used by our manufacturing operations
are PVC resin, VCM, polyolefin and other thermoplastic resins,
plasticizers, inorganic and organic pigments, all of which are in
adequate supply. We have long-term supply contracts with OxyVinyls
under which the majority of our PVC resin and all of our VCM is
supplied. These contracts will expire in 2013, although they contain
two five-year renewal provisions that are at our option. We believe
these contracts should assure the availability of adequate amounts
of PVC resin and VCM. We also believe that the pricing under these
contracts provides PVC resins and VCM to us at a competitive cost.

Patents and Trademarks

We own and maintain a large number of U.S. and foreign patents
and trademarks that contribute to our competitiveness in the mar-
kets we serve because they protect our inventions and product
names against infringement by others. Patents vary in duration up
to 20 years, and trademarks have an indefinite life based upon
continued use. While we view our patents and trademarks to be
valuable because of the broad scope of our products and services
and brand recognition we enjoy, we do not believe that the loss or
expiration of any single patent or trademark would have a material
adverse effect on our results of operations, financial position or the
continuation of our business. Nevertheless, we have implemented
management processes designed to protect our inventions and
trademarks.

Seasonality and Backlog

Sales of our products and services are slightly seasonal as demand
is generally slower in the first and fourth calendar quarters of the

P O L Y O N E C O R P O R A T I O N

year. Because of the nature of our business, we do not believe that
our backlog is a meaningful indicator of the level of our present or
future business.

Working Capital Practices

The nature of our business does not require us to carry significant
amounts of inventories to meet the delivery requirements for our
products or services or assure ourselves of a continuous allotment
of goods from suppliers. Our products are generally manufactured
with a short turnaround time, and the scheduling of manufacturing
activities from customer orders generally includes enough lead time
to assure delivery of an adequate supply of raw materials. We offer
payment terms to our customers that are competitive. We generally
allow our customers to return merchandise if pre-agreed quality
standards or specifications are not met; however, we employ quality
assurance practices that seek to minimize customer returns.

Significant Customers

No customer accounts for more than three percent of our consol-
idated revenues, and neither we nor any of our operating segments
would suffer a material adverse effect were we to lose any single
customer.

Research and Development

We have substantial technology development capabilities. Our
efforts are largely devoted to developing new product formulations
to satisfy defined market needs, providing quality technical services
to evaluate alternative raw materials, assuring the continued suc-
cess of our products for customer applications, providing technol-
ogy to improve our products, processes and applications, and
providing support to our manufacturing plants for cost reduction,
productivity and quality improvement programs. We operate
research and development centers that support our commercial
development activities and manufacturing operations. These facil-
ities are equipped with state-of-the-ar t analytical, synthesis, poly-
mer characterization and testing equipment, along with pilot plants
and polymer compounding operations that simulate specific pro-
duction processes that allow us to rapidly translate new technolo-
gies into new products.

Our investment in product research and development totaled
$20.3 million in 2006, $19.5 million in 2005 and $16.7 million in
2004. In 2007, we expect our investment in research and devel-
opment to increase as we deploy greater resources to increase and
accelerate material and service innovations.

Methods of Distribution

We sell products primarily through direct sales personnel,
distributors,
including our PolyOne Distribution segment, and
commissioned sales agents. We primarily use truck carriers to
transpor t our products to customers, although some customers
pick up product at our operating facilities or warehouses for each of
these segments. We also ship some of our manufactured products
to customers by railroad cars.

Employees

As of February 19, 2007, we employed approximately 4,600 people.
Approximately 60 employees were represented by labor unions
under collective bargaining agreements that expire on October 31,
2007, May 31, 2008 and December 31, 2011, respectively, and
approximately another 115 employees are currently in negotiations
to enter into a collective bargaining agreement. We believe that
relations with our employees are good, and we do not anticipate
significant operating issues to occur as a result of current negoti-
ations or when we renegotiate collective bargaining agreements as
they expire.

Environmental, Health and Safety

We are subject to various environmental laws and regulations that
apply to the production, use and sale of chemicals, emissions into
the air, discharges into waterways and other releases of materials
into the environment, and the generation, handling, storage, trans-
portation, treatment and disposal of waste material. We endeavor
to ensure the safe and lawful operation of our facilities in the
manufacture and distribution of products, and we believe we are
in material compliance with all applicable laws and regulations.

We maintain a disciplined environmental and occupational
safety and health compliance program and conduct periodic internal
and external regulatory audits at our facilities to identify and cat-
egorize potential environmental exposures, including compliance
issues and any actions that may be required to address them. This
effort can result in process or operational modifications, the instal-
lation of pollution control devices or cleaning up grounds or facil-
ities. We believe that we are in material compliance with all
applicable requirements. We incurred environmental expense of
$2.5 million in 2006, $0.2 million in 2005 and $10.3 million in
2004, respectively, of which $2.5 million in 2006, $0.9 million in
2005 and $8.7 million in 2004 relates to inactive or formerly owned
sites. Environmental expense is presented net of insurance recov-
eries of $8.1 million in 2006, $2.2 million in 2005 and $1.8 million
in 2004. The insurance recoveries all relate to inactive or formerly
owned sites. We expect future environmental remediation expense
will be approximately $3 million to $5 million per year.

We are strongly committed to safety as evidenced by the fact
that our injury incidence rate was 1.30 in 2006, an improvement
from 1.38 in 2005. The 2005 average injury incidence rate for our
SIC Code (30 Rubber and Miscellaneous Plastic Products) was 8.5.
The U.S. Department of Labor defines the incidence rate as the
number of injuries per 100 full-time workers per year.

We believe that compliance with all current governmental reg-
ulations will not have a material adverse effect on our results of
operations or financial condition. The risk of additional costs and
liabilities, however, is inherent in certain plant operations and
certain products produced at these plants, as is the case with
other companies in the plastics industry. Therefore, we may incur
additional costs or liabilities in the future. Other developments,
such as increasingly strict environmental, safety and health laws,
regulations and related enforcement policies, discovery of unknown

P O L Y O N E C O R P O R A T I O N

conditions, and claims for damages to property, persons or natural
resources resulting from plant emissions or products could also
result in additional costs or liabilities.

A number of foreign countries and domestic communities have
enacted, or are considering enacting, laws and regulations concern-
ing the use and disposal of plastic materials. Widespread adoption
of these laws and regulations, along with public perception, may
have an adverse impact on sales of plastic materials. Although
many of our major markets are in durable, longer-life applications
that could reduce the impact of these kinds of environmental reg-
ulations, more stringent regulation of the use and disposal of
plastics may have an adverse effect on our business.

The European business community (EU) has adopted REACH, a
legislative act to cover Registration, Evaluation, Authorization and
Restriction of Chemicals. The goal of this legislation, which will
become effective in June 2007, is to minimize risk to human health
and to the environment. We have a global team of experts to provide
our customers with compliance solutions to adapt to these regula-
tions. As these regulations evolve, we will endeavor to remain in
compliance with REACH.

We have been notified by federal and state environmental
agencies and by private parties that we may be a potentially respon-
sible party (PRP) in connection with the investigation and remedia-
tion of a number of environmental waste disposal sites. While
government agencies assert that PRPs are jointly and severally
liable at these sites, in our experience, interim and final allocations
of liability costs are generally made based on the relative contribu-
tion of waste. However, even when allocations of costs based on
relative contribution of waste have been made, we cannot assure
that our allocation will not increase if other PRPs do not pay their
allocated share of these costs.

We also conduct investigations and remediation at several of
our active and inactive facilities and have assumed responsibility for
the resulting environmental liabilities from operations at sites for-
merly owned or operated by us or our predecessors. We believe that
our potential continuing liability at these sites will not have a
material adverse effect on our results of operations or financial
position. In addition, we voluntarily initiate corrective and preventive
environmental projects at our facilities. Based on current informa-
tion and estimates prepared by our environmental engineers and
consultants, we had reserves on our December 31, 2006 Consol-
idated Balance Sheet totaling $59.5 million to cover probable future
environmental expenditures related to previously contaminated
sites. This figure represents management’s best estimate of costs
for probable remediation, based upon the information and technol-
ogy currently available and management’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 we could incur additional costs in
excess of the amount accrued at December 31, 2006. Such costs,
if any, cannot be currently estimated. We may revise our estimate of

this liability as new regulations or technologies are developed or
additional information is obtained.

International Operations

Our international operations are subject to a variety of risks, includ-
ing currency fluctuations and devaluations, exchange controls, cur-
rency restrictions and changes in local economic conditions. While
the impact of these risks is difficult to predict, any one or more of
them could adversely affect our future operations. For more infor-
mation about our international operations, see Note R to the Con-
solidated Financial Statements, which is incorporated by reference
into this Item 1.

Available Information

Our Internet address is www.polyone.com. Our 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 are available, free of charge, on our website or upon written
request, as soon as reasonably practicable after we electronically
file or furnish them to the SEC. These reports are also available on
the SEC’s website at www.sec.gov.

ITEM 1A. RISK FACTORS

The following are certain risk factors that could affect our business,
results of operations and financial condition. These risk factors
should be considered along with the forward-looking statements
contained in this Annual Report on Form 10-K because these
factors could cause our actual results or financial condition to
differ materially from those projected in forward-looking state-
ments. Before you invest in us, you should understand that making
such an investment involves some risks, including the risks we
describe below. The risks that are discussed below are not the only
ones we face. If any of the following risks occur, our business,
results of operations or financial condition could be negatively
affected.

In 2006, we developed an enterprise risk management (ERM)
process to manage risks we face in a holistic and integrated
approach. The purpose of this process is to manage risks that
can prevent us from achieving our strategic, operational and finan-
cial goals. It is important to understand that this process is
designed to manage risks and not to eliminate risks.

The ERM process addresses many of the risks outlined below.
Senior management identifies and reviews with our Board of Direc-
tors potential risk uncertainties and develops risk management
strategies for those strategic, operating and financial risks that may
affect our business at the enterprise-level. Similarly, each of our
operating segments identifies risk uncertainties and develops risk
management strategies for those risks that may prevent it from
realizing strategic, operating and financial objectives.

Each of the risks discussed below is considered in the ERM
process. However, it is not possible to evaluate and manage every
risk that our business faces and further, it may not be possible to

P O L Y O N E C O R P O R A T I O N

adequately manage risks even when a risk management plan has
been developed and implemented.

Demand for and supply of our products and services may be
adversely affected by several factors, some of which we cannot
predict or control, that could adversely affect our results of
operations.

Several factors may affect the demand for and supply of our prod-
ucts and services, including:

(cid:129) end of application life-cycle, model change-over or obsoles-
cence due to more cost effective alternative materials;

(cid:129) changes in the market acceptance of our products and

services;

(cid:129) competition from other polymer and chemical companies;

(cid:129) declines in the general level of industrial production;

(cid:129) declines in general economic conditions, both domestically

and globally;

(cid:129) changes in world or regional plastic consumption growth

rates;

(cid:129) changes in the PVC, VCM or chlor-alkali industry capacities
and changes to price structures as a result of potential
supply/demand dislocations;

(cid:129) changes in environmental regulations that would limit our
ability to sell our products and services in specific
markets; and

(cid:129) inability to obtain raw materials or supply products to cus-
tomers due to factors such as weather (especially situations
where weather-related events create production or transpor-
tation dislocations similar to what our industry faced in
2005 as a result of Hurricanes Katrina and Rita), supplier
work stoppages, supply shortages, plant outages or regula-
tory changes that may limit or prohibit overland transporta-
tion of certain hazardous materials.

If any of these factors occur, the demand for and supply of our
products and services could suffer, which would adversely affect
our results of operations.

Increased energy costs could reduce our income.

Any increases in energy costs will increase our production costs and
those of our suppliers. Although we attempt to pass on higher raw
material and energy costs to our customers, given our competitive
markets, it is often not possible to pass on all of these increases in
a timely manner.

Our participation in joint ventures may adversely affect our
results of operations.

We participate in joint ventures in the United States and Colombia
and we may enter into additional joint ventures in the future. The
nature of a joint venture requires us to share control with unaffil-
iated third parties. If our joint venture partners do not fulfill their

obligations, the joint venture may not be able to operate as planned.
If this happens, our results of operations may be adversely affected
or we may be required to increase our financial commitment to the
joint venture.

OxyVinyls and SunBelt are our two largest equity investments.
The earnings of each of these partnerships may be significantly
affected by changes in the commodity cycle for hydrocarbon feed-
stocks and for chlor-alkali products. If the profitability of either
OxyVinyls or SunBelt is adversely affected, we may receive less
cash distributions from that partnership or we may choose to make
additional cash contributions to that partnership, either of which
could adversely affect our financial condition.

A major failure of our information systems could harm our
business.

We depend on integrated information systems to conduct our busi-
ness. We may experience operating problems with our information
systems as a result of system failures, viruses, computer “hackers”
or other causes. Any significant disruption or slowdown of our
systems could cause customers to cancel orders or cause standard
business processes to become ineffective, which could adversely
affect our results of operations.

Our manufacturing operations are subject to hazards and other
risks associated with polymer production and the related stor-
age and transportation of raw materials, products and wastes.

Our manufacturing operations are subject to the usual hazards and
risks associated with polymer production and the related storage
and transpor tation of raw materials, products and wastes. These
hazards and risks include, but are not limited to:

(cid:129) explosions, fires, inclement weather and natural disasters;

(cid:129) mechanical failure resulting in protracted or short duration

unscheduled downtime;

(cid:129) labor difficulties;

(cid:129) regulatory changes that effect or limit the transpor tation of

raw materials;

(cid:129) inability to obtain or maintain any required licenses or

permits;

(cid:129) interruptions and environmental hazards such as chemical
spills, discharges or releases of toxic or hazardous sub-
stances or gases into the environment or workplace; and

(cid:129) storage tank leaks or other issues resulting from remedial

activities.

The occurrence of any of these operating problems at our
facilities may have a material adverse effect on the productivity
and profitability of a particular manufacturing facility, or on our
operations as a whole, during and after the period of these oper-
ating difficulties. These operating problems may also cause per-
sonal injury and loss of life, severe damage to or destruction of
property and equipment, and environmental damage. We are

P O L Y O N E C O R P O R A T I O N

subject to present and potential future claims with respect to
workplace exposure, workers’ compensation and other matters.
Although we maintain property and casualty insurance of the types
and in the amounts that we believe are customary for the industry,
we are not fully insured against all potential hazards that are
incident to our business.

Extensive environmental, health and safety laws and regula-
tions impact our operations and assets, and compliance with
these regulations could adversely affect our results of
operations.

Our operations on and ownership of real property are subject to
extensive environmental, health and safety laws and regulations at
the national, state and local governmental levels. The nature of our
business exposes us to risks of liability under these laws and
regulations due to the production, storage, transpor tation, recycling
or disposal and/or sale of materials that can cause contamination
or personal
injury if they are released into the environment or
workplace. Environmental laws may have a significant effect on
the costs of these activities involving raw materials, finished prod-
ucts and wastes. We may incur substantial costs, including fines,
damages, criminal or civil sanctions, remediation costs, or experi-
ence interruptions in our operations for violations of these laws.

Also, federal and state environmental statutes impose strict,
and under some circumstances, joint and several liability for the
cost of investigations and remedial actions on any company that
generated the waste, arranged for disposal of the waste, trans-
ported the waste to the disposal site or selected the disposal site,
as well as on the owners and operators of these sites. Any or all of
the responsible parties may be required to bear all of the costs of
clean up, regardless of fault or legality of the waste disposal or
ownership of the site, and may also be subject to liability for natural
resource damages. We have been notified by federal and state
environmental agencies and private parties that we may be a
potentially responsible party in connection with several sites. We
may incur substantial costs for some of these sites. It is possible
that we will be identified as a potentially responsible party at more
sites in the future, which could result in our being assessed sub-
stantial investigation or cleanup costs.

During 2007,

the European business community will be
required to follow new legislation called REACH, which covers Reg-
istration, Evaluation, Authorization and Restriction of Chemicals.
REACH will apply to all chemical substances manufactured or
imported and placed on the European market. These regulations
will require us to adapt to the regulatory environment as well as
provide compliance solutions to our customers. We already have
the ability to do this through a global team of experts. As the
regulatory environment changes, the extent to which REACH may
impact us is not expected to be material. Even though we do not
believe complying with existing REACH directives will have a material
effect on our results of operations or financial condition, we may
incur substantial costs to comply with the new regulations.

We also conduct investigations and remediation at some of our
active and inactive facilities, and have assumed responsibility for
environmental
liabilities based on operations at sites formerly
owned or operated by our predecessors or by us.

We accrue costs for environmental matters that have been
identified when it is probable that these costs will be required and
when they can be reasonably estimated. However, accruals for
estimated costs, including, among other things, the ranges asso-
ciated with our accruals for future environmental compliance and
remediation, may be too low or we may not be able to quantify the
potential costs. We may be subject to additional environmental
liabilities or potential liabilities that have not been identified. We
expect that we will continue to be subject to increasingly stringent
environmental, health and safety laws and regulations. We antici-
pate that compliance with these laws and regulations will continue
to require capital expenditures and operating costs, which could
adversely affect our results of operations or financial condition.

Because our operations are conducted worldwide, they are
inherently affected by risk.

As noted above in Item 1. “Business,” we have extensive operations
outside of the United States. Revenue from these operations (prin-
cipally from Canada, Mexico, Europe and Asia) was 34% in 2006,
33% in 2005 and 34% in 2004 of our total revenue during these
periods. Long-lived assets of our foreign operations represented
32% in 2006, 31% in 2005 and 31% in 2004 of our total long-lived
assets.

International operations are subject to risks, which include, but

not limited to, the following:

(cid:129) Changes in local government

regulations and policies,
including, but not limited to foreign currency exchange con-
trols or monetar y policy; repatriation of earnings; expropri-
ation of property; duty or
tariff restrictions; investment
limitations; and tax policies;

(cid:129) political and economic instability and disruptions, including
labor unrest, civil strife, acts of war, guerilla activities, insur-
rection and terrorism;

(cid:129) legislation that regulates the use of chemicals;

(cid:129) disadvantages of competing against companies from coun-
tries that are not subject to U.S. laws and regulations,
including the Foreign Corrupt Practices Act;

(cid:129) difficulties
operations;

staffing

and managing multi-national

(cid:129) limitations on our ability to enforce legal

rights and

remedies;

(cid:129) reduced protection of intellectual property rights; and

(cid:129) other risks arising out of foreign sovereignty over the areas

where our operations are conducted.

P O L Y O N E C O R P O R A T I O N

Any of these events could have an adverse effect on our
international operations by reducing the demand for our products
or reducing the prices at which we can sell our products, which could
result in an adverse effect on our business, financial condition or
results of operations. We may not be able to continue to operate in
compliance with applicable customs, currency exchange control
regulations, transfer pricing regulations or any other laws or regu-
lations that we may be subject to. In addition, these laws or reg-
ulations may be modified in the future, and we may not be able to
operate in compliance with those modifications.

We have a significant amount of goodwill, and any future good-
will impairment charges could adversely impact our results of
operations.

As of December 31, 2006, we had goodwill of $287.0 million. We
completed the annual impairment review required by Statement of
Financial Accounting Standards No. 142, “Goodwill and Other Intan-
gible Assets” (SFAS No. 142), as of July 1, 2006 and determined
that there was no impairment. However, the occurrence of a poten-
tial 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 require
us to per form another valuation analysis, as required under
SFAS No. 142, for some or all of our reporting units prior to the
next required annual assessment. These types of events and the
resulting analysis could result in additional charges for goodwill,
which could adversely impact our results of operations.

increase in our defined benefit pension plan obligations. As a result,
we may need to modify our capital expenditure plans to meet our
obligations.

An inability to collect the remaining amounts owed to us from
purchasers of our former businesses could adversely affect our
results of operations or financial condition.

In the third quarter of 2004, we sold our Elastomers and Per for-
mance Additives business, and in February 2006 we sold our
Engineered Films business. These transactions included seller
financing, where we retained notes receivable for a portion of the
purchase price that is owed to us. The ability to collect these funds
from the purchasers of these businesses depends on the future
results of operations, financial position and cash flows of the
purchasers. The purchasers may not have the funds necessary
to repay the principal and interest due to us on these notes when
they become due, which could adversely affect our results of oper-
ations or financial condition.

The guarantee of our SunBelt joint venture’s debt could result
in our having to pay the outstanding principal and interest if
SunBelt cannot make these payments when due.

We guaranteed $67.0 million of SunBelt’s outstanding senior
secured notes at December 31, 2006 in connection with the con-
struction of a chlor-alkali facility. These notes mature in 2017. If
SunBelt is unable to make the future payments required on this debt
as they come due, it could result in our having to make those
payments on SunBelt’s behalf, which could adversely impact our
financial condition and cash flows.

Lower investment performance by our pension plan assets may
require us to increase our pension liability and expense.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Lower investment per formance by our pension plan assets or a
decline in investment grade bond interest rates could result in an

We have no outstanding or unresolved comments from the staff of
the SEC.

P O L Y O N E C O R P O R A T I O N

ITEM 2. PROPERTIES

As of December 31, 2006, we operated facilities in the United States and internationally. We own substantially all of our facilities. During
2006, we made effective use of our productive capacity at our principal facilities. We believe that the quality and production capacity of our
facilities is sufficient to maintain our competitive position for the foreseeable future. Following are the principal facilities of our segments:

Vinyl Business

Long Beach, California
Terre Haute, Indiana
Louisville, Kentucky
Plaquemine, Louisiana
Avon Lake, Ohio
Pasadena, Texas
Niagara Falls, Ontario, Canada
Orangeville, Ontario, Canada
St. Remi de Napierville,

Quebec, Canada

Cartagena, Colombia (joint

venture)
Henry, Illinois
Pedricktown, New Jersey

Producer Services
Dyersburg, Tennessee
Seabrook, Texas
Clinton, Tennessee

International Color and
Engineered Materials

Pudong (Shanghai), China
Shenzhen, China
Glostrup, Denmark
Cergy, France
Tossiat, France
Bendor f, Germany
Gyor, Hungary
Gaggenau, Germany
Pamplona, Spain
Angered, Sweden
Bangkok, Thailand
Suzhou, China
Jurong, Singapore
Istanbul, Turkey
Assesse, Belgium
Barbastro, Spain
Melle, Germany

North American
Color and Additives

Glendale, Arizona
Suwanee, Georgia
Elk Grove Village,

Illinois

St. Peters, Missouri
Norwalk, Ohio
Lehigh, Pennsylvania
Vonore, Tennessee
Toluca, Mexico

North American Engineered
Materials

Avon Lake, Ohio
Macedonia, Ohio
Dyersburg, Tennessee
Valleyfield, Quebec,

Canada

Polymer Coating Systems

Los Angeles, California
Kennesaw, Georgia
St. Louis, Missouri
Sullivan, Missouri
Massillon, Ohio
North Baltimore, Ohio
Sussex, Wisconsin
Melbourne, Australia
Bolton, England
Shenzhen, China
Hyde, England
Widnes, England

PolyOne Distribution Facilities
Lemont, Illinois
Ayer, Massachusetts
Massillon, Ohio
Rancho Cucamonga, California
Statesville, North Carolina
Denver, Colorado

Chester field Township, Michigan
Eagan, Minnesota
Hazelwood, Missouri
La Porte, Texas
Mississauga, Ontario, Canada

Resin and Intermediates Facilities

OxyVinyls joint venture – various locations in North America
SunBelt joint venture – McIntosh, Alabama

ITEM 3. LEGAL PROCEEDINGS

In addition to the matters regarding the environment described in
Item 1 under the heading “Environmental, Health and Safety,” we
are 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 that seek remedies or damages. We believe
that the probability is remote that losses in excess of the amounts
we have accrued could be materially adverse to our financial con-
dition, results of operations or cash flows.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY

HOLDERS

No matters were submitted to a vote of security holders during the
fourth quarter of 2006.

EXECUTIVE OFFICERS OF THE REGISTRANT

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

The following lists information, as of February 28, 2007, about
each of our executive officers, including his or her position with us
as of that date and other positions held by him or her for at least the
past five years. Executive officers are elected by our Board of
Directors to serve one-year terms.

P O L Y O N E C O R P O R A T I O N

Stephen D. Newlin
Age: 54

Wendy C. Shiba
Age: 56

Chief Legal Officer, November 2001 to date, and Vice President and
Secretary, December 2001, named Senior Vice President, May
2006 to date. Vice President, Bowater Incorporated (a pulp and
paper company), 1997 to November 2001, and Secretary and
Assistant General Counsel, 1993 to November 2001.

Kenneth M. Smith
Age: 52

Chief Human Resources Officer, January 2003 to date, and Vice
President and Chief Information Officer, September 2000 upon
formation of PolyOne, named Senior Vice President and Chief Infor-
mation Officer, May 2006 to date. Vice President, Information
Technology, The Geon Company, May 1999 to August 2000, and
Chief Information Officer, August 1997 to May 1999.

W. David Wilson
Age: 53

Vice President and Chief Financial Officer, September 2000 upon
formation, named Senior Vice President May 2006 to date. Vice
President and Chief Financial Officer, The Geon Company, May
1997 to August 2000.

Chairman, President and Chief Executive Officer, February 21,
2006 to date. President – Industrial Sector of Ecolab Inc. (a global
developer and marketer of cleaning and sanitizing specialty chem-
icals, products and services) from 2003 to 2006. Mr. Newlin served
as President and a Director of Nalco Chemical Company (a manu-
facturer of specialty chemicals, services and systems) from 1998
to 2001 and was Chief Operating Officer and Vice Chairman from
2000 to 2001. Mr. Newlin serves on the Board of Directors of Black
Hills Corporation.

Bernard Baert
Age: 57

Vice President and General Manager, Colors and Engineered Mate-
rials, Europe and Asia, September 2000 upon formation of PolyOne,
named Senior Vice President and General Manager, Colors and
Engineered Materials, Europe and Asia, May 2006 to date. General
Manager, Color Europe, M.A. Hanna Company, 1997 to August
2000.

Michael E. Kahler
Age: 49

Senior Vice President, Commercial Development, May 2006 to
date. President, Process Technology Division, Alfa Laval Inc. (a
global provider of heat transfer, separation and fluid handling prod-
ucts and engineering solutions) from January 2004 to March 2006.
Group Vice President, Nalco Chemical Company (a manufacturer of
specialty chemicals, services and systems) from December 1999
to October 2002.

Michael L. Rademacher
Age: 56

Vice President and General Manager, PolyOne Distribution, Sep-
tember 2000 upon formation of PolyOne, named Senior Vice Pres-
ident and General Manager, PolyOne Distribution, May 2006 to
date. Senior Vice President – Plastics Americas, M.A. Hanna Com-
pany, January 2000 to August 2000. Vice President and General
Manager, Industrial Chemical and Solvents Division, Ashland Chem-
ical Company (chemical manufacturing and distribution), 1998 to
January 2000.

Rober t M. Rosenau
Age: 52

Vice President and General Manager, Vinyl Business, January
2003, named Senior Vice President and General Manager, Vinyl
Business, May 2006 to date. General Manager, Extrusion Products,
September 2000 to December 2002. General Manager, Custom
Profile Compounds, The Geon Company, April 1998 to August 2000.

P O L Y O N E C O R P O R A T I O N

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY

SECURITIES

The following table sets forth 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 are traded under the symbol “POL,” for the periods indicated.

Common stock price:

High

Low

2006 Quarters

2005 Quarters

Fourth

Third

Second

First

Fourth

Third

Second

First

$8.76

$6.71

$9.18

$7.70

$9.89

$7.45

$9.88

$6.31

$6.57

$5.31

$7.73

$5.75

$9.40

$6.00

$10.25

$ 8.05

As of February 20, 2007, there were 2,781 holders of record of our common stock.

Effective with the first quarter of 2003, we suspended payment of our quarterly dividend. Future declarations of dividends on common
stock are at the discretion of the Board of Directors, and the declaration of any dividends will depend on, among other things, earnings,
capital requirements and our financial condition. The Board of Directors has not declared any dividends on common stock since 2003.
Additionally, the indenture governing our 10.625% senior notes due in 2010 and the agreements that govern our receivables sale facility
contain restrictions that could limit our ability to pay future dividends.

ITEM 6. SELECTED FINANCIAL DATA

(In millions, except per share data)

Sales
Operating income (loss)

2006

2005

2004

2003

2002

$2,622.4
$ 190.2

$2,450.6
$ 140.3

$2,267.7
$ 128.4

$2,048.1
(43.2)
$

$1,981.1
13.7
$

Income (loss) before discontinued operations and change in accounting

$ 125.9

62.2

27.6

$ (134.7)

(18.9)

Discontinued operations
Change in method of accounting

Net income (loss)

(2.7)
—

(15.3)
—

(4.1)
—

(144.7)
—

13.7
(53.7)

$ 123.2

46.9

23.5

$ (279.4)

(58.9)

Basic and diluted earnings (loss) per common share:

Before discontinued operations and change in method of accounting

1.36

0.68

0.30

(1.48)

(0.21)

Discontinued operations

Change in method of accounting

Basic and diluted earnings (loss) per common share

Dividends per common share

Total assets

Long-term debt, net of current portion

In August 2004, we sold our Elastomers and Per formance
Additives business. This business was previously reported as a
discontinued operation and is reflected as such in our historical
results.

In February 2006, we sold 82% of our Engineered Films busi-
ness. This business was previously reported as discontinued oper-
ations and is reflected as such in our historical results. The retained
ownership of 18% is reported on the cost method of accounting and
is reflected in the financial statements as such.

(0.03)

—

(0.17)

—

(0.04)

—

(1.59)

—

0.15

(0.59)

1.33

0.51

0.26

(3.07)

(0.65)

— $

0.25

$1,773.6

$1,687.7

$1,746.5

$1,872.6

$1,997.5

$ 567.7

$ 638.7

$ 640.5

$ 757.1

$ 492.2

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

Purpose of Management’s Discussion and Analysis (MD&A)

The purpose of the following discussion is to provide relevant
information to investors who use our financial statements so they
can assess our financial condition and results of operations by
evaluating the amounts and certainty of cash flows from our oper-
ations and from outside sources.

The three principal objectives of MD&A are: to provide a nar-
rative explanation of financial statements that enables investors to
see our company through the eyes of management; to enhance
overall financial disclosure and provide the context within which
financial information should be analyzed; and to provide information

P O L Y O N E C O R P O R A T I O N

about the quality and potential variability of earnings and cash flows
so that investors can judge the likelihood that past per formance is
indicative of future per formance.

Business Overview

We are a leading global provider of specialized polymer materials,
services and solutions with operations in thermoplastic com-
pounds, specialty vinyl resins, specialty polymer formulations, color
and additive systems, and thermoplastic resin distribution with
equity investments in manufacturers of PVC resin and its interme-
diates. Headquartered in Avon Lake, Ohio, with 2006 sales of
$2.6 billion, we have manufacturing sites and distribution facilities
in North America, Europe and Asia, and joint ventures in North
America and South America. We employ approximately 4,600 peo-
ple and sell more than 35,000 different specialty and general
purpose products to over 10,000 customers in 35 countries. We
provide value to our customers through our ability to link our knowl-
edge of polymers and formulation technology with our manufactur-
ing and supply chain to provide an essential link between large
chemical producers (our raw material suppliers) and designers,
assemblers and processors of plastics (our customers).

Recent Developments

Sale of businesses and discontinued operations

In February 2006, we sold 82% of our Engineered Films business for
$26.7 million. This business is presented as a discontinued oper-
ation in these financial statements. We maintain an 18% ownership
interest in this business that is reflected in our 2006 financial
statements on the cost basis of accounting. Unless otherwise
noted, disclosures contained in this Annual Report on Form 10-K
relate to continuing operations. For more information about our
discontinued operations, see Note B to the Consolidated Financial
Statements.

Purchase of businesses

In October 2006, we purchased the remaining 50% of our equity
investment in DH Compounding Company from a wholly-owned
subsidiary of The Dow Chemical Company for $10.2 million. Our
equity investment was previously reflected in the Consolidated
Balance Sheets on the line “Investment in equity affiliates.” DH
Compounding Company is now consolidated in our Consolidated
Balance Sheet as of December 31, 2006, and the results of oper-
ations are included in our Consolidated Statement of Operations
beginning October 1, 2006. DH Compounding is included in our
Producer Services operating segment.

In October 2006, we announced that we had entered into a
definitive agreement to acquire the vinyl compounding business and
assets of Ngai Hing PlastChem Company Ltd., a subsidiary of NHH.
In connection with this acquisition, we initiated the purchase of
certain assets at a manufacturing facility in Dongguan, China with a
deposit of $2.7 million. This acquisition is expected to be com-
pleted during the first half of 2007, subject to customary closing
conditions.

Restructuring initiatives and facility closures

During the first quarter of 2006, we completed the closure of our

Manchester, England color additives manufacturing facility to

reduce costs and align capacity with market demand. Key custom-

ers product demand requirements were transitioned to other com-

pany facilities.

During the fourth quarter of 2006, we announced the reloca-

tion of our Commerce, California latex business to our Massillon,

Ohio facility to better support the growth occurring in the latex

business east of the Mississippi River. This transition will be com-

pleted in the first quarter of 2007 and resulted in charges related to

employee separation and plant phaseout of approximately

$0.5 million.

Sale of assets

During 2006, we sold previously closed facilities as part of our

restructuring initiatives and cost reduction plans for a total of

$8.7 million.

Results of Operations

Summary of Consolidated Results:

Income from continuing operations in 2006 improved by $63.7 mil-

lion, or $0.69 per share, compared to 2005. Sales increased by 7%

from 2005, primarily due to increased volume in our International

Color and Engineered Materials, North American Color and Addi-

tives, North American Engineered Materials and Producer Services

operating segments. Volume improvements in Europe resulted from

regaining market share that was lost in 2005 and from general

improvement in key economies. Asian volume was up due to new

application developments and further penetration into key markets.

Domestic volume growth resulted primarily from strong demand in

packaging, custom injection molding, appliance, construction, and

wire and cable markets. The sales increase was also driven by a

shift in sales mix towards high value specialized applications,

combined with higher selling prices that were required to offset

higher raw material and energy costs.

Improved earnings were primarily the result of margin expan-

sion as we increased selling prices in a high raw material and energy

cost escalation environment combined with strong earnings from

our equity affiliates. Also impacting the year-over-year comparison

were a $22.9 million pre-tax asset impairment charge in the third

quarter of 2005 related to a previously idled chlor-alkali facility at

OxyVinyls and a $15.8 million reversal of our deferred tax valuation

allowance in the fourth quarter of 2006.

P O L Y O N E C O R P O R A T I O N

(In millions)

Sales:

2006

2005

2004

Vinyl Business

$ 925.8

$ 926.7

$ 831.4

International Color and
Engineered Materials

PolyOne Distribution

All Other

539.9

732.8

598.6

473.2

679.2

543.1

466.4

606.3

519.9

Corporate and eliminations

(174.7)

(171.6)

(156.3)

$2,622.4

$2,450.6

$2,267.7

65.3

59.8

67.8

22.3

19.2

102.5

(0.2)

(18.9)

190.2

(66.5)

3.4

16.2

19.5

90.9

(4.5)

(41.6)

140.3

(68.1)

1.9

34.1

17.8

53.7

(0.4)

(44.6)

128.4

(72.1)

1.5

(4.4)

(2.8)

—

(5.3)

(3.3)

(13.2)

Total sales

Net income:

Vinyl Business

International Color and
Engineered Materials

PolyOne Distribution

Resin and Intermediates

All Other

Corporate and eliminations

Operating income

Interest expense

Interest income

Premium on early

extinguishment of long-term
debt

Other expense, net

Income before income taxes

and discontinued
operations

Income tax benefit (expense)

Income before discontinued

operations

125.9

62.2

27.6

Loss from discontinued

operations, net of taxes

(2.7)

(15.3)

(4.1)

Net income

$ 123.2

46.9

23.5

Year-to-year changes in sales and operating income are dis-
cussed in the “Segment Information” section that follows. Seg-
ments are also discussed in detail in Note R to the Consolidated
Financial Statements.

Selected Operating Costs:

Selected operating costs, expressed as a percentage of sales, are
as follows:

Cost of sales

Selling and administrative costs

2006

2005

2004

87.0% 87.9% 85.3%

7.7%

7.3%

9.2%

our specialization strategy to increase new higher value business.
Cost of sales increased in 2005 from 2004 levels primarily as a
result of raw material, transpor tation and energy cost increases
that were not fully offset by selling price increases and manufac-
turing cost reduction initiatives.

Selling and Administrative – These costs generally include
selling, technology and general and administrative charges. Selling
and administrative costs increased in 2006 compared to 2005 from
higher share-based compensation and incentive costs and
increased investment in commercial resources and capabilities,
partially offset by a higher benefit in 2006 than 2005 from legal and
other
related settlements. Selling and administrative costs
declined in 2005 compared to 2004 from lower incentive costs
combined with a higher benefit in 2005 compared to 2004 from
legal and other related settlements.

Employee Separation and Plant Phaseout – These costs rep-
resent severance, employee outplacement, lease termination, facil-
ity closing costs and the write-down of the carrying value of plant and
equipment resulting from the consolidation of operations, restruc-
turing initiatives and executive separation agreements. For more
information about our employee separation and plant phaseout
activities, see Note E to the Consolidated Financial Statements.

Asset Impairments – These charges are to adjust the carrying
values of intangible assets and other investments to expected net
future cash flows resulting from an evaluation that we per form each
year-end, or more often when indicators of impairment exist. These
non-cash charges will not result in future cash expenditures.

Environmental Remediation at Inactive Sites – These costs
represent those charges associated with environmental remedia-
tion costs for manufacturing facilities that we either no longer own
or that we closed in prior years. We increased our reserves in 2006
based on increased estimates for future remediation at one site
that we no longer own. We increased our reserves significantly in
2004 to reflect a reduction in expected recoveries from an insur-
ance company whose policies now only service remaining liabilities
for groundwater remediation costs at a site that we no longer own
and to recognize an increase over previous cost estimates for a
remedial action work plan at an inactive site.

Other Components of Income and Expense:

119.9

6.0

68.8

(6.6)

41.3

(13.7)

(In millions)

Internet investments

Community development investments

Customer contract – lower profit expectations

2006

2005

2004

$ — $0.2

$0.2

0.2

—

0.2

—

0.3

3.3

$0.2

$0.4

$3.8

Cost of Sales – These costs include raw materials, plant con-
version and distribution charges. As a percentage of sales, these
costs declined in 2006 compared to 2005 primarily from the full
year effect of efforts to increase our selling prices to pass on higher
raw material, distribution and utility costs, as well as the effect of

Following are discussions of significant components of income and
expense that are presented below the line “operating income.”

Interest Expense – The decrease in interest expense from year
to year is largely the result of lower average borrowing levels.
Payment of maturing debt and voluntary repurchases of debt are

P O L Y O N E C O R P O R A T I O N

effective and statutor y tax rate for 2006 and 2005. For 2004,
the difference between the effective and statutor y tax rate was
principally the tax rates of foreign operations.

The deferred tax valuation allowance was recorded in accor-
dance with SFAS No. 109, “Accounting for Income Taxes,” which
requires a company to evaluate its deferred tax assets for recov-
erability. This evaluation process is based upon the company’s
ability to demonstrate future taxable income that would result in
utilization of those assets. As a result of a review in the fourth
quarter of 2003, we determined that it was more likely than not that
the majority of our deferred tax assets were impaired and, accord-
ingly, a valuation allowance was recorded.

Subsequent to 2003, the valuation allowance was either
increased to offset the creation of additional deferred tax assets,
as was the case in 2004, or reduced for use of deferred tax assets
in 2005 and 2006. In 2006, the valuation allowance was reduced by
$75.5 million as a result of the following factors: a) $44.3 million for
the utilization of net operating loss carryforwards; b) $15.4 million
associated with changes in accumulated other comprehensive
income related to the pension and post-retirement health care
liabilities; and c) $15.8 million associated with our determination
that it is now more likely than not that the deferred tax assets will be
realized. The domestic deferred tax valuation allowance was $0 at
December 31, 2006.

The resulting tax expense for the years ended December 31,
2006, 2005 and 2004 includes foreign, state and alternative min-
imum tax. Income taxes are discussed in detail in Note P to the
Consolidated Financial Statements.

Loss from Discontinued Operations, Net of Income Taxes –
Discontinued operations are discussed in detail in Note B to the
Consolidated Financial Statements. The loss from discontinued
operations included a pre-tax benefit of $0.2 million in 2005 and
a pre-tax charge of $7.5 million in 2004 for employee separation
and plant phaseout costs from restructuring initiatives and closing
certain manufacturing facilities of the Engineered Films and Elas-
tomers and Per formance Additives businesses.

As required by generally accepted accounting principles in the
United States, the losses from discontinued operations, shown
below, do not include any depreciation or amortization expense.

the main reasons for the continued decline in debt. Included in
interest expense in 2006 and 2004 were charges of $0.8 million
and $0.2 million, respectively, to write off deferred debt issuance
costs that resulted from the early extinguishment of long-term debt.

In the second and fourth quarters of 2006, we repurchased
$15.0 million and $43.6 million, respectively, of our 10.625% senior
notes. The following table presents the quarterly average of short-
and long-term debt for the past three years and the related interest
expense:

(In millions)

Short-term debt

2006

2005

2004

5.6

4.5

2.1

Current portion of long-term debt

12.5

35.2

34.4

Long-term debt

610.8

639.5

716.8

Quarterly average

$628.9

$679.2

$753.3

Interest expense

$ 66.5

$ 68.1

$ 72.1

Premium on Early Extinguishment of Long-term Debt — Cash
expense from the repurchase of $58.6 million aggregate principal
amount of our 10.625% senior notes in 2006 was $4.4 million.
Cash expense from the repurchase of $67.0 million aggregate
principal amount of our medium-term notes and bank debentures
in 2004 was $3.3 million.

Other Expense, Net – Finance costs associated with our receiv-
ables sale facility, foreign currency gains and losses, retained post-
employment benefit costs from previously discontinued operations
and other miscellaneous items are as follows:

(In millions)

Currency exchange loss

2006

2005

2004

$(1.3)

$(0.1)

$ (3.0)

Foreign exchange contracts gain (loss)

1.1

0.6

Discount on sale of trade receivables

(1.9)

(5.5)

(1.1)

(6.1)

Retained post-employment benefit costs
related to previously discontinued
operations

Other income (expense), net

—

(0.7)

(1.3)

1.0

(3.6)

0.6

$(2.8)

$(5.3)

$(13.2)

The decline in the discount on sale of trade receivables in 2006
compared to 2005 was primarily from the lower average balance of
receivables that were sold during 2006.

Income Tax Expense – The income tax expense (benefit) for
2006, 2005 and 2004, including changes in the deferred tax
valuation allowance, is summarized as follows:

(In millions)

2006

2005

2004

Tax expense prior to valuation allowance $ 54.1

$ 27.9

$ 8.6

Valuation allowance

(60.1)

(21.3)

5.1

Total tax (benefit) expense

$ (6.0)

$ 6.6

$13.7

In calculating the tax expense or benefit prior to changes in the
valuation allowance, the effect of the repatriation of foreign divi-
dends was the principal cause of the difference between the

P O L Y O N E C O R P O R A T I O N

(In millions)

Sales:

2006

2005

2004

2006

2005

Change

Operating income (loss) as a

percentage of sales:

Elastomers and Performance Additives

$ — $ — $220.1

Engineered Films

9.6

119.6

125.7

Vinyl Business

7.1% 6.5%

0.6%points

$ 9.6 $119.6 $345.8

Pre-tax income from operations:

Elastomers and Performance Additives

$ — $ — $ 17.2

Engineered Films

0.4

0.5

0.6

17.8

Pre-tax charges to adjust net assets of
businesses held for sale to projected
net sale proceeds:

Elastomers and Performance Additives

—

(0.7)

(17.0)

Engineered Films

(3.1)

(15.1)

(4.3)

(2.7)

(15.3)

(3.5)

Income tax expense (net of valuation

allowance)

—

(0.6)

Loss from discontinued operations

$(2.7) $ (15.3) $ (4.1)

Segment Information:

2006 compared with 2005:

(In millions)

Sales:

2006

2005

Change

% Change

Vinyl Business

$ 925.8 $ 926.7 $ (0.9)

International Color and
Engineered Materials

PolyOne Distribution

All Other

Corporate and
eliminations

539.9

732.8

598.6

473.2

679.2

543.1

66.7

53.6

55.5

(174.7)

(171.6)

(3.1)

$2,622.4 $2,450.6 $171.8

14%

10%

Operating income (loss):

Vinyl Business

65.3 $

59.8 $

5.5

International Color and
Engineered Materials

PolyOne Distribution

Resin and Intermediates

All Other

Corporate and
eliminations

22.3

19.2

102.5

(0.2)

16.2

19.5

90.9

(4.5)

6.1

(0.3)

11.6

4.3

(18.9)

(41.6)

22.7

$ 190.2 $ 140.3 $ 49.9

International Color and
Engineered Materials

PolyOne Distribution

All Other

Total

4.1% 3.4%

0.7%points

2.6% 2.9% (0.3)%points

0.0% (0.8)% 0.8%points

7.3% 5.7%

1.6%points

Effective with the first quarter of 2006, our operating and
reportable segments changed. The Producer Services operating
segment was formed at the start of 2006 from portions of the North
American Color and Additives and the North American Engineered
Materials operating segments. As a result, the North American
Color and Additives operating segment no longer meets, nor is
expected to meet, any of the quantitative thresholds that would
require separate disclosure as a reportable segment, and, accord-
ingly, it is included in the All Other segment. The new Producer
Services operating segment also does not meet, nor is expected to
meet, any of these quantitative thresholds, and, as a result, it is
also included in the All Other segment. Effective with the fourth
quarter of 2006, the former Specialty Resins operating segment
was subsumed into the former Vinyl Compounds operating segment
to create the new Vinyl Business operating and reportable segment.
Segment information for prior periods has been reclassified to
conform to the 2006 presentation.

Operating income is the primary financial measure that is
reported to the chief operating decision maker for purposes of
making decisions about allocating resources to the segment and
assessing its per formance. Operating income at the segment level
does not include: corporate general and administrative costs that
are not allocated to segments; intersegment sales and profit elim-
inations; charges related to specific strategic initiatives, such as
the consolidation of operations; restructuring activities, including
employee separation costs resulting from personnel reduction pro-
grams, plant closure and phaseout costs; executive separation
agreements; share-based compensation costs; asset impairments;
environmental remediation costs for facilities no longer owned or
closed in prior years; gains and losses on the divestiture of joint
ventures and equity investments; and certain other items that are
not included in the measure of segment profit or loss that is
reported to and reviewed by the chief operating decision maker.
These costs are included in “Corporate and eliminations.”

Vinyl Business sales were flat in 2006 compared to 2005 as
higher average selling prices offset 6% lower volume. Selling prices
at the beginning of 2006 reflected the increases that we realized in
the fourth quarter of 2005. Volume was down as a result of slower
building and construction market demand in the second half of
2006 compared with the unusually high demand in the second half
of 2005 due to the rebuilding activities that were created in the
wake of Hurricanes Katrina and Rita. Also negatively impacting
2006 volume was greater competition from overseas suppliers
who increased their market share, largely in flooring applications,

P O L Y O N E C O R P O R A T I O N

increases in raw material costs as well as the result of improve-
ments in manufacturing and new technologies. The volume
increases were in the packaging, custom injection molding and
profile extrusion markets.

North American Engineered Materials sales increased 19%
from a resurgence in the wire and cable market and continued
improvement in the general purpose product lines. In addition, we
expanded our market position as a leading compounder of special-
ized formulations and materials. New technology platforms have
been introduced that complement our new plant established to
focus on specialized compounding.
Increases in commercial
resources have and will continue to create better leverage for our
domestic and global capabilities to meet customer needs.

Producer Services sales increased 24% from continued strong
demand in the pipe market, penetration of new markets and new
business resulting from the acquisition of the remaining 50% inter-
est in DH Compounding Company in the fourth quarter of 2006. The
acquisition of DH Compounding Company enabled us to offer a
broader range of blends and alloys materials that serve the medical,
food and consumer markets.

Polymer Coating Systems sales increased 5% in 2006 com-
pared to 2005 from increased sales of higher-priced products such
as inks and specialty colorants, the introduction of new products,
higher selling prices, and continued growth in China. These sales
increases were partially offset by a decline in volume. Volume
decreased due to a combination of slower order patterns at existing
customers and the conclusion of several large automotive programs
at the end of 2005.

Operating income in 2006 for the All Other segment improved

$4.3 million compared to 2005.

Corporate and eliminations expense of $18.9 million in 2006
was $22.7 million lower than in 2005. The primar y drivers of this
improvement include the elimination of charges in 2006 related to
the impairment of a previously idled facility at OxyVinyls that
amounted to $22.9 million in 2005; an increase of $14.5 million
in 2006 for benefits received from insurance and legal settlements
and changes to the related reserves; and a net charge of $0 in 2006
as compared to $5.5 million in 2005 related to employee separa-
tion and plant phaseout costs. These improvements were partially
offset by increases in share-based compensation and employee
incentive costs of $9.5 million; pension costs of $4.0 million;
administrative personnel costs of $3.0 million; and net insurance
costs of $2.7 million.

in the second half of 2005. Operating income increased $5.5 million
primarily from price-driven margin improvements.

International Color and Engineered Materials sales increased
14% due primarily to the strengthening of foreign economies and an
improvement in our customer portfolio. Sales in Europe increased
from recapturing market share , increased sales of higher margin
specialty products in the wire and cable and automotive markets,
continued growth in Eastern European countries and strong results
in the packaging market. Sales in Asia increased primarily from
growth in the higher-margin appliance and electrical and electronics
markets, the introduction of new product lines and the development
of
favorable currency
exchange rates contributed approximately $4.8 million to the sales
increase. Volume also rose 14% in 2006. Operating income
increased $6.1 million, or 38% from 2005, primarily as a result
of higher volume, a shift in mix to higher-margin products and an
increase in selling prices. Differences in average currency exchange
rates did not materially impact earnings.

the South Korean market.

In addition,

PolyOne Distribution’s sales increased 8% led by an increase in
selling prices and, to a lesser extent, a 1% increase in volume. The
increase in selling prices was driven by both passing through
increases from our supplier base and from a shift in mix towards
higher-priced engineered products. The change in volume was a
result of gains from our National Account programs that were mostly
offset by a softening demand in the building and construction and
automotive markets in the second half of 2006. Operating income
decreased $0.3 million in 2006 due to increased investment in
commercial resources. Hurricanes Katrina and Rita caused a surge
in demand in 2005 that temporarily increased selling prices and
margins, both of which have returned to normalized levels in 2006
as demand has softened.

Resin and Intermediates operating

income increased
$11.6 million, or 13%, over 2005. OxyVinyls’ equity earnings
increased $4.6 million primarily due to higher industry average
PVC resin and VCM price spreads over raw material costs. Sun-
Belt’s equity earnings increased $6.6 million due to higher selling
prices for chlorine and caustic soda that were driven by strong
demand.

North American Colors and Additives sales improved 2% due to
higher average selling prices and a 4% increase in volume. The
increase in sales was a result of higher selling prices to recapture

P O L Y O N E C O R P O R A T I O N

2005 compared with 2004:

(In millions)

Sales:

2005

2004

Change

% Change

Vinyl Business

$ 926.7 $ 831.4 $ 95.3

11%

International Color and
Engineered Materials

PolyOne Distribution

All Other

Corporate and
eliminations

473.2

679.2

543.1

466.4

606.3

519.9

6.8

72.9

23.2

12%

(171.6)

(156.3)

(15.3)

10%

$2,450.6 $2,267.7 $182.9

Operating income (loss):

Vinyl Business

59.8 $

67.8 $ (8.0)

International Color and
Engineered Materials

PolyOne Distribution

Resin and Intermediates

All Other

Corporate and
eliminations

16.2

19.5

90.9

(4.5)

34.1

17.8

53.7

(17.9)

1.7

37.2

(0.4)

(4.1)

(41.6)

(44.6)

3.0

$ 140.3 $ 128.4 $ 11.9

2005

2004

Change

Operating income (loss) as a

percentage of sales:

Vinyl Business

6.5% 8.2% (1.7)% points

International Color and Engineered

Materials

PolyOne Distribution

All Other

Total

3.4% 7.3% (3.9)% points

2.9% 2.9%

—

(0.8)% (0.1)% (0.7)% points

5.7% 5.7%

—

Vinyl Business sales were up 11% driven by higher average
selling prices from efforts to recapture increases in the cost of resin
and non-resin raw materials. Volume was down 4% due to softer
demand in virtually all markets except custom extrusions and
fittings. The majority of our customers experienced softer market
conditions, which negatively affected their demand for our products.
This decline in volume was partially offset by new business obtained
in custom extrusion and wire and cable applications. Operating
income fell $8.0 million primarily from the volume decline and higher
raw material and energy costs.

International Color and Engineered Materials sales increased
by 1% from higher average selling prices from efforts to recapture
raw material cost increases, combined with favorable Euro to
U.S. dollar currency exchange rates totaling approximately $3 mil-
lion. The sale of the Melos rubber granules business negatively
affected the year-over-year revenue comparison by 3 percentage
points. Volume declined 11% in 2005 compared to 2004. The May
2004 sale of the Melos rubber granules business accounted for
9 percentage points of the 11% year-over-year volume decline. The
balance of the volume decline was primarily the result of weakness

in demand for certain engineered materials applications and a
general weakness in European plastics markets that was partially
offset by higher volume in Asia. In the second quarter of 2005, we
began operations at our new manufacturing facility in Shenzhen,
China. This plant manufactures engineered material compounds,
inks. The sales and operating
color compounds and plastisol
income associated with plastisol inks are reported within the All
Other segment. Operating income declined by $17.9 million largely
reflecting increased competition experienced in the European engi-
neered materials markets. Energy-related operating costs nega-
tively affected earnings, and selling price increases did not fully
offset strong raw material cost increases. The sale of Melos neg-
atively
impacted 2005 earnings compared with 2004 by
$1.1 million.

PolyOne Distribution’s sales were up 12% driven by selling price
increases and a shift in product mix toward higher-priced products.
Volume declined 2%, primarily in commodity resins, which was
consistent with the general softening across the North American
plastics industry during the second quarter. Operating income
improved by $1.7 million. The effect of lower volumes and material
cost increases were offset by higher selling prices.

Resin and Intermediates operating

income increased
$37.2 million primarily as a result of a $29.0 million increase in
SunBelt’s earnings contribution and a $6.1 million increase from
OxyVinyls. OxyVinyls benefited from higher industry average PVC
resin and VCM product spreads that resulted from favorable supply
and demand dynamics and improved chlor-alkali profitability as
compared to 2004. This benefit was tempered in the third quarter
of 2005 by the adverse impact of the combination of hurricane-
related production interruptions and significant increases in ethyl-
ene and natural gas costs. SunBelt’s earnings improvement was
largely from significantly higher combined selling prices for chlorine
and caustic soda that were driven by favorable supply and demand
dynamics.

The All Other segment includes the North American Color and
Additives, North American Engineered Materials, Producer Services
and Polymer Coating Systems operating segments. Sales improved
4% despite a 4% decline in volume. The Producer Services operating
segment was formed at the start of 2006 from portions of the North
American Color and Additives and North American Engineered
Materials operating segments. As such, data for Producer Services
for 2004 is not available, preventing a comparison of results
between 2005 and 2004 for this operating segment. Therefore,
the following discussion combines these three operating segments,
North American Color and Additives, North American Engineered
Materials and Producer Services, for purposes of comparing 2005
results with 2004. Polymer Coating Systems, the other operating
segment within the All Other segment, was not affected.

Sales for the North American Color and Additives, North Amer-
ican Engineered Materials and Producer Services operating

P O L Y O N E C O R P O R A T I O N

segments were up by 6% in 2005 compared to 2004 despite a 4%
decline in volume. The decline in volume resulted from lower
demand in the packaging, pipe and fittings, film applications, and
general purpose and contract manufactured automotive applica-
tions markets, partially offset by an increase in volume in the
construction market. Higher average selling prices that resulted
from efforts to recapture raw material cost increases, combined
with a shift in product mix towards higher value-added products,
drove the sales increase.

Polymer Coating Systems sales were up 2%, though volume
was down 6% primarily due to a decline in automotive demand
caused by reduced production schedules and platform build-outs.
Some customers with their own compounding capability also
decided to bring the manufacture of a portion of their plastisol
requirements in-house, which reduced our volume. Higher average
selling prices drove the sales increase.

Operating income in 2006 for the All Other segment decreased
by $4.1 million primarily due to a lower volume and from higher
polyethylene and additives raw material costs that were not fully
recaptured in price increases due to competitive pressures.

Corporate and eliminations expense of $41.6 million in 2005
was $3.0 million lower than in 2004. The primary drivers for this
improvement include a net decrease of $12.7 million as a result of
decreases in legal and insurance reserves combined with legal
settlements; a decrease in net environmental costs of $7.8 million
associated with inactive or formerly owned sites; a decrease of
$5.3 million in share-based compensation and employee incentive
costs; a decrease in pension costs of $3.4 million; and the elim-
ination of the loss on sale of assets of $5.9 million that occurred in
2004. These improvements were not fully offset by the recognition
of a charge of $22.9 million related to the impairment of a previ-
ously idled facility at OxyVinyls in 2005 and an increase of $6.9 mil-
lion in charges related to employee separation and plant phaseout
activities in 2005 compared to 2004.

Impact of Inflation

Although inflation has slowed in recent years, we believe it remains
a factor in our economy and we continually seek ways to lessen its
impact. Toward that end, we deploy three primar y mitigating strat-
egies: a) within the context of competitive markets, we offset higher
raw material and energy costs by increasing the prices of our
products to customers over time; b) we are improving our ability
to sell higher valued specialized materials, services and solutions
to our customers where price is determined by value received by the
customer rather than by changes to cost inputs; and c) we are
implementing specific efficiency programs such as Lean Six Sigma,
energy conservation initiatives, and inventory and distribution cost
optimization programs, that are expected to lower our delivered cost
of product to customers, helping to negate portions of the detri-
mental effect of inflation.

Additionally, we use the last-in, first-out (LIFO) method of
accounting for 43% of our inventories and the first-in, first-out (FIFO)
or average cost method for the remainder. Under the LIFO method,

the cost of products sold that are reported in the financial state-
ments approximates current costs, providing a better match of
current period revenue and expenses. Charges to operations for
depreciation represent the allocation of historical costs incurred
over past years and are lower than if they were based on the current
cost of the productive capacity that is being consumed.

Critical Accounting Policies and Estimates

Significant accounting policies are described more fully in Note C to
the Consolidated Financial Statements. The preparation of financial
statements in conformity with generally accepted accounting prin-
ciples requires us to make estimates and assumptions about future
events that affect the amounts reported in our financial statements
and accompanying notes. We base our estimates on historical
experience and assumptions that we believe are reasonable under
the related facts and circumstances. The application of these crit-
ical accounting policies involves the exercise of judgment and use of
assumptions for future uncertainties. Accordingly, actual results
could differ significantly from these estimates. We believe that the
following discussion addresses our most critical accounting poli-
cies, which are those that are the most important to the portrayal of
our financial condition and results of operations and require our
most difficult, subjective and complex judgments.

Sales Discounts and Rebates — Sales discounts and rebates
are offered to certain customers to promote customer loyalty and to
encourage greater product sales. These programs provide custom-
ers with credits against their purchases if they attain pre-estab-
lished volumes or revenue milestones for a specific period. We
estimate the provision for rebates based on the specific terms of
each agreement at the time of shipment and an estimate of the
customer’s future achievement of the respective volume or revenue
milestones. The actual amounts earned can differ from these
estimates. In the past, the actual amounts earned by our customers
have not differed materially from our estimates.

Allowance for Doubtful Accounts — Allowances for doubtful
accounts are determined based on estimates of losses related to
customer receivable balances. In establishing the appropriate pro-
visions for customer receivable balances, we make assumptions
about their future collectibility. Our assumptions are based on an
individual assessment of each customer’s credit quality as well as
subjective factors and trends, including the aging of receivable
balances. We regularly analyze significant customer accounts and
record a specific reserve to reduce the related receivable to the
amount we reasonably believe is collectible when we become aware
of a customer’s inability to meet its financial obligations to us, such
as in the case of a bankruptcy filing or deterioration in the custom-
er’s operating results or financial position. We also record reserves
for all other customers based on a variety of factors, including the
length of time the receivables are past due, the financial health of
the customer, economic conditions and our historical experience. If
circumstances related to specific customers change, our estimates
of the collectibility of receivables may be adjusted further. In the
past, the actual losses incurred have differed from our estimates

P O L Y O N E C O R P O R A T I O N

primarily as a result of unforeseen bankruptcy filings by our
customers.

Environmental Accrued Liability — Based upon estimates pre-
pared by our environmental engineers and consultants, we have
$59.5 million accrued at December 31, 2006 to cover probable
future environmental remediation expenditures. We do not believe
that any of these matters, either individually or in the aggregate, will
have a material adverse effect on our capital expenditures, consol-
idated financial condition, results of operations or cash flow beyond
the amount accrued. This accrual represents our best estimate of
the remaining probable remediation costs based upon information
and technology currently available and our 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 we could incur additional costs in excess
of the amount accrued. However, such additional costs, if any,
cannot currently be estimated. Our estimate of this liability may
be revised as new regulations or technologies are developed or
additional information is obtained. Changes during the past five
years have primarily resulted from an increase in the estimate of
future remediation costs at existing sites and payments made each
year for remediation costs that were already accrued.

For more information about our environmental liabilities, see

Note N to the Consolidated Financial Statements.

Asbestos-Related Claims — We have been named in various
lawsuits involving multiple claimants and defendants for alleged
asbestos exposure in the past by, among others, workers and
contractors and their families at plants owned by us or our prede-
cessors, or on board ships owned or operated by us or our prede-
cessors. We have reserves totaling $0.5 million as of December 31,
2006 for asbestos-related claims that are probable and estimable.
We believe that the probability is remote that losses in excess of the
amounts we have accrued could be materially adverse to our finan-
cial condition, results of operations or cash flows. This belief is
based on our ongoing assessment of the strengths and weak-
nesses of the specific claims and our defenses and insurance
coverage available for these claims, as well as the probability
and expected magnitude of reasonably anticipated future asbes-
tos-related claims. Our assessment includes: whether the plead-
ings allege exposure to asbestos, asbestos-containing products or
premises exposure; the severity of the plaintiffs’ alleged injuries
from exposure to asbestos or asbestos-containing products and the
length and certainty of exposure on our premises, to the extent
disclosed in the pleadings or identified through discovery; whether
the named defendant related to us manufactured or sold asbestos-
containing products; the outcomes of cases recently resolved; and
the historical pattern of the number of claims. If the underlying facts
and circumstances change in the future, we will modify our
reserves, as appropriate. The amount of this accrual has not
materially changed over the past several years.

Restructuring-Related Accruals — Since PolyOne was formed
in 2000, we have recorded accruals for charges in connection with

restructuring our businesses, as well as integrating acquired busi-
nesses. These accruals include estimates related to employee
separation costs, the closure and/or consolidation of facilities,
contractual obligations and the value of assets such as property,
plant and equipment, and inventories. Actual amounts could differ
from the original estimates, and have differed in the past primarily
from differences between estimated and actual net proceeds
received upon the sale of property, plant and equipment.

Restructuring-related accruals are reviewed on a quarterly
basis and changes to these accruals are made when changes to
plans occur. Changes to restructuring plans for existing businesses
are recorded as employee separation and plant phaseout costs in
the period when the change occurs.

For more information about our restructuring activities, see

Note E to the Consolidated Financial Statements.

Goodwill — Under SFAS No. 142, “Goodwill and Other Intan-
gible Assets,” we are required to per form impairment tests of our
goodwill and intangible assets. These tests must be done at least
once a year, and more frequently if an event or circumstance
indicates that an impairment or a decline in value may have
occurred. We test for goodwill impairment on July 1 of each year.
The goodwill impairment test is a two-step process, which requires
us to make judgments about the assumptions that we use in the
calculation. The first step of the process consists of estimating the
fair value of each reporting unit based on a number of factors,
including projected future operating results and business plans,
economic projections, anticipated future cash flows, comparable
marketplace data from within a consistent industry grouping, and
the cost of capital. We compare these estimated fair values with
their carrying values, which includes the allocated goodwill. If the
estimated fair value is less than the carrying value, a second step is
per formed to compute the amount of the impairment by determining
an “implied fair value” of goodwill. The determination of a reporting
unit’s “implied fair value” of goodwill requires us to allocate the
estimated fair value of the reporting unit to the assets and liabilities
of the reporting unit. Any unallocated fair value represents the
“implied fair value” of goodwill, which is then compared to its
corresponding carrying value.

We cannot predict what future events might adversely affect
the reported value of our goodwill. These events include, but are not
limited to, strategic decisions made in response to economic com-
petitive conditions, the impact of the economic environment on our
customer base, or a material negative change in relationships with
significant customers.

For more information about our goodwill, see Note D to the

Consolidated Financial Statements.

Income Taxes — Estimates of full year taxable income are
used in the tax rate calculations for the legal entities and jurisdic-
tions in which we operate throughout the year and these estimates
may change during the year to reflect evolving facts and circum-
stances. During the year, we use judgment to estimate our income

P O L Y O N E C O R P O R A T I O N

the year. Because judgment is involved, the tax rate may

for
increase or decrease significantly in any period.

To determine income or loss for financial statement purposes,
we make estimates and judgments. These estimates and judg-
ments occur in the calculation of certain tax liabilities and in
determining the recoverability of deferred tax assets that result
from temporar y differences between the tax and financial state-
ment recognition of revenue and expense. SFAS No. 109, “Account-
ing for Income Taxes,” also requires us to reduce the deferred tax
assets by a valuation allowance if 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 the process of determining our ability to recover our deferred
tax assets, we consider all of the available positive and negative
evidence, including our past operating results, the existence of
cumulative losses in recent years and our forecast of future taxable
income. To estimate future taxable income we develop assumptions
including the amount of future state, federal and international pre-
tax income, the reversal of temporar y differences and the imple-
mentation of feasible and prudent tax planning strategies. These
assumptions require significant judgment to forecast future taxable
income and are consistent with the plans and estimates that we use
to manage our businesses.

As a result of our conclusions at December 31, 2006, we
recorded a $75.5 million reversal of our valuation allowance. This
amount is comprised of $44.3 million for the current year utilization
of net operating loss carryforwards, $15.4 million associated with
changes in accumulated other comprehensive income related to
pension and post-retirement health care benefit liabilities and a
$15.8 million reversal of the valuation allowance associated with
our determination that it is more likely than not that the deferred tax
asset will be realized.

In addition, the calculation of tax liabilities deals with uncer-
tainties in applying complex tax regulations in a large number of
jurisdictions. We recognize potential liabilities for anticipated tax
audit issues based on our estimate of the extent to which additional
taxes may be due. To the extent we prevail in matters for which
accruals have been established, or are required to pay amounts in
excess of recorded reserves, the effective tax rate in a given
financial statement period may be materially impacted.

For more information about our income taxes, see Note P to the

Consolidated Financial Statements.

Pensions and Post-retirement Benefits — Effective Decem-
ber 31, 2006, we adopted SFAS No. 158 (SFAS No. 158), “Employ-
ers’ Accounting
for Defined Benefit Pension and Other
Postretirement Plans, an amendment of FASB Statements
No. 87, 88, 106 and 132(R).” This statement requires employers
to recognize the overfunded or under funded status of defined
benefit post-retirement plans in their balance sheets. This is mea-
sured as the difference between the fair value of plan assets and
the benefit obligation of the plans (the projected benefit obligation
for pension plans and the accumulated post-retirement benefit

obligation for other post-retirement plans). The change in the funded
status of the plans must be recognized in the year in which the
change occurs through accumulated other comprehensive income.

Prior to the adoption of SFAS No. 158, we accounted for our
defined benefit post-retirement plans under SFAS No. 87, “Employ-
ers Accounting for Pensions,” and SFAS No. 106, “Employers
Accounting for Postretirement Benefits Other Than Pensions.”
SFAS No. 87 required that a liability (minimum pension liability)
be recorded when the accumulated benefit obligation (ABO) liability
exceeded the fair value of plan assets. Any adjustment to this
liability was recorded as a non-cash charge to accumulated other
comprehensive income within shareholders equity. SFAS No. 106
required that the liability that was recorded should represent the
actuarial present value of all future benefits attributable to an
employee’s service rendered to date. Under both SFAS No. 87
and No. 106, any change in the funded status was not immediately
recognized. Instead, they were deferred and recognized ratably over
future periods. Upon adoption of SFAS No. 158, we recognized the
amounts of prior changes in the funded status of our post-retire-
ment benefit plans through accumulated other comprehensive
income. As a result, the net impact of accounting for SFAS No. 158
was an increase of $6.4 million on a pre-tax basis and a decrease of
$0.4 million on an after-tax basis to our accumulated other com-
prehensive loss. In addition, we recorded an adjustment of $2.7 mil-
lion to increase accumulated other comprehensive loss to record
our proportionate share of OxyVinyls’ adoption of SFAS No. 158.

The adoption of SFAS No. 158 had no impact on our consol-
idated statements of operations for the year ended December 31,
2006 or for any prior period. Also, the adoption of SFAS No. 158
does not affect any financial covenants contained in the agree-
ments governing our debt and our receivables sale facility and is not
expected to affect operating results in future periods.

We have several pension plans, of which only two continue to
accrue benefits for certain U.S. employees. These two plans gen-
erally provide benefit payments using a formula that is based upon
employee compensation and length of service. Length of service for
determining benefit payments was frozen as of December 31,
2002. All U.S. defined-benefit pension plans are closed to new
participants. Regarding our other post-employment benefit plans,
only certain employees hired prior to December 31, 1999 are
eligible to participate.

Included in our results of operations are significant pension
and post-retirement benefit costs that we measure using actuarial
valuations. Inherent in these valuations are key assumptions,
including assumptions about discount rates and expected returns
on plan assets. These assumptions are updated at the beginning of
each fiscal year. We consider current market conditions, including
changes in interest
rates, when making these assumptions.
Changes in pension and post-retirement benefit costs may occur
in the future due to changes in these assumptions.

To develop our discount rate, we consider the yields of high-
quality, fixed-income investments with maturities that correspond to
the timing of our benefit obligations. To develop our expected return

P O L Y O N E C O R P O R A T I O N

on plan assets, we consider our 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 consider the duration of
the plan liabilities and give more weight to equity investments than
to fixed-income securities. Holding all other assumptions constant,
a 0.5 percentage point increase or decrease in the discount rate
would have increased or decreased our 2006 net pension and post-
retirement expense by approximately $2.0 million. Likewise, a
0.5 percentage point increase or decrease in the expected return
on plan assets would have increased or decreased our 2006 net
pension cost by approximately $1.9 million.

Market conditions and interest rates significantly affect the
value of future assets and liabilities of our pension and post-retire-
ment plans. It is difficult to predict these factors due to the volatility
of market conditions. Holding all other assumptions constant, a
0.5 percentage point increase or decrease in the discount rate
would have increased or decreased accumulated other comprehen-
sive income and the related pension and post-retirement liability by
approximately $35 million as of December 31, 2006.

The rate of increase in medical costs that we assume for the next
five years was held constant with prior years to reflect both our actual
experience and projected expectations. The health care cost trend
rate assumption has a significant effect on the amounts reported.
Holding all other assumptions constant, a 0.5 percentage increase or
decrease in the health care cost trend rate would have increased or
decreased our 2006 net periodic benefit cost by $0.2 million and our
accumulated other comprehensive income and the related post-
retirement liability by approximately $2.8 million as of December 31,
2006.

For more information about our pensions and post-retirement

benefits, see Note M to the Consolidated Financial Statements.

Share-Based Compensation — Prior to January 1, 2006, as
provided under SFAS No. 123, we applied APB No. 25 and related
interpretations to account for our share-based compensation plans.
Under APB No. 25, compensation expense was recognized for stock
option grants if the exercise price of the grant was below the fair
value of the underlying stock at the measurement date. On Janu-
ary 1, 2006, we adopted SFAS No. 123(R), which requires us to
recognize compensation expense based on the fair value on the
date of the grant. We are using the modified prospective transition
method, which does not require prior period financial statements to
be restated. The impact on pre-tax earnings from adopting
SFAS No. 123(R) for the year ended December 31, 2006 was a
charge of $2.5 million.

The option-pricing model that we used to value the stock
appreciation rights granted during 2006 was a Monte Carlo simu-
lation method. Under this method, the fair value of awards on the
date of grant is an estimate and is affected by our stock price, as
well as assumptions regarding a number of highly complex and
subjective variables. Expected volatility was set at the average of
the six-year historical weekly volatility for our common stock and the
implied volatility rates for exchange-traded options. The expected

term of options that were granted was set equal to halfway between
the vesting and expiration dates for each grant. Dividends were not
included in this calculation because we do not currently pay divi-
dends. The risk-free rate of return for periods within the contractual
life of the option is based on U.S. Treasury rates in effect at the time
of the grant. Forfeitures were estimated at 3% per year based on our
historical experience.

For more information on the adoption and impact of
SFAS No. 123(R), see Note C and Note Q to the Consolidated
Financial Statements.

Contingencies — We are 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 that
we judge to be probable and estimable has been accrued. The
actual amounts resulting from these matters can differ from our
estimates.

New Accounting Pronouncements — In June 2006, the FASB
issued FASB Interpretation No. 48 (FIN 48), “Accounting for Uncer-
tainty in Income Taxes — an interpretation of FASB Statement
No. 109, Accounting for Income Taxes,” which is effective for fiscal
years beginning after December 15, 2006. FIN 48 clarifies the
recognition threshold and measurement attributes for the financial
statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance
on derecognition, classification, interest and penalties, accounting
in interim periods, disclosure and transition. We are currently eval-
uating the provisions of FIN 48; however, the adoption is not
expected to have a material impact on our financial statements.

In September 2006, the FASB issued SFAS No. 158, “Employ-
er’s Accounting for Defined Benefit Pension and Other Postretire-
ment Plans — an Amendment of FASB Statements No. 87, 88, 106
and 132(R).” SFAS No. 158 requires an employer that is a business
entity and sponsors one or more single employer benefit plans to
(1) recognize the funded status of the benefit in its statement of
financial position, (2) recognize as a component of other compre-
hensive income, net of tax, the gains or losses and prior service
costs or credits that arise during the period but are not recognized
as components of net periodic benefit cost, (3) measure defined
benefit plan assets and obligations as of the date of the employer’s
fiscal year end statement of financial position and (4) disclose
additional information in the notes to financial statements about
certain effects on net periodic benefit costs for the next fiscal year
that arise from delayed recognition of gains or losses, prior service
costs or credits, and transition assets or obligations. SFAS No. 158
is effective for fiscal years ending after December 15, 2006. We
adopted SFAS No. 158 on December 31, 2006, which resulted in an
increase of $6.4 million on a pre-tax basis and a decrease of
$0.4 million on an after-tax basis on our accumulated other com-
prehensive loss. We also recorded an adjustment of $2.7 million to
increase accumulated other comprehensive loss to record our
proportionate share of OxyVinyls’ adoption of SFAS No. 158. The
adoption of SFAS No. 158 will have no effect on our compliance with

P O L Y O N E C O R P O R A T I O N

the financial covenants contained in the agreements governing our
debt and our receivables sale facility, and is not expected to affect
our operating results in future periods. For further discussion of the
impact of the adoption of SFAS No. 158, see Note M to the Con-
solidated Financial Statements.

Cash Flows

Detail about cash flows can be found in the Consolidated Statement
of Cash Flows. The following discussion focuses on the material
components of cash flows from operating, investing and financing
activities.

Operating Activities — In 2006, our operations provided
$111.7 million of cash. The primary sources of cash were: profit-
able business operations; a decline in accounts receivable due to
lower sales levels at the end of 2006 compared with the prior year;
and cash distributions that we received from our equity invest-
ments. Primary uses of cash included: cash payments for interest
and income taxes; an increase in inventories due to the slower than
expected sales volume at the end of the year; and a decrease in
accounts payable at the end of the year. Cash used by discontinued
operations was $0.1 million.

In 2005, our operations provided $63.7 million of cash. Pri-
mary sources of cash were: profitable business operations; a
decline in inventories from improved inventory turnover; an increase
in accounts payable due to higher purchasing levels to support
higher sales levels at the end of the year compared to the prior year;
cash distributions that we received from our equity investments;
and short-term borrowings under our receivables sale facility. Pri-
mary uses of cash were: cash payments for environmental reme-
diation at inactive sites; cash payments for interest and income
taxes; an increase in accounts receivable due to higher sales levels
at the end of the year compared to the prior year; and the payment of
employee bonuses that had been accrued at the end of 2004 that
were greater than those that were accrued at the end of 2005. Cash
provided by discontinued operations was $1.8 million.

In 2004, our operations used $20.6 million of cash. Primary
sources of cash were: profitable business operations; an increase
in accounts payable due to a higher purchasing levels to support
higher sales levels at the end of the year compared to the prior year,
combined with longer payment terms; and cash distributions that
we received from our equity investments. Primar y uses of cash
were: cash payments for employee separation and plant closure
initiatives; cash payments for interest and income taxes; an
increase in accounts receivable due to higher sales levels at the
end of the year compared to the prior year; the repayment of short-
term borrowings under our receivables sale facility; and a $65 mil-
lion voluntary contribution to a defined-benefit pension plan. Cash
provided by discontinued operations was $5.9 million.

Working capital management

Our working capital management focus is on three metrics that we
believe are the most critical to maximizing cash provided by oper-
ating activities. These three metrics measure the number of days of

sales in receivables (DSO), and the days of cost of goods sold in
inventories (DSI) and accounts payable (DSP). These metrics allow
us to better understand the total dollar changes in the three dollar
components of working capital by isolating the effects of sales and
production levels in the business versus management’s efforts to
drive more efficient use of company funds.

The following table presents our working capital metrics and
the impact of changes in efficiency and volume on accounts receiv-
able, inventories and accounts payable:

Accounts receivable DSO

Inventories DSI

Accounts payable DSP

2006

2005

2004

50.7

44.0

51.4

43.7

52.8

45.9

(41.7)

(40.2)

(44.1)

Average annual net days

53.0

54.9

54.6

Change in net days from prior year end

1.9

(0.3)

Compared to 2005, 2006 average annual net days improved
1.9 days as management initiatives around working capital dem-
onstrated continued improvement. Comparing 2005 versus 2004,
DSO and DSI performance improved 3.6 days collectively, offset by
a less favorable per formance in DSP.

(In millions)

Cash provided (used) by

Accounts receivable

Inventories

Accounts payable

2006

2005

$ 23.0

$(23.6)

(39.6)

(17.2)

9.3

13.0

$(33.8)

$ (1.3)

Impact of change in net days

$ 20.4

$ 36.8

Impact of change in sales and production levels

(54.2)

(38.1)

$(33.8)

$ (1.3)

From December 31, 2005 to December 31, 2006, $33.8 mil-
lion of cash was consumed in working capital investment driven by
higher inventories and lower payables. Year-end 2005 demand was
significantly above typical seasonal levels and caused a larger than
expected reduction in inventories reflecting heightened customer
demand following the severe storms in the U.S. Gulf Coast. Con-
versely, at the end of 2006, demand softened resulting in a rela-
tively higher year-end inventory levels. The decline in accounts
payable was due to lower purchases during December of 2006.

Higher sales levels during 2005 used $38.1 million of cash
from operating activities to fund the increase in sales from 2004 to
2005. Effective working capital programs, however, resulted in a
minimal overall increase of 0.3 net days outstanding over the same
time period. This contributed $36.8 million to cash provided by
operating activities, holding the increase in our total investment in
receivables, inventory and payables from the effect of higher sales
levels to a minimum.

Investing Activities — In 2006, we used $16.8 million for
investing activities, primarily for capital spending in support of

P O L Y O N E C O R P O R A T I O N

manufacturing operations. This use of cash was partially offset by
the proceeds from the sale of our Engineered Films business.
Capital spending in 2006 as a percentage of depreciation was
75%. Cash used by discontinued operations was $0.2 million.

In 2005, we used $24.2 million for investing activities, reflect-
ing capital spending in support of manufacturing operations, the
purchase of the remaining 16% of Star Color, a Thailand-based color
and additives business, and the purchase of certain assets of
Novatec Plastics Corporation. Star Color is included in our Interna-
tional Color and Engineered Materials segment, and Novatec’s
assets are included in our Vinyl Business segment. This capital
spending was partially offset by proceeds that we received from the
sale of previously closed facilities. Capital spending as a percent-
age of depreciation was 67% in 2005. Cash used by discontinued
operations was $1.7 million.

In 2004, we generated $106.8 million from investing activities,
largely from the sale of our Elastomers and Per formance Additives
business and our European Melos rubber granules business. Melos
was formerly included in our International Color and Engineered
Materials segment. Elastomers and Per formance Additives was a
separate segment that was reclassified as a discontinued operation
as of December 31, 2003. This cash generation was partially offset
by capital spending in support of manufacturing operations and the
acquisition of the North American distribution business of Resin-
Direct LLC, which is included in our PolyOne Distribution segment.
Capital spending as a percentage of depreciation in 2004 was 51%.
Cash used by discontinued operations was $4.6 million.

Financing Activities — Cash used by financing activities in
2006, 2005 and 2004 was primarily for the extinguishment of debt.

Discontinued Operations — Cash flows from discontinued
operations are presented separately on a single line in each section
of the Consolidated Statements of Cash Flows. The absence of
future cash flows from discontinued operations is not expected to
materially affect future liquidity and capital resources.

Balance Sheets

The following discussion focuses on material changes in balance
sheet line items from December 31, 2005 to December 31, 2006
that are not discussed in the preceding “Cash Flows” section.

Other non-current assets — The increase of $4.5 million was
primarily due to the recording of a note receivable of $6.2 million
resulting from the sale of our Engineered Films business in February
2006.

Accrued expenses — The increase of $10.7 million was pri-
marily due to an increase in accrued employee benefit costs,
including incentives and vacation benefits, partially offset by a
reduction in accrued payroll taxes and accrued income taxes.

Post-retirement benefits other than pensions — The reduc-
tion of $24.3 million was due to the adoption of SFAS No. 158 and
an increase in the discount rate to determine the liability for other

post-employment benefits (OPEBs), both of which resulted in a
decrease in the liability for OPEBs.

Other non-current liabilities including pensions — The reduc-
tion of $13.8 million was primarily due to a decrease in the pension
liability of $10.3 million that resulted primarily from an increase in
the discount rate at December 31, 2006, partially offset by an
increase of $6.6 million in non-current environmental reserves. The
remaining decrease in other non-current liabilities including pen-
sions is comprised of other less significant account changes such
as employment costs, insurance accruals and other reserves.

Capital Resources and Liquidity

Liquidity is defined as an enterprise’s ability to generate adequate
amounts of cash to meet both current and future needs. These
needs include paying obligations as they mature, maintaining pro-
duction capacity and providing for planned growth. Capital
resources are sources of funds other than those generated by
operations. We are not aware of any trends, demands, commit-
ments, events, or uncertainties that are reasonably likely to result
in our liquidity increasing or decreasing to the extent that it would
have a material adverse effect on our financial condition.

As of December 31, 2006, we had existing facilities to access
available capital resources (receivables sale facility, uncommitted
short-term credit lines and senior unsecured notes and debentures)
totaling $706.9 million. As of December 31, 2006, we had used
$595.4 million of these facilities, and $111.5 million was available
to be drawn while remaining in compliance with all facilities. In
addition, at December 31, 2006, we could incur additional secured
debt in an amount up to $31.6 million while remaining in compliance
with the debt coverage limit contained in the Guarantee and Agree-
ment, discussed in the section titled “Revolving Credit Facility”
below. As of December 31, 2006, we also had a $66.2 million
cash and cash equivalents balance that exceeded our typical oper-
ating cash requirements of $35 million to $40 million, adding to our
available liquidity.

The following table summarizes our available and outstanding

facilities at December 31, 2006:

(In millions)

Outstanding

Available

Long-term debt, including current maturities

$590.2

$ —

Receivables sale facility

Short-term debt

—

5.2

111.5

—

$595.4

$111.5

Long-Term Debt — At December 31, 2006, long-term debt
totaled $590.2 million, with maturities ranging from 2007 to
2015. Current maturities of
long-term debt at December 31,
2006 were $22.5 million. During 2006, we repurchased $58.6 mil-
lion aggregate principal amount of our 10.625% senior notes due
2010 at a premium of $4.4 million. This premium is shown as a
separate line item in the Consolidated Statements of Operations.
Unamortized deferred note issuance costs of $0.8 million were
expensed due to this repurchase and are included in interest

P O L Y O N E C O R P O R A T I O N

expense in the Consolidated Statements of Operations. We also
made a payment of $0.7 million of aggregate principal amount of our
medium-term notes which matured during 2006. As part of our
purchase of DH Compounding Company during the fourth quarter
2006, we issued a promissory note in the principal amount of
$8.7 million, payable in 36 equal installments at a rate of 6% per
annum. During 2006, we made principal payments totaling $0.7 mil-
lion on this promissory note. For more information about our debt,
see Note G to the Consolidated Financial Statements.

Revolving Credit Facility — We decided not to renew our
revolving credit facility, and, accordingly, it expired on June 6,
2006. To replace some of the features of this expired facility, we
entered into a definitive Guarantee and Agreement with Citicorp
USA, Inc. on June 6, 2006. Under this Guarantee and Agreement,
we guarantee the treasury management and banking services pro-
vided to us and our subsidiaries, such as subsidiary borrowings,
interest rate swaps, foreign currency forwards, letters of credit,
credit card programs and bank overdrafts. This guarantee is
secured by our inventories located in the United States.

Receivables Sale Facility — Our receivables sale facility will
expire in July 2010. Our receivables sale facility allows us to sell
accounts receivable and obtain proceeds of up to $175.0 million.
The maximum proceeds that we may receive is limited to 85% of the
eligible domestic accounts receivable sold. This facility also makes
up to $40.0 million available for issuing standby letters of credit, of
which $10.9 million was used at December 31, 2006.

The receivables sale facility requires us to maintain a minimum
Fixed Charge Coverage Ratio (defined as Adjusted EBITDA less
capital expenditures, divided by interest expense and scheduled
debt repayments for the next four quarters) of at least 1 to 1 when
availability under the facility is $40 million or less. As of Decem-
ber 31, 2006, the Fixed Charge Coverage Ratio was 2.3 to 1 and
availability under the facility was $111.5 million.

Of the capital resource facilities available to us as of Decem-
ber 31, 2006, the portion of the receivables sale facility that was
actually sold provided security for the transfer of ownership of these
receivables. Each indenture governing our senior unsecured notes
and debentures and our guarantee of the SunBelt notes allows a
specific level of secured debt, above which security must be pro-
vided on each indenture and our guarantee of the SunBelt notes.
The receivables sale facility and our guarantee of the SunBelt notes
are not considered debt under the covenants associated with our
senior unsecured notes and debentures. As of December 31, 2006,
we had not sold any accounts receivable and had guaranteed
$67.0 million of our SunBelt equity affiliate’s debt.

The following table summarizes our obligations under long-term
interest

debt, operating leases, standby

letters of credit,

obligations, pension and post-retirement obligations, guarantees
and purchase obligations as of December 31, 2006:

Payment Due by Period

Less than

More than

Total

1 Year

1-3 Years 4-5 Years

5 Years

(In millions)

Contractual

Obligations

Long-term debt

$ 590.2 $ 22.5 $ 42.4 $276.2 $249.1

Operating leases

Standby letters of

credit

65.0

15.2

21.2

13.4

15.2

10.9

—

Interest obligations(1)

235.8

53.7 103.2

56.5

22.4

Pension and post-

retirement
obligations(2)

Guarantees

Purchase obligations

198.1

25.1

67.0

1.9

6.1

1.4

55.6

12.2

0.4

49.4

12.2

0.1

68.0

36.5

—

Total

$1,168.9 $134.9 $235.0 $407.8 $391.2

(1) Interest obligations are stated at the rate of interest that is defined
by the debt instrument and take into effect any impact of rate swap
agreements, assuming that the debt is paid at maturity.

(2) Pension and post-retirement obligations relate to our U.S. and inter-
national pension and other post-retirement plans. Based upon our
interpretation of the new pension regulations, there will be minimum
funding requirements in 2007 of approximately $11.1 million for our
U.S. qualified defined benefit pension plans. Obligations are based
on the plans’ current funded status and actuarial assumptions, and
include funding requirements projected to be made to our qualified
pension plans, projected benefit payments to participants in our
other post-employment benefit plans, and projected benefit pay-
ments to participants in our non-qualified pension plans through
2016.

We expect that profitable operations in 2007 will enable us to
maintain existing levels of available capital resources and meet our
cash requirements. Expected sources of cash in 2007 include net
income, additional borrowings under existing loan agreements,
cash distributions from equity affiliates and proceeds from the sale
of previously closed facilities and redundant assets. Expected uses
of cash in 2007 include interest expense and discounts on the sale
of accounts receivable, cash taxes, a contribution to a defined
benefit pension plan, capital expenditures, early extinguishment
of a portion of long-term debt and the retirement of medium-term
notes maturing in 2007. Capital expenditures are currently esti-
mated to be between $45 and $50 million in 2007, primarily to
support strategic growth initiatives and manufacturing operations.
Cash expenditures for environmental remediation in future years
are expected to be generally consistent with 2006 levels.

Based on current projections, we believe that we should be
able to continue to manage and control working capital, discretion-
ary spending and capital expenditures and that cash provided by
operating activities, along with available borrowing capacity under
our receivables sale facility, should allow us to maintain adequate
levels of available capital resources to fund our operations and
meet debt service and minimum pension funding requirements for
both the short- and long-term.

P O L Y O N E C O R P O R A T I O N

Related-Party Transactions

We purchase a substantial portion of our PVC resin and all of our
VCM raw materials under supply agreements with OxyVinyls, a 24%
equity-owned company. These agreements have an initial term of
15 years, commencing May 1, 1999, and we have the right to renew
these agreements for two five-year periods. We have also entered
into various service agreements with OxyVinyls. Net amounts owed
to OxyVinyls, primarily for raw material purchases, totaled $17.3 mil-
lion at December 31, 2006 and $28.0 million at December 31,
2005. Our total purchases of raw materials from OxyVinyls were
$369 million during 2006 and $368 million during 2005.

Off-Balance Sheet Arrangements

Receivables sale facility — We sell our accounts receivable to
PolyOne Funding Corporation (PFC), a wholly-owned, bankruptcy-
remote subsidiary. At December 31, 2006, accounts receivable
totaling $161.6 million were sold to PFC and, as a result, they are
reflected as a reduction of accounts receivable in our Consolidated
Balance Sheets. PFC in turn sells an undivided interest in these
accounts receivable to certain investors and realizes proceeds of up
to $175 million. The maximum proceeds that PFC may receive under
the facility is limited to 85% of the eligible accounts receivable sold
to PFC. At December 31, 2006, PFC had not sold any of its undivided
interests in accounts receivable. We retained an interest in the
$161.6 million of trade receivables sold by us to PFC. As a result,
this retained interest is included in accounts receivable on our
Consolidated Balance Sheet at December 31, 2006. We believe
that available funding under our receivables sale facility provides us
increased flexibility to manage working capital requirements and is
an important source of liquidity. For more information about our
receivables sale facility, see Note I to the Consolidated Financial
Statements.

Guarantee of indebtedness of others — As discussed in Note N
to the Consolidated Financial Statements, we guarantee $67.0 mil-
lion of unconsolidated equity affiliate debt of Sunbelt in connection
with the construction of a chlor-alkali facility in McIntosh, Alabama.
This debt guarantee matures in 2017.

Letters of credit — We maintain approximately $10.9 million
letters of credit under the receivables sale facility. These letters of
credit are issued by the bank in favor of third parties and are mainly
related to insurance claims and interest rate swap agreements.

We have no other off-balance sheet arrangements as defined in

Item 303(a)(4)(ii) of Regulation S-K.

Outlook

We anticipate that the North American market and operating envi-
ronment experienced during the last half of 2006 will continue into
early 2007, as the industrial slowdown we experienced is projected
to continue through the first half. Sales demand was sluggish at the
end 2006, reflecting softening in the building and construction,
automotive and consumer durables (e.g., appliance) markets.

Pockets of strengthening demand have been seen, but it is prema-
ture to view them as sustainable and predictive of a broader
rebound. Overall
industrial production is projected to moderate
approximately 1.5 percentage points to 2.5% compared to 2006.
Automobile production is also projected to soften compared to
2006. The leading construction index, on the other hand, started
to show signs of improvement in the fourth quarter of 2006. While it
is too early to suggest a strong uptrend, it is encouraging for a
rebound in late spring 2007. Moreover, the leading home price
index is also rising. If this advance continues, it would point to the
bottom in home prices as early as late spring. This would also likely
bolster consumer confidence and spending. Sustained lower energy
prices to the consumer, at least compared to the two previous
years, should also strengthen confidence with the attendant ben-
eficial impacts on the overall economy. With this backdrop, we do
not anticipate a material change to long term North American plastic
consumption growth trends of 2.5% to 4% in 2007.

After having strengthened markedly in 2006, Eurozone eco-
nomic growth, in terms of gross domestic product (GDP) and indus-
trial production, is projected to moderate in 2007. This trend is
expected to be generally mirrored in our principal market economies
of Germany, France, United Kingdom and Benelux. Spain, on the
other hand, is expected to experience continued strong economic
growth in 2007 of approximately 3.5% after 3.9% growth in 2006.
The primary economies in Eastern Europe are projected to experi-
ence GDP growth between 2 and 3 times that of Western Europe.
Plastics consumption growth in Western Europe is projected to
remain in the 1.5% to 2.5% range, whereas Eastern Europe plastic
consumption is expected to remain in the high single digits. Addi-
tionally, per capita plastics consumption is approximately 55 kilo-
grams in Eastern Europe, only 60% of the 95 kilogram consumption
experienced in Western Europe.

GDP growth for key Asian economies in 2007 is projected to
moderate compared to 2006. GDP growth in China is projected to be
9% to 10%. Industrial production is projected to be approximately
50% higher than GDP growth rates. Plastics growth for ASEAN is
projected at 5% to 6%, and plastics growth in China is projected at
14% in the aggregate, with regional differences accounting for
growth rates that range between 12% and 20%. Our target is to
grow sales 15% to 20% annually, well in excess of market growth
rates, through organic programs and entry into new markets and
geographies.

Even though margin pressures experienced across most busi-
ness segments at the end of 2006 are not expected to abate in the
near term, we project improved gross margins in 2007 due to more
effective pricing, an improved sales mix through specialization and
accelerated rates of higher value new business closes. Gross
margins will also benefit from sourcing leverage and operating
efficiencies resulting from Lean-Six Sigma implementation. It is
also noteworthy that fourth quarter 2006 pricing actions should
provide a degree of margin momentum entering 2007, despite
market pressures being exerted on our businesses.

P O L Y O N E C O R P O R A T I O N

Chlorovinyl and derivative hydrocarbon costs are projected to
decline from cycle peaks realized in 2006. This trend began in the
third quarter of 2006 and is expected to continue through 2007.
Natural gas, on the other hand, is projected to average moderately
higher in 2007 compared to 2006. Aggregate chlorine and caustic
prices are projected to fall, adversely impacting earnings in Resin
and Intermediates. Based on these expectations, the overall net
2007 chlorovinyl chain margin drivers are expected to negatively
impact operating income in 2007.

Listed below are some of the priorities that we have identified

for 2007:

(cid:129) Transform our culture towards specialization to drive addi-
tional sales of new high margin business by having a cus-
tomer first focus.

(cid:129) Improve gross margins through value pricing, upgrading
sales mix, developing differentiated new product technolo-
gies and closing more new high value business across each
operating business.

(cid:129) Implement initiatives that drive our key strategies:

(cid:129) Specialization — Shift basis of competition to differenti-

ation from a cost and commodity orientation;

(cid:129) Globalization — Leverage

our

global

competitive

advantages;

as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,”
“believe” and other words and terms of similar meaning in connec-
tion with any discussion of future operating or financial per for-
mance. In particular, these include statements relating to future
actions; prospective changes in raw material costs, product pricing
or product demand; future per formance or results of current and
anticipated market conditions and market strategies; sales efforts;
expenses; the outcome of contingencies such as legal proceedings;
and financial results. Factors that could cause actual results to
differ materially include, but are not limited to:

(cid:129) the effect on foreign operations of currency fluctuations,
tariffs, nationalization, exchange controls, limitations on
foreign investment in local businesses and other political,
economic and regulatory risks;

(cid:129) changes in polymer consumption growth rates within the
U.S., Europe or Asia or other geographic regions where
PolyOne conducts business;

(cid:129) changes in global industry capacity or in the rate at which
anticipated changes in industry capacity come online in the
PVC, chlor-alkali, VCM or other industries in which PolyOne
participates;

(cid:129) fluctuations in raw material prices, quality and supply and in
energy prices and supply, in particular fluctuations outside
the normal range of industry cycles;

(cid:129) Operational Excellence — Drive cultural
answer

Voice

and

the

address
relentlessly; and

change to
Customer

(cid:129) production outages or material costs associated with sched-

uled or unscheduled maintenance programs;

(cid:129) Commercial Excellence — Improve

of
sales, marketing and innovation resources to strengthen
our value proposition to sell valued solutions, not
products.

effectiveness

(cid:129) Restore profitability and reposition North American Engi-
neered Materials further into being a high value custom
specialty business.

(cid:129) Deliver meaningful progress toward re-establishing North

American Color and Additives profitability.

(cid:129) Further strengthen our financial profile.

CAUTIONARY NOTE ON FORWARD-LOOKING STATEMENTS

In this Annual Report on Form 10-K, statements that are not
reported financial results or other historical information are “for-
ward-looking statements” within the meaning of the Private Secu-
rities Litigation Reform Act of 1995. Forward-looking statements
give current expectations or forecasts of future events and are not
guarantees of future per formance. They are based on manage-
ment’s expectations that involve a number of business risks and
uncertainties, any of which could cause actual results to differ
materially from those expressed in or implied by the forward-looking
statements. You can identify these statements by the fact that they
do not relate strictly to historic or current facts. They use words such

P O L Y O N E C O R P O R A T I O N

(cid:129) costs, difficulties or delays related to the operation of joint

venture entities;

(cid:129) lack of day-to-day operating control, including procurement of

raw materials, of equity affiliates or joint ventures;

(cid:129) partial control over investment decisions and dividend dis-
tribution policy of the OxyVinyls partnership and other minor-
ity equity holdings of PolyOne;

(cid:129) an inability to launch new products and/or services within

PolyOne’s various businesses;

(cid:129) the possibility of further goodwill impairment;

(cid:129) an inability to maintain any required licenses or permits;

(cid:129) an inability to comply with any environmental

laws and

regulations;

(cid:129) the cost of compliance with environmental laws and regula-
tions, including any increased cost of complying with new or
revised laws and regulations;

(cid:129) unanticipated developments that could occur with respect to
contingencies such as litigation and environmental matters,
including any developments that would require any increase
in our costs and/or reserves for such contingencies;

(cid:129) the cost of complying, or the inability to comply, with the
REACH legislation in Europe that may make it more difficult

to use recycled wastes and imported chemical
materials;

raw

identify all risk factors. Consequently, you should not consider any
such list to be a complete set of all potential risks or uncertainties.

(cid:129) an inability to achieve or delays in achieving or achievement
of less than the anticipated financial benefit from initiatives
related to cost reductions and employee productivity goals;

(cid:129) a delay or inability to achieve targeted debt level reductions;

(cid:129) an inability to access the receivables sale facility as a result
of breaching covenants due to not achieving anticipated
earnings per formance or for any other reason;

(cid:129) any poor per formance of our pension plan assets and any
obligation on our part to fund PolyOne’s pension plan;

(cid:129) any delay and/or inability to bring the North American Color
and Additives and the Engineered Materials segments to
profitability;

(cid:129) an inability to raise or sustain prices for products or services;

(cid:129) an inability to maintain appropriate relations with unions and
employees in certain locations in order to avoid business
disruptions;

(cid:129) other factors affecting our business beyond our control,
including, without limitation, changes in the general econ-
omy, changes in interest rates and changes in the rate of
inflation;

(cid:129) any change in agreements with product suppliers to PolyOne
Distribution that prohibit PolyOne from distributing products;

(cid:129) the timing and amounts of any repurchases of outstanding
senior notes or medium-term notes, including the amount of
any premiums paid;

(cid:129) the timing of completion of acquisitions, including the acqui-

sition of Ngai Hing PlastChem Company;

(cid:129) the future financial per formance of acquired businesses,
including that of Ngai Hing PlastChem Company and DH
Compounding Company; and

(cid:129) other factors described in this Annual Repor t on Form 10-K

under Item 1A, “Risk Factors.”

We cannot guarantee that any forward-looking statement will
be realized, although we believe we have been prudent in our plans
and assumptions. Achievement of future results is subject to risks,
uncertainties and inaccurate assumptions. Should known or
unknown risks or uncertainties materialize, or should underlying
assumptions prove inaccurate, actual results could vary materially
from those anticipated, estimated or projected. Investors should
bear this in mind as they consider forward-looking statements. We
undertake no obligation to publicly update forward-looking state-
ments, whether as a result of new information, future events or
otherwise, except as otherwise required by law. You are advised,
however, to consult any further disclosures we make on related
subjects in our reports on Forms 10-Q, 8-K and 10-K furnished to
the SEC. You should understand that it is not possible to predict or

P O L Y O N E C O R P O R A T I O N

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE

MANAGEMENT’S REPORT

ABOUT MARKET RISK

We are exposed to certain market risks as part of our ongoing
business operations, including risks from changes in interest rates
on debt obligations and foreign currency exchange rates, that could
impact our financial condition, results of operations and cash flows.
We manage our exposure to these and other market risks through
regular operating and financing activities, including the use of
derivative financial instruments. We intend to use these derivative
financial instruments as risk management tools and not for spec-
ulative investment purposes.

Interest rate exposure — We periodically enter into interest
rate swap agreements that modify our exposure to interest rate risk
by converting some of our fixed-rate obligations to floating rates. We
have six agreements with a net fair value liability of $5.1 million and
$5.8 million at December 31, 2006 and 2005, respectively. The
weighted-average interest rate for these six agreements was 9.3%
at December 31, 2006 and 8.2% at December 31, 2005. These
exchange agreements are perfectly effective as defined by SFAS
No. 133, “Accounting for Derivative Financial
Instruments and
Hedging Activities.” There were no material changes in the market
risk that we faced during 2006. For more information about our
interest rate exposure, see Note C to the Consolidated Financial
Statements.

Foreign currency exposure — We enter into intercompany
lending transactions that are denominated in various foreign cur-
rencies and are subject to financial exposure from foreign exchange
rate movement from the date a loan is recorded to the date it is
settled or revalued. To mitigate this risk, we enter into foreign
exchange contracts. Gains and losses on these contracts generally
offset gains or losses on the assets and liabilities being hedged,
and are recorded as other income or expense in the Consolidated
Statements of Operations. We do not hold or issue financial instru-
ments for trading purposes. For more information about our foreign
currency exposure, see Note T to the Consolidated Financial
Statements.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Financial Statements and Financial Statement
Schedule

Management’s Report

Reports of Independent Registered Public Accounting Firm

Consolidated Financial Statements:

Consolidated Statements of Operations

Consolidated Balance Sheets

Consolidated Statements of Cash Flows
Consolidated Statements of Shareholders’ Equity

Notes to Consolidated Financial Statements

Financial Statement Schedules:

Schedule II — Valuation and Qualifying Accounts

Page
30

34
35

36-61

P O L Y O N E C O R P O R A T I O N

The management of PolyOne Corporation is responsible for prepar-
ing the consolidated financial statements and disclosures included
in this Annual Report on Form 10-K. The financial statements and
disclosures included in this Annual Repor t fairly present in all
material respects the financial position, results of operations,
shareholders’ equity and cash flows of PolyOne Corporation as of
and for the year ended December 31, 2006.

Management is responsible for establishing and maintaining
disclosure controls and procedures designed to ensure that the
information required to be disclosed by the company is captured
and reported in a timely manner. Management has evaluated the
design and operation of the company’s disclosure controls and
procedures at December 31, 2006, and found them to be effective.

financial

Internal control over

Management is also responsible for establishing and main-
taining a system of internal control over financial reporting that is
designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted
accounting principles.
reporting
includes policies and procedures that provide reasonable assur-
ance that: PolyOne Corporation’s accounting records accurately and
fairly reflect the transactions and dispositions of the assets of the
company; unauthorized or improper acquisition, use or disposal of
company assets will be prevented or timely detected; the compa-
ny’s transactions are properly recorded and reported to permit the
preparation of the company’s financial statements in conformity
with generally accepted accounting principles; and the company’s
receipts and expenditures are made only in accordance with autho-
rizations of management and the board of directors of the company.

financial

Management has assessed the effectiveness of PolyOne’s
internal control over
reporting as of December 31,
2006, and has prepared Management’s Annual Repor t On Internal
Control Over Financial Reporting contained on page 62 of this
Annual Repor t. This report concludes that internal control over
financial reporting is effective and that no material weaknesses
were identified.

Ernst & Young LLP, who audited the consolidated financial
statements of PolyOne Corporation as of and for the year ended
December 31, 2006, also audited management’s assessment of
internal control over financial reporting and issued an attestation
report on that assessment.

/s/ STEPHEN D. NEWLIN

/s/ W. DAVID WILSON

Stephen D. Newlin
President and
Chief Executive Officer

February 26, 2007

W. David Wilson
Senior Vice President
and Chief Financial Officer

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders PolyOne Corporation

have

included

assessment,

audited management’s

We
in
Item 9A,“Controls and Procedures — Management’s Annual Report
on Internal Control over Financial Reporting,” that PolyOne Corporation
maintained effective internal control over financial reporting as of
December 31, 2006, based on criteria established in Internal Con-
trol — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). Poly-
One Corporation’s management is responsible for maintaining effec-
tive internal control over financial reporting and for its assessment of
the effectiveness of internal control over
financial reporting. Our
responsibility is to express an opinion on management’s assessment
and an opinion on the effectiveness of the company’s internal control
over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and per form the audit to obtain rea-
sonable assurance about whether effective internal control over finan-
cial reporting was maintained in all material respects. Our audit
included obtaining an understanding of internal control over financial
reporting, evaluating management’s assessment, testing and evalu-
ating the design and operating effectiveness of internal control over
financial reporting, and per forming such other procedures as we con-
sidered necessary in the circumstances. We believe that our audit
provides a reasonable basis for our opinion.

financial

A company’s internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principles. A company’s internal control over
reporting
includes those policies and procedures that: (1) pertain to the main-
tenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and
(3) provide reasonable assurance regarding prevention or timely detec-
tion of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections
of any evaluation of effectiveness to future periods are subject to the
risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or
procedures may deteriorate.

In our opinion, management’s assessment that PolyOne Corpo-
ration maintained effective internal control over financial reporting as
of December 31, 2006 is fairly stated, in all material respects, based
on the COSO criteria. Also, in our opinion, PolyOne Corporation main-
tained, in all material respects, effective internal control over financial
reporting as of December 31, 2006, based on the COSO criteria.

We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the con-
solidated balance sheets of PolyOne Corporation and subsidiaries as of
December 31, 2006, and 2005, and the related consolidated state-
ments of operations, shareholders’ equity, and cash flows for each of
the three years in the period ended December 31, 2006 of PolyOne
Corporation and our report dated February 26, 2007 expressed an
unqualified opinion thereon.

/s/ ERNST & YOUNG

Cleveland, Ohio
February 26, 2007

To the Board of Directors and Shareholders PolyOne Corporation
We have audited the consolidated balance sheets of PolyOne Corpo-
ration and subsidiaries as of December 31, 2006 and 2005, and the
related consolidated statements of operations, shareholders’ equity,
and cash flows for each of the three years in the period ended Decem-
ber 31, 2006. Our audits also included the financial statement sched-
ule listed in the Index at Item 15(a)(2). These financial statements and
schedule are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements
and schedule based on our audits. The financial statements of Oxy
Vinyls, LP (a limited partnership in which the Company has a 24%
interest) have been audited by other auditors whose report has been
furnished to us, and our opinion on the consolidated financial state-
ments, insofar as it relates to 2006, 2005 and 2004 amounts included
for Oxy Vinyls, LP, is based solely on the report of the other auditors.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and per form the audit to obtain rea-
sonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe
that our audits and the report of other auditors provide a reasonable
basis for our opinion.

In our opinion, based on our audits and the report of other audi-
tors, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of PolyOne Cor-
poration and subsidiaries at December 31, 2006 and 2005, and the
consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 2006, in conformity
with U.S. generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.

As discussed in Note C to the consolidated financial statements,
the Company adopted SFAS No. 123(R), “Share-Based Payment”
applying the modified prospective transition method effective Janu-
ary 1, 2006. As discussed in Note C to the consolidated financial
statements, the Company adopted the provisions of SFAS No. 158,
“Employers’ Accounting for Defined Benefit Pension and Other Postre-
tirement Plans, an amendment of FASB Statements No. 87, 88, 106
and 132»” effective December 31, 2006.

We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the effec-
tiveness of the Company’s internal control over financial reporting as
of December 31, 2006, based on criteria established in Internal Con-
trol-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated Feb-
ruary 26, 2007 expressed an unqualified opinion thereon.

/s/ ERNST & YOUNG

Cleveland, Ohio
February 26, 2007

P O L Y O N E C O R P O R A T I O N

Consolidated Statements of Operations

(In millions, except per share data)

Sales

Operating costs and expenses:

Cost of sales

Selling and administrative

Depreciation and amortization

Employee separation and plant phaseout

Asset impairments

Environmental remediation at inactive sites

Income from equity affiliates and minority interest

Operating income

Interest expense

Interest income

Premium on early extinguishment of long-term debt

Other expense, net

Income before income taxes and discontinued operations

Income tax benefit (expense)

Income before discontinued operations

Loss from discontinued operations and loss on sale, net of income taxes

Net income

Basic and diluted earnings (loss) per common share:

Before discontinued operations

Discontinued operations

Basic and diluted earnings per common share

Weighted average shares used to compute earnings per common share:

Basic

Diluted

See Notes to Consolidated Financial Statements.

Year Ended December 31,

2006

2005

2004

$2,622.4

$2,450.6

$2,267.7

2,282.7

2,153.5

1,934.2

201.3

57.1

—

0.2

2.5

178.2

50.7

5.5

0.4

0.9

207.8

50.9

(1.4)

3.8

8.7

(111.6)

(78.9)

(64.7)

190.2

(66.5)

3.4

(4.4)

(2.8)

119.9

6.0

125.9

(2.7)

140.3

(68.1)

1.9

—

(5.3)

68.8

(6.6)

62.2

(15.3)

128.4

(72.1)

1.5

(3.3)

(13.2)

41.3

(13.7)

27.6

(4.1)

$ 123.2

46.9

23.5

1.36

0.68

0.30

(0.03)

(0.17)

(0.04)

1.33

0.51

0.26

92.4

92.8

91.9

92.0

91.6

91.8

P O L Y O N E C O R P O R A T I O N

Consolidated Balance Sheets

(In millions, except per share data)

ASSETS

Current assets

Cash and cash equivalents

Accounts receivable (less allowance of $5.9 in 2006 and $6.4 in 2005)

Inventories

Deferred income tax assets

Other current assets

Discontinued operations

Total current assets

Property, net

Investment in equity affiliates

Goodwill

Other intangible assets, net

Deferred income tax assets

Other non-current assets

Discontinued operations

Total assets

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities

Short-term debt

Accounts payable, including amounts payable to related party (see Note N)

Accrued expenses

Current portion of long-term debt

Discontinued operations

Total current liabilities

Long-term debt

Post-retirement benefits other than pensions

Other non-current liabilities including pensions

Minority interest in consolidated subsidiaries

Total liabilities

Commitments and Contingencies (see Note N)

Shareholders’ equity

Preferred stock, 40.0 shares authorized, no shares issued

Common stock, $0.01 par, 400.0 shares authorized, 122.2 shares issued in 2006 and 2005

Additional paid-in capital

Retained deficit

Common stock held in treasury, 29.4 shares in 2006 and 30.3 shares in 2005

Accumulated other comprehensive loss

Total shareholders’ equity

Total liabilities and shareholders’ equity

See Notes to Consolidated Financial Statements.

December 31,

2006

2005

66.2

32.8

316.4

240.8

18.1

27.8

—

669.3

442.4

276.1

287.0

9.4

25.0

64.4

—

320.5

191.8

20.1

27.4

20.9

613.5

436.0

273.9

287.0

10.6

0.1

59.9

6.7

$1,773.6

$1,687.7

5.2

7.1

221.0

232.6

93.1

22.5

—

341.8

567.7

83.6

200.5

5.5

82.4

0.7

11.2

334.0

638.7

107.9

214.3

5.4

1,199.1

1,300.3

—

1.2

—

1.2

1,065.7

1,066.4

(67.1)

(326.2)

(99.1)

(190.3)

(337.1)

(152.8)

574.5

387.4

$1,773.6

$1,687.7

P O L Y O N E C O R P O R A T I O N

Consolidated Statements of Cash Flows

(In millions)

Operating activities
Net income
Adjustments to reconcile net income to net cash provided (used) by operating activities:

Employee separation and plant phaseout charge (benefit)
Cash payments for employee separation and plant phaseout
Asset impairment charges
Premium on extinguishment of long-term debt
Charges for environmental remediation at inactive sites
Cash receipts (payments) for environmental remediation at inactive sites, net of insurance benefits
Depreciation and amortization
Loss on disposition of discontinued businesses and related plant phaseout charge
Companies carried at equity and minority interest:

Income from equity affiliates
Dividends and distributions received

Provision (benefit) for deferred income taxes
Changes in assets and liabilities:

Accounts receivable
Inventories
Accounts payable
Increase (decrease) in sale of accounts receivable
Accrued expenses and other
Net cash provided (used) by discontinued operations

Net cash provided (used) by operating activities
Investing activities
Capital expenditures
Return of capital by equity affiliates, net
Business acquisitions, net of cash acquired
Deposit on pending business acquisition
Proceeds from sale of discontinued business, net
Proceeds from sale of assets
Net cash used by discontinued operations

Net cash provided (used) by investing activities
Financing activities
Change in short-term debt
Repayment of long-term debt
Premium on early extinguishment of long-term debt
Debt issuance costs
Termination of interest rate swap agreements
Proceeds from the exercise of stock options

Net cash used by financing activities
Effect of exchange rate changes on cash

Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year

Cash and cash equivalents at end of year

See Notes to Consolidated Financial Statements.

P O L Y O N E C O R P O R A T I O N

Year Ended December 31,

2006

2005

2004

$ 123.2

$ 46.9

$ 23.5

—
(1.8)
0.2
4.4
2.5
1.8
57.1
3.1

(111.6)
97.7
(13.6)

23.0
(39.6)
(17.2)
(7.9)
(9.5)
(0.1)

5.5
(3.6)
0.4
—
0.9
(8.7)
50.7
15.6

(78.9)
67.4
2.0

(23.6)
9.3
13.0
7.9
(42.9)
1.8

(1.4)
(23.3)
3.8
3.3
8.7
(1.6)
50.9
28.8

(64.7)
51.5
0.7

(21.7)
1.5
22.2
(70.7)
(38.0)
5.9

111.7

63.7

(20.6)

(41.1)
—
1.2
(2.7)
17.3
8.7
(0.2)

(32.1)
—
(2.7)
—
—
12.3
(1.7)

(23.9)
8.3
(6.7)
—
101.5
32.2
(4.6)

(16.8)

(24.2)

106.8

(2.1)
(60.0)
(4.4)
—
—
3.1

(63.4)
1.9

33.4
32.8

4.8
(49.0)
—
—
—
0.5

(43.7)
(1.6)

(5.8)
38.6

1.2
(92.9)
(3.3)
(0.4)
(0.3)
0.3

(95.4)
(0.9)

(10.1)
48.7

$ 66.2

$ 32.8

$ 38.6

Consolidated Statements of Shareholders’ Equity

(In millions, except per share

data; shares in thousands)

Balance January 1, 2004
Comprehensive income:

Net income
Translation adjustment
Adjustment of minimum pension liability, net of

tax benefit of $0.4

Total comprehensive income:
Stock-based compensation and benefits and

exercise of options

Common

Additional

Retained

Common

Other

Common

Shares Held

Common

in Treasury

Total

Stock

Paid-in

Capital

Earnings

Stock Held

Ownership

Comprehensive

(Deficit)

in Treasury

Trust

Income (Loss)

122,192 30,425 $338.5 $1.2 $1,068.7 $(260.7) $(339.8) $(1.3)

$(129.6)

Accumulated

23.5
7.9

(19.9)

11.5

23.5

7.9

(19.9)

2.1

(1.5)

0.8

1.3

1.5

Balance December 31, 2004

122,192 30,480 $352.1 $1.2 $1,067.2 $(237.2) $(339.0) $ —

$(140.1)

Comprehensive income:

Net income
Translation adjustment
Adjustment of minimum pension liability, net of

tax benefit of $1.0

Total comprehensive income:
Stock-based compensation and benefits and

exercise of options

46.9

46.9
(9.3)

(2.4)

35.2

(225)

0.1

(0.8)

1.9

(9.3)

(2.4)

(1.0)

Balance December 31, 2005

122,192 30,255 $387.4 $1.2 $1,066.4 $(190.3) $(337.1) $ —

$(152.8)

Comprehensive income:

Net income
Translation adjustment
Adjustment of minimum pension Liability, net of

tax expense of $0.3

Total comprehensive income:
Adjustment to initially apply SFAS No. 158, net of

tax benefit of $6.8

Stock-based compensation and benefits and

exercise of options

123.2

123.2
12.1

44.6

179.9

(2.3)

(871)

9.5

(0.7)

10.9

12.1

44.6

(2.3)

(0.7)

Balance December 31, 2006

122,192 29,384 $574.5 $1.2 $1,065.7 $ (67.1) $(326.2) $ —

$ (99.1)

See Notes to Consolidated Financial Statements.

P O L Y O N E C O R P O R A T I O N

Notes to Consolidated Financial Statements

Note A. DESCRIPTION OF BUSINESS

PolyOne Corporation (PolyOne or Company) is an international poly-
mer services company with operations in thermoplastic com-
pounds, specialty polyvinyl chloride (PVC)
resins, specialty
polymer formulations, color and additive systems, and thermoplas-
tic resin distribution. PolyOne also has equity investments in man-
ufacturers of PVC resin and its intermediates and in a formulator of
polyurethane compounds.

PolyOne’s operations are located primarily in the United States,
Europe, Canada, Asia and Mexico. PolyOne operations are reflected
in four reportable segments: Vinyl Business, International Color and
Engineered Materials, PolyOne Distribution and Resin and Interme-
diates. PolyOne also has an All Other segment that includes North
American Color and Additives, North American Engineered Materi-
als, Producer Services and Polymer Coating Systems. See Note R
for more information.

In February 2006, PolyOne sold 82% of its Engineered Films
business for $26.7 million. This business is presented in discon-
tinued operations in these financial statements. PolyOne maintains
an 18% ownership interest in this business, which is reflected in the
2006 financial statements on the cost basis of accounting.

In October 2006, PolyOne purchased the remaining 50% of its
equity investment in DH Compounding Company from a wholly-
owned subsidiary of The Dow Chemical Company for $10.2 million.
The equity investment was previously reflected in the Consolidated
Balance Sheets on the line “Investment in equity affiliates.” DH
Compounding Company is consolidated in the Consolidated Bal-
ance Sheet as of December 31, 2006, and the results of operations
are included in the Consolidated Statement of Operations beginning
October 1, 2006. DH Compounding is included in the Producer
Services operating segment.

Unless otherwise noted, disclosures contained in this Annual

Repor t relate to continuing operations.

Note B. DISCONTINUED OPERATIONS

In October 2003, PolyOne announced that its future focus would be
on its global Plastics Compounding, Color & Additive Masterbatch
and PolyOne Distribution businesses to improve profitability and
strengthen its balance sheet because management believes these
businesses have the strongest market synergies and potential for
long-term success. Consequently, the Elastomers and Per formance
Additives, Engineered Films and Specialty Resins businesses were
targeted for divestment. In December 2003, PolyOne’s board of
directors authorized management to complete and execute plans to
sell these businesses. As a result, these businesses qualified for
accounting treatment as discontinued operations as of Decem-
ber 31, 2003 under Statement of Financial Accounting Standards
(SFAS) No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets.”

In August 2004, PolyOne sold the Elastomers and Per formance
Additives business to an entity formed by an investor group led by
Lion Chemical Capital, LLC and ACI Capital Co., Inc. for gross
proceeds of $120 million before associated fees and costs. A cash
payment of $106 million was made on the closing date and the
remaining $14 million was in the form of a six-year note from the
buyer. Consequently, PolyOne recognized a $17.0 million non-cash
pre-tax charge to adjust the net asset carrying value of the Elas-
tomers and Per formance Additives business on the date of sale to
the net proceeds received. In the fourth quarter of 2004, PolyOne
also recorded a $4.3 million charge to reduce the net carrying value
of the net assets held for sale of the Engineered Films business to
reflect management’s best estimate of the projected net sale
proceeds. These charges are included in “Loss from discontinued
operations and loss on sale, net of income taxes” in the Consol-
idated Statement of Operations for the year ended December 31,
2004.

In December 2005, PolyOne announced that the Specialty
Resins divestment process was unlikely to result in a sale of the
business at acceptable terms. As a result, its financial results were
reclassified from discontinued operations to continuing operations.
No adjustments to the carrying value were required when it was
reclassified to continuing operations. During the fourth quarter of
2006, Specialty Resins was subsumed into the Vinyl Business
operating segment and is no longer a separate operating segment.

During 2005, PolyOne recorded additional charges of
$15.1 million to further reduce the net assets held for sale of
the Engineered Films business to reflect its net realizable value
based upon current estimates.

On February 15, 2006, PolyOne sold 82% of the Engineered
Films business to an investor group consisting of members of the
operating segment’s management team and Matrix Films, LLC for
gross proceeds of $26.7 million before associated fees and costs.
A cash payment of $20.5 million was received on the closing date
and the remaining $6.2 million was in the form of a five-year note
from the buyer. PolyOne retained an 18% ownership interest in the
company. Under EITF 03-13, “Applying the Conditions in Para-
graph 42 of FASB Statement No. 144 in Determining Whether to
Repor t Discontinued Operations,” when a business is sold with a
retained interest, the cost method of accounting is appropriate if
the disposal group qualifies as a component of an entity, the selling
entity has no significant influence or continuing involvement in the
new entity, and the operations and cash flows of the business being
sold will be eliminated from the ongoing operations of the company
selling it. The Engineered Films business qualified as a component
of an entity and PolyOne will have no significant influence or con-
tinuing involvement in the new entity. Activities that would be con-
sidered continuing cash flows (consisting of warehousing services
and short-term transitional services) amount to less than one
percent of the new entity’s corresponding costs, and for that reason
are not considered significant. The operations and cash flows of the
business being sold will be eliminated from the ongoing operations
of PolyOne. PolyOne also considered the provisions of FASB Inter-
pretation No. 46, “Consolidation of Variable Interest Entities,” and

P O L Y O N E C O R P O R A T I O N

determined that the new entity is not a variable interest entity
subject to consolidation. As a result, the retained minority interest
investment in the Engineered Films business is reported on the cost
method of accounting. The carrying amount of the major classes of
assets and liabilities of Engineered Films at December 31, 2005 is
reflected in “Discontinued operations” in the Consolidated Balance
Sheets.

During 2006, PolyOne recognized charges of $3.1 million to
adjust the carrying value of the net assets of the Engineered Films
Business to the net proceeds received, to recognize costs that were
not able to be recognized until the business was sold due to the
contingent nature of the costs, and for costs related to the pension
benefits of the business.

The following table summarizes the results of discontinued
operations. As required by generally accepted accounting principles
in the United States, the results of discontinued operations, as
presented below, do not include any depreciation or amortization
expense.

(In millions)

Sales:

Elastomers and Performance

Additives

Engineered Films

Pre-tax income from operations:

Elastomers and Performance

Additives

Engineered Films

Pre-tax loss on disposition of

businesses:

Elastomers and Performance

Additives

Engineered Films

2006

2005

2004

$ — $ — $220.1

9.6

119.6

125.7

$ 9.6

$119.6

$345.8

$ — $ — $ 17.2

0.4

0.5

0.6

17.8

—

(3.1)

(2.7)

(0.7)

(17.0)

(15.1)

(15.3)

(4.3)

(3.5)

Income tax expense, net of valuation

allowance

—

(0.6)

Loss from discontinued operations

$(2.7)

$ (15.3)

$ (4.1)

Note C. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Consolidation and Basis of Presentation — The Consolidated
Financial Statements include the accounts of PolyOne and its sub-
sidiaries. All majority-owned affiliates over which PolyOne has con-
trol are consolidated. Investments in affiliates and joint ventures in
which PolyOne’s ownership is 50% or less, or in which PolyOne does
not have control but has the ability to exercise significant influence
over operating and financial policies, are accounted for under the
equity method. Intercompany transactions are eliminated. Transac-
tions with related parties, including joint ventures, are in the ordi-
nary course of business.

Cash and Cash Equivalents — PolyOne considers all highly
liquid investments purchased with a maturity of less than three

months to be cash equivalents. Cash equivalents are stated at cost,
which approximates fair value.

Allowance for Doubtful Accounts — PolyOne evaluates the
collectibility of trade receivables based on a combination of factors.
PolyOne regularly analyzes significant customer accounts and, when
PolyOne becomes aware of a specific customer’s inability to meet
its financial obligations to PolyOne, such as in the case of a bank-
ruptcy filing or deterioration in the customer’s operating results or
financial position, PolyOne records a specific reserve for bad debt to
reduce the related receivable to the amount PolyOne reasonably
believes is collectible. PolyOne also records bad debt reserves for
all other customers based on a variety of factors including the length
of time the receivables are past due, the financial health of the
customer, economic conditions and historical experience. If circum-
stances related to specific customers change, PolyOne’s estimates
of the recoverability of receivables could be adjusted further.

Concentrations of Credit Risk — Financial instruments that
subject PolyOne to potential credit risk are trade accounts receiv-
able, foreign exchange contracts and interest rate swap agree-
ments. Concentration of credit risk for trade accounts receivable
is limited due to the large number of customers constituting its
customer base and their distribution among many industries and
geographic locations. PolyOne is exposed to credit risk with respect
to forward foreign exchange contracts and interest rate swap agree-
ments in the event of non-per formance by the counter-par ties to
these financial instruments. Management believes that the risk of
incurring material
losses related to this credit risk is remote.
PolyOne does not require collateral to support the financial position
of its credit risks.

Sale of Accounts Receivable — PolyOne follows the provisions
of SFAS No. 140, “Accounting for Transfers and Servicing of Finan-
cial Assets and Extinguishment of Liabilities.” As a result, trade
accounts receivable that are sold are removed from the balance
sheet at the time of sale.

Inventories — Inventories are stated at the lower of cost or
market. Approximately 43% and 39% of PolyOne’s inventories at
December 31, 2006 and 2005 are valued using the last-in, first-out
(LIFO) cost method. Inventories not valued by the LIFO method are
valued using the first-in, first-out (FIFO) or average cost method.

Property and Depreciation — Property, plant and equipment is
recorded at cost, net of depreciation and amortization that is
computed principally using the straight-line method over the esti-
mated useful life of the assets, which ranges from three to 15 years
for machinery and equipment and up to 40 years for buildings.
Computer software is amortized over periods not exceeding ten
years. Property, plant and equipment is generally depreciated on
accelerated methods for income tax purposes. Repair and mainte-
nance costs are expensed as incurred.

Depreciation expense was $55.0 million in 2006, $48.0 million

in 2005 and $47.3 million in 2004.

Impairment

by
SFAS No. 144, “Accounting for the Impairment or Disposal of

Long-Lived Assets — As

required

P O L Y O N E C O R P O R A T I O N

Long-Lived Assets,” PolyOne reviews long-lived assets for impair-
ment when circumstances indicate that the carrying value of an
asset may not be recoverable. For assets that are to be held and
used, an impairment charge is recognized when the estimated
undiscounted future cash flows associated with the asset or group
of assets are less than their carrying value. If an impairment exists,
an adjustment is made to write the asset down to its fair value, and
a loss is recorded for the difference between the carrying value and
the fair value. Fair values are determined based on quoted market
values, discounted cash flows, internal appraisals or external
appraisals, as applicable. Assets to be disposed of are carried at
the lower of their carrying value or estimated net realizable value.

Goodwill and Other

Intangible Assets — Goodwill

is the
excess of the purchase price paid over the fair value of the net
assets of the acquired business. Goodwill is subject to annual
impairment testing and the Company has selected July 1 as the
annual
impairment testing date. Other intangible assets, which
consist primarily of non-contractual customer relationships, sales
contracts, patents and technology, are amortized over their esti-
mated useful lives. The remaining lives range from three to 20 years.

fixed-rate debt to a floating rate. The interest rate swap and instru-
ment being hedged are marked to market in the balance sheet. The
net effect on PolyOne’s operating results is that interest expense on
the portion of fixed-rate debt being hedged is recorded based on the
variable rate that is stated within the swap agreement. No other
cash payments are made unless the contract is terminated prior to
its maturity. In this case, the amount paid or received at settlement
is established by agreement at the time of termination and usually
represents the net present value, at current rates of interest, of the
remaining obligations to exchange payments under the terms of the
contract. Any gains or losses incurred upon the early termination of
interest rate swap contracts are deferred within the hedged item
and recognized over the remaining life of the contract. See Note T
for more information.

Revenue Recognition — Revenue is recognized when title and
the risks and rewards of ownership of the product is transferred to
the customer, usually at the Company’s shipping point or when the
service is per formed.

Shipping and Handling Costs — Shipping and handling costs

Total amortization expense of other intangibles was $2.1 mil-

are included in cost of sales.

lion in 2006, $2.7 million in 2005 and $3.6 million in 2004.

Derivative Financial Instruments — SFAS No. 133, “Account-
ing for Derivative Instruments and Hedging Activities,” requires that
all derivative financial instruments, such as foreign exchange con-
tracts and interest rate swap agreements, be recognized in the
financial statements and measured at fair value, regardless of the
purpose or intent in holding them. Changes in the fair value of
derivative financial instruments are recognized in the period when
the change occurs in either net income or shareholders’ equity (as a
component of accumulated other comprehensive income or loss),
depending on whether
the derivative is being used to hedge
changes in fair value or cash flows. PolyOne’s interest rate swaps
qualify as fair value hedges in accordance with SFAS No. 133.

PolyOne is exposed to foreign currency changes and interest
rate fluctuations in the normal course of business. PolyOne has
established policies and procedures that manage these exposures
through the use of financial instruments. By policy, PolyOne does
not enter
trading purposes or
speculation.

into these instruments for

PolyOne enters into foreign currency exchange forward con-
tracts with major financial institutions to reduce the effect of fluc-
tuating exchange rates, primarily on foreign currency inter-company
lending transactions. These contracts are not treated as hedges
and, as a result, are marked to market, with the resulting gains and
losses recognized as other income or expense in the Consolidated
Statements of Operations. Realized gains and losses on these
contracts offset the foreign exchange gains and losses on the
underlying transactions. PolyOne’s forward contracts have original
maturities of one month.

From time to time, PolyOne also enters into interest rate swap
agreements that modify the exposure to interest risk by converting

Equity Affiliates — PolyOne recognizes its proportionate share
of the income of equity affiliates. Losses of equity affiliates are
recognized to the extent of PolyOne’s investment, advances, finan-
cial guarantees and other commitments to provide financial support
to the investee. Any losses in excess of this amount are deferred
and reduce the amount of future earnings of the equity investee
recognized by PolyOne. At December 31, 2006 and 2005, there
were no deferred losses related to equity investees.

PolyOne accounts for its investments in equity affiliates under
Accounting Principles Board (APB) Opinion No. 18, “The Equity
Method of Accounting for Investments in Common Stock,” and
recognizes impairment losses in the value of investments that
management judges to be other than temporar y. See Note F for
more information.

Environmental Costs — PolyOne expenses costs that are
associated with managing hazardous substances and pollution in
ongoing operations on a current basis. Costs associated with the
remediation of environmental contamination are accrued when it
becomes probable that a liability has been incurred and PolyOne’s
proportionate share of the amount can be reasonably estimated.

Research and Development Expense — Research and devel-
opment costs, which were $20.3 million in 2006, $19.5 million in
2005 and $16.7 million in 2004, are charged to expense as
incurred.

Income Taxes — Deferred tax liabilities and assets are deter-
mined based upon the differences between the financial reporting
and tax basis of assets and liabilities, and are measured using the
tax rate and laws currently in effect.

P O L Y O N E C O R P O R A T I O N

Comprehensive Income — Accumulated other comprehensive

loss at December 31, 2006 and 2005 are as follows:

(In millions)

2006

2005

Foreign currency translation adjustments

$ (8.0)

$ (20.1)

Minimum pension liability adjustments

(88.8)

(133.4)

Impact of adopting SFAS No. 158

Share-based compensation

(2.3)

—

0.7

$(99.1)

$(152.8)

Foreign Currency Translation — Revenues and expenses are
translated at average currency exchange rates during the related
period. Assets and liabilities of foreign subsidiaries and equity
investees are translated using the exchange rate at the end of
the period. PolyOne’s share of the resulting translation adjustment
is recorded as accumulated other comprehensive income or loss in
shareholders’ equity. The cumulative unrecognized translation
adjustment balance was $8.0 million at December 31, 2006,
$20.1 million at December 31, 2005 and $10.8 million at Decem-
ber 31, 2004. Gains and losses resulting from foreign currency
transactions, including intercompany transactions that are not con-
sidered permanent investments, are included in net income.

Marketable Securities — Marketable securities are classified
as available for sale and are presented at current market value. Net
unrealized gains and losses on marketable securities available for
sale are reflected in accumulated other comprehensive income or
loss in shareholders’ equity.

Share-Based Compensation — As of December 31, 2006,
PolyOne had one active share-based employee compensation plan,
which is described more fully in Note Q. Prior to January 1, 2006,
PolyOne accounted for share-based compensation under the pro-
visions of APB Opinion No. 25, “Accounting for Stock Issued to
Employees” (APB No. 25). Under APB No. 25, compensation cost for
stock options was measured as the excess, if any, of the quoted
market price of PolyOne common stock at the date of the grant over
the amount an option holder must pay to acquire the common stock.
Compensation cost for stock appreciation rights (SARs) was rec-
ognized upon vesting as the amount by which the quoted market
value of the shares of PolyOne common stock covered by the grant
exceeded the SARs specified value.

On January 1, 2006, PolyOne adopted SFAS No. 123(revised
2004), “Share-Based Payment,” using the modified prospective
transition method. SFAS No. 123(R) requires the Company to esti-
mate the fair value of share-based awards on the date of grant using
an option-pricing model. The value of the portion of the award that is
ultimately expected to vest is recognized as expense over the
requisite service periods in the Consolidated Statements of Oper-
ations. Under the modified prospective transition method, compen-
sation cost recognized during the year ended December 31, 2006
includes (a) compensation cost for all share-based payments
granted prior to, but not yet vested as of, January 1, 2006, based
on the grant date fair value estimated in accordance with the
original provisions of SFAS No. 123(R), plus (b) compensation cost
to
for all share-based payments granted on or subsequent

January 1, 2006, based on the grant date fair value estimated in
accordance with the provisions of SFAS No. 123(R). In accordance
with the modified prospective transition method, the Consolidated
Financial Statements for prior periods have not been restated to
reflect, nor do they include, the impact of SFAS No. 123(R). Total
share-based compensation cost for the year ended December 31,
2006 was $4.5 million pre-tax.

The adoption of SFAS No. 123(R) on January 1, 2006 resulted
in compensation cost for the year ended December 31, 2006 of
$2.5 million on a pre-tax basis, or $0.03 per diluted share, more
than what it would have been under APB No. 25.

SFAS No. 123(R) requires that the benefits of tax deductions in
excess of compensation cost recognized be reported as a financing
cash flow, rather than as an operating cash flow as was previously
required. This requirement will reduce net operating cash flows and
increase net financing cash flows.

The following table illustrates the effect on net income and
earnings per share as if PolyOne had applied the fair value recog-
nition provisions of SFAS No. 123 to share-based employee com-
pensation using the fair value estimate computed by the Black-
Scholes-Mer ton option-pricing model for the years ended Decem-
ber 31, 2005 and 2004. The Black-Scholes-Mer ton option-pricing
model was developed to estimate the fair value of traded options
that have no vesting restrictions and are fully transferable. In addi-
tion, option valuation models use highly subjective assumptions,
including expected share price volatility.

(In millions, except per share data)

Net income, as reported

Add: Total share-based employee

compensation (benefit) included in
reported net income, net of tax

Deduct: Total share-based employee
compensation expense determined
under the fair value-based method for
all awards, net of tax

Pro forma net income

Net earnings per share:

Basic and diluted — as reported

Basic and diluted — pro forma

Year Ended

December 31,

2005

$46.9

2004

$23.5

(0.6)

2.7

(4.1)

$42.2

$0.51

$0.46

(4.3)

$21.9

$0.26

$0.24

New Accounting Pronouncements — In November 2004, the
FASB issued SFAS No. 151, “Inventory Costs.” SFAS No. 151
amends Accounting Research Bulletin (ARB) No. 43, Chapter 4,
“Inventory Pricing,” to clarify the accounting for abnormal amounts
of idle facility expense, freight, handling costs and wasted material.
SFAS No. 151 requires that these items be recognized as current-
period charges and requires that the allocation of fixed production
overhead to the costs of conversion be based on the normal
capacity of the associated production facilities. PolyOne adopted
SFAS No. 151 effective January 1, 2006. The adoption of
SFAS No. 151 did not have a material impact on the Company’s
financial position or results of operations.

P O L Y O N E C O R P O R A T I O N

In May 2005, the FASB issued SFAS No. 154, “Accounting
Changes and Error Corrections.” SFAS No. 154 applies to all vol-
untary changes in accounting principle and to changes required by
an accounting pronouncement that do not include explicit transition
provisions. SFAS No. 154 requires that changes in accounting
principle be applied retroactively, instead of including the cumula-
tive effect in the income statement. The correction of an error will
continue to require financial statement restatement. A change in
accounting estimate will continue to be accounted for in the period
if necessary. PolyOne
of change and in subsequent periods,
adopted SFAS No. 154 as of January 1, 2006. The adoption of
SFAS No. 154 did not have a material impact on the Company’s
financial position or results of operations.

In June 2006, the FASB issued FASB Interpretation No. 48
(FIN 48), “Accounting for Uncertainty in Income Taxes — an inter-
pretation of FASB Statement No. 109, Accounting for Income
Taxes,” which is effective for fiscal years beginning after Decem-
ber 15, 2006. FIN 48 clarifies the recognition threshold and mea-
surement attributes for the financial statement recognition and
measurement of a tax position taken or expected to be taken in
a tax return. FIN 48 also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. The Company is currently evaluating the
provisions of FIN 48; however, the adoption is not expected to have
a material impact on its financial statements.

In September of 2006, the FASB issued FASB Staff Position
(FSP) AUG AIR-1, “Accounting for Planned Major Maintenance Activ-
ities” (FSP AUG AIR-1). FSP AUG AIR-1 prohibits the use of the
accrue-in-advance method of accounting for planned major mainte-
nance activities in annual and interim financial reporting periods
and is effective for the first fiscal year beginning after December 15,
2006. PolyOne’s equity affiliate, OxyVinyls, will adopt FSP AUG AIR-1
in the first quarter of 2007, on a retrospective basis, and will use
the deferral method of accounting for planned major maintenance.
The effect on OxyVinyls’ financial statements upon adoption will be
an increase of $38.3 million in other assets, a decrease of
$12.3 million in accrued liabilities, an increase of $4.2 million in
minority interest and an increase of $46.4 million in partners’
capital. PolyOne’s proportionate share of OxyVinyls’ operations is
24%.

On December 31, 2006, the Company adopted SFAS No. 158,
“Employer’s Accounting for Defined Benefit Pension and Other
Postretirement Plans — an Amendment of FASB Statements
No. 87, 88, 106 and 132(R).” SFAS No. 158 requires an employer
that is a business entity and sponsors one or more single employer
benefit plans to (1) recognize the funded status of the benefit in its
statement of financial position, (2) recognize as a component of
other comprehensive income, net of tax, the gains or losses and
prior service costs or credits that arise during the period but are not
recognized as components of net periodic benefit cost, (3) measure
defined benefit plan assets and obligations as of the date of the
employer’s fiscal year end statement of financial position and
(4) disclose additional information in the notes to financial state-
ments about certain effects on net periodic benefit costs for the

next fiscal year that arise from delayed recognition of gains or
losses, prior service costs or credits, and transition assets or
obligations. The adoption of SFAS No. 158 resulted in an increase
of $6.4 million on a pre-tax basis and a $0.4 million decrease on an
after-tax basis on the Company’s accumulated other comprehen-
sive loss. PolyOne also recorded an adjustment of $2.7 million to
increase accumulated other comprehensive loss to record its pro-
portionate share of OxyVinyls’ adoption of SFAS No. 158. The
adoption of SFAS No. 158 had no effect on the Company’s com-
pliance with the financial covenants contained in the agreements
governing its debt and its receivables sales facility, and is not
expected to affect the Company’s operating results in future peri-
ods. For further discussion, see Note M.

Use of Estimates — The preparation of consolidated financial
statements in conformity with generally accepted accounting prin-
ciples requires management to make extensive use of estimates
and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date
of the consolidated financial statements, and the reported amounts
of revenues and expenses during these periods. Significant esti-
mates in these Consolidated Financial Statements include sales
discounts and rebates, restructuring charges, allowances for doubt-
ful accounts, estimates of
future cash flows associated with
assets, asset impairments, useful lives for depreciation and amor-
tization, loss contingencies, net realizable value of inventories,
environmental and asbestos-related liabilities, income taxes and
tax valuation reserves, goodwill and the determination of discount
and other rate assumptions used to determine pension and post-
retirement employee benefit expenses. Actual results could differ
from these estimates.

Reclassification — Certain amounts for 2005 and 2004 have
been reclassified to conform to the 2006 presentation. During
2006, PolyOne changed its reportable segments. As a result,
PolyOne’s segment disclosures for 2005 and 2004 have been
restated to conform with the changes made in 2006.

Note D. GOODWILL AND INTANGIBLE ASSETS

There were no changes in the carrying amount of goodwill during the
year ended December 31, 2006. Changes in the carrying amount of
goodwill by operating segment during the year ended December 31,
2005 was as follows:

International Color

Vinyl

and Engineered

Polymer Coating

PolyOne

(In millions)

Business

Materials

Systems

Distribution

Total

January 1,
2005

Business

$156.7

$73.3

$61.1

$1.6

$292.7

acquisition

—

1.0

Reduction of

acquired tax
accrual

December 31,

(4.4)

(2.3)

—

1.0

—

(6.7)

2005

$152.3

$72.0

$61.1

$1.6

$287.0

P O L Y O N E C O R P O R A T I O N

PolyOne acquired the remaining 16% of Star Color, a Thailand-
based color and additives business, in the first quarter of 2005,
resulting in goodwill of $1.0 million.

The reduction of the acquired tax accrual represents an adjust-
ment to goodwill from resolving certain income tax uncertainties
that existed prior to the business combination of Geon and Hanna.

As of December 31, 2006, PolyOne had $287.0 million of
goodwill that resulted from acquiring businesses. SFAS No. 142
requires that goodwill and intangible assets with indefinite lives be
tested for impairment at least once a year. Carrying values are
compared with fair values, and when the carrying value exceeds the
fair value, the carrying value of the impaired asset is reduced to its
fair value. PolyOne has elected July 1 as its annual assessment
date.

PolyOne uses a combination of two valuation methods, a mar-
ket approach and an income approach, to estimate the fair value of
its reporting units. Absent an indication of fair value from a potential
buyer or similar specific transactions, the Company believes that
the use of these two methods provides reasonable estimates of a
reporting unit’s fair value. Fair value computed by these two meth-
ods is arrived at using a number of factors, including projected
future operating results and business plans, economic projections,
anticipated future cash flows, comparable marketplace data within
a consistent industry grouping, and the cost of capital. There are
inherent uncertainties, however, related to these factors and to
management’s judgment in applying them to this analysis. None-
theless, management believes that the combination of these two
methods provides a reasonable approach to estimate the fair value
of PolyOne’s reporting units. Assumptions for sales, earnings and
cash flows for each reporting unit were consistent between these
two methods.

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 per formance
adjusted for non-recurring items. Management believes that this
approach is appropriate because it provides a fair value estimate
using multiples from entities with operations and economic char-
acteristics comparable to PolyOne’s reporting units. The key esti-
mates and assumptions that are used to determine fair value under
this approach include trailing twelve- and thirty-six month results
and a control premium applied to the market multiples to adjust the
enterprise value upward for a 100% ownership interest, where
applicable.

The income approach is based on projected future debt-free
cash flow that is discounted to present value using factors that
consider the timing and risk of the future cash flows. Management
believes that this approach is appropriate because it provides a fair
value estimate based upon the reporting unit’s expected long-term
operating and cash flow per formance. 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 that is

discounted using a weighted-average cost of capital. The projection
is based upon management’s best estimates of projected eco-
nomic and market conditions over the related period including
growth rates, estimates of future expected changes in operating
margins and cash expenditures. Other significant estimates and
assumptions include terminal value growth rates, terminal value
margin rates, future capital expenditures and changes in future
working capital requirements based on management projections.

SFAS No. 142 requires that this assessment be per formed at
the “reporting unit” level. At July 1, 2006, PolyOne had three
reporting units, consistent with PolyOne’s operating segments, that
had a significant amount of goodwill: Vinyl Business, International
Color and Engineered Materials, and Polymer Coating Systems.
Under the provisions of SFAS No. 142, these three reporting units
were tested for impairment as of July 1, 2006. The average fair
values of the market approach and income approach exceeded the
carrying value of Vinyl Business, International Color and Engineered
Materials, and Polymer Coating Systems by 81%, 28% and 19%,
respectively, as of July 1, 2006.

Even though PolyOne determined that there was no additional
goodwill impairment as of the July 1, 2006 annual assessment, the
future occurrence of a potential indicator of impairment, such as a
significant adverse change in legal factors or business climate, an
adverse action or assessment by a regulator, unanticipated com-
petition, a material negative change in relationships with significant
customers, strategic decisions made in response to economic or
competitive conditions, 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 require an interim
assessment for some or all of the reporting units prior to the next
required annual assessment on July 1, 2007.

Information regarding other intangible assets follows:

As of December 31, 2006

Acquisition

Accumulated

Currency

(In millions)

Cost

Amortization

Translation

Net

Non-contractual customer

relationships

Sales contract

Patents, technology and

other

Total

$ 8.6

$ (6.1)

$ — $2.5

9.6

8.0

(9.1)

—

0.5

(2.9)

1.3

6.4

$26.2

$(18.1)

$1.3

$9.4

As of December 31, 2005

Acquisition

Accumulated

Currency

(In millions)

Cost

Amortization

Translation

Net

Non-contractual customer

relationships

Sales contract

Patents, technology and

other

Total

$ 8.6

$ (5.6)

$ — $ 3.0

9.6

7.3

(8.4)

—

1.2

(2.0)

1.1

6.4

$25.5

$(16.0)

$1.1

$10.6

P O L Y O N E C O R P O R A T I O N

There were no indefinite-lived intangible assets as of Decem-

ber 31, 2006 and 2005.

continuing operations are reflected on the line “Corporate and
eliminations” in Note R, “Segment Information.”

Amortization of other intangible assets was $2.1 million for the
year ended December 31, 2006 and $2.7 million for the year ended
December 31, 2005. Amortization expense for each of the next five
years is expected to be approximately $2 million per year.

The carrying values of intangible assets and other investments
are adjusted to estimated net future cash flows as a result of an
evaluation done each year end, or more often when indicators of
impairment exist. No impairment charges were recorded in 2006,
2005 or 2004.

Note E. EMPLOYEE SEPARATION AND PLANT PHASEOUT

Since the formation of PolyOne in 2000, management has under-
taken several restructuring initiatives to improve profitability and, as
a result, PolyOne has incurred employee separation and plant
phaseout costs.

Employee separation costs include salary continuation bene-
fits, medical coverage and outplacement assistance and are based
on a formula that takes into account each individual employee’s
base compensation and length of service. PolyOne maintains a
severance plan that provides specific benefits to all employees
(except those who are employed under collective bargaining agree-
ments) who lose their jobs due to reduction in workforce or job
elimination initiatives, or from closing manufacturing facilities. Col-
lective bargaining employees are covered under the terms of each
specific agreement. The amount is determined separately for each
employee and is recognized at the date the employee is notified if
the expected termination date will be within 60 days of notification
or is accrued on a straight-line basis over the period from the
notification date to the expected termination date if the termination
date is more than 60 days after the notification date.

Plant phaseout costs include the impairment of property, plant
and equipment at manufacturing facilities, and the resulting write-
down of the carrying value of these assets to fair value, which
represents management’s best estimate of the net proceeds to be
received for the assets to be sold or scrapped, less any costs to
sell. Plant phaseout costs also include cash facility closing costs
and lease termination costs. Assets transferred to other PolyOne
facilities are transferred at net book value.

Plant phaseout costs associated with continuing operations
are reflected on the Consolidated Statements of Operations on the
line “Employee separation and plant phaseout.” Plant phaseout
costs associated with discontinued operations are included in the
Consolidated Statements of Operations on the line “Loss from
discontinued operations and loss on sale, net of income taxes.”
Plant phaseout costs for continuing operations relate to the Vinyl
Business, Polymer Coating Systems, North American Color and
Additives, and North American Engineered Materials operating seg-
ments, and for discontinued operations relate to the Engineered
Films and the Elastomers and Per formance Additives businesses.
Employee separation and plant phaseout costs associated with

2006 Activity — Employee separation and plant phaseout
costs for 2006 includes a $0.5 million charge related to the Novem-
ber 2006 announcement to move the latex product manufacturing
business located at the Company’s Commerce, California facility to
its Massillon, Ohio location to better serve customers. The six
employees affected by this relocation were terminated by Febru-
ary 28, 2007.

Operating income also includes an additional $0.6 million
charge to complete the separation of the 22 remaining employees
from the November 2005 announcement to close the Manchester,
England color additives facility.

Fully offsetting these charges was a net gain of $1.1 million
from the sale of facilities that were previously identified as part of
the Company’s plant phaseout activities.

2005 Activity — Employee separation and plant phaseout
costs for 2005 were $5.5 million. Operating income includes a
$2.5 million charge to be paid pursuant to the terms of an October 6,
2005 separation agreement between PolyOne and Thomas A.
Waltermire as the President, Chief Executive Officer and a Director.
The amounts accrued at December 31, 2005 are expected to be
paid out through 2008.

The $2.5 million loss on the sale of facilities and equipment of
previously idled operations reflects the amount in excess of the
estimate at December 31, 2004 when the carrying value of these
assets was reduced to estimated future net proceeds.

Operating income was also reduced by $0.5 million from the
November 2005 announcement to close the Company’s Manches-
ter, England plastic color additives facility by the end of the first
quarter of 2006. Of the 44 employees affected by the facility
closing, 22 were terminated by December 31, 2005. An additional
charge of $0.6 million for employee separation was recognized in
2006 as the plant phaseout was completed.

Loss from discontinued operations reflects a $0.2 million ben-
efit relative to employee separation costs as a result of adjusting
estimates when the activities were completed.

2004 Activity — Operating income includes a $1.4 million
benefit from adjusting the estimated remaining liabilities associ-
ated with restructuring initiatives announced in prior years. Loss
from discontinued operations included a $7.5 million pre-tax charge
from closing an Engineered Films’ manufacturing facility and two
Elastomers and Per formance Additives’ manufacturing facilities in
the first quarter of 2004. All of the employees who were affected by
the restructuring initiatives announced in 2004 and prior years were
terminated as of December 31, 2004.

The following table summarizes the provisions, payments and
remaining reserves associated with each of these initiatives from
December 31, 2003 through December 31, 2006:

P O L Y O N E C O R P O R A T I O N

(In millions, except employee numbers)

January 2003 reduction of staff personnel

Balance at December 31, 2003

Continuing operations benefit

Utilized 2004

Employee Separation

Plant Phaseout Costs

Number of

Cash

Asset Write-

Employees

Costs

Closure

Downs

Total

—

$ 1.5

$—

$ 1.5

(0.5)

(1.0)

(0.5)

(1.0)

Balance at December 31, 2004, 2005 and 2006

—

$ —

$—

$ —

(In millions, except employee numbers)

North American manufacturing restructuring announced in 2001

Balance at December 31, 2003

Continuing operations benefit

Utilized 2004

Employee Separation

Plant Phaseout Costs

Number of

Cash

Asset Write-

Employees

Costs

Closure

Downs

Total

—

$ 0.9

$ 0.1

$ —

$ 1.0

(0.9)

(0.1)

(0.3)

0.3

(1.3)

0.3

Balance at December 31, 2004, 2005 and 2006

—

$ —

(In millions, except employee numbers)

Closure and exit of Engineered Films manufacturing plants

Balance at December 31, 2003

Discontinued operations charge

Utilized 2004

Balance at December 31, 2004

Discontinued operations benefit

Utilized 2005

Employee Separation

Plant Phaseout Costs

Number of

Cash

Asset Write-

Employees

Costs

Closure

Downs

Total

117

$ 2.6

$ 2.3

$—

$ 4.9

(117)

3.6

(5.2)

(0.1)

(1.4)

3.5

(6.6)

—

$ 1.0

$ 0.8

$—

$ 1.8

(0.2)

(0.8)

(0.2)

(1.6)

Balance at December 31, 2005 and 2006

—

$ —

$—

$ —

(In millions, except employee numbers)

Wynne, Arkansas and Deforest, Wisconsin production facility closures

Balance at December 31, 2003

Discontinued operations charge

Utilized 2004

Employee Separation

Plant Phaseout Costs

Number of

Cash

Asset Write-

Employees

Costs

Closure

Downs

Total

137

$ 1.6

$ —

$—

$ 1.6

(137)

1.0

(2.6)

2.5

(2.5)

3.5

(5.1)

Balance at December 31, 2004, 2005 and 2006

—

$ —

$—

$ —

(In millions, except employee numbers)

June 2003 closure of Ft. Worth, Texas color additives plant

Balance at December 31, 2003

Continuing operations charge

Utilized 2004

Employee Separation

Plant Phaseout Costs

Number of

Cash

Asset Write-

Employees

Costs

Closure

Downs

Total

—

$ —

$—

$ —

0.6

(0.6)

0.6

(0.6)

Balance at December 31, 2004, 2005 and 2006

—

$ —

$—

$ —

P O L Y O N E C O R P O R A T I O N

(In millions, except employee numbers)

Mexico & North America administrative staff reductions

Balance at December 31, 2003

Continuing operations benefit

Discontinued operations charge

Utilized 2004

Balance at December 31, 2004

Continuing operations charge

Utilized 2005

Balance at December 31, 2005

Continuing operations benefit

Utilized 2006

Balance at December 31, 2006

(In millions, except employee numbers)

Executive severance

Balance at December 31, 2004

Continuing operations charge

Utilized 2005

Balance at December 31, 2005

Utilized 2006

Balance at December 31, 2006

(In millions, except employee numbers)

Closure and exit of Manchester, England Color Additives facility

Balance at December 31, 2004

Continuing operations charge

Utilized 2005

Balance at December 31, 2005

Continuing operations charge

Utilized 2006

Balance at December 31, 2006

(In millions, except employee numbers)

Closure and exit of Commerce Polymer Coating Systems facility

Balance at December 31, 2005

Continuing operations charge

Utilized 2006

Balance at December 31, 2006

P O L Y O N E C O R P O R A T I O N

Employee Separation

Plant Phaseout Costs

Number of

Cash

Asset Write-

Employees

Costs

Closure

Downs

Total

151

$ 9.0

$ 2.2

$ —

$ 11.2

(0.2)

0.5

(8.5)

(1.5)

(151)

(0.2)

0.5

(10.0)

—

$ 0.8

$ 0.7

$ —

$ 1.5

(0.8)

(0.7)

2.5

(2.5)

2.5

(4.0)

—

$ —

(1.1)

1.1

(1.1)

1.1

—

$ —

Employee Separation

Plant Phaseout Costs

Number of

Cash

Asset Write-

Employees

Costs

Closure

Downs

Total

—

(1)

—

$ —

2.5

$ 2.5

(1.2)

$ 1.3

$—

$ —

$—

2.5

—

$ 2.5

(1.2)

$ 1.3

Employee Separation

Plant Phaseout Costs

Number of

Cash

Asset Write-

Employees

Costs

Closure

Downs

Total

—

(22)

—

$ —

$—

$ —

0.5

(0.5)

$ —

0.6

(0.6)

$ —

$—

—

$—

—

$—

0.5

(0.5)

$ —

0.6

(0.6)

$ —

Employee Separation

Plant Phaseout Costs

Number of

Cash

Asset Write-

Employees

Costs

Closure

Downs

Total

—

(1)

$ —

0.1

$ —

0.1

—

$ —

0.3

(0.3)

0.5

(0.3)

$0.1

$ —

$ 0.2

(In millions, except employee numbers)

Total

Balance at December 31, 2003

Continuing operations

Discontinued operations

Utilized 2004

Balance at December 31, 2004

Continuing operations

Discontinued operations

Utilized 2005

Balance at December 31, 2005

Continuing operations

Utilized 2006

Balance at December 31, 2006

Employee Separation

Plant Phaseout Costs

Number of

Cash

Asset Write-

Employees

Costs

Closure

Downs

Total

405

$ 15.6

$ 4.6

$ —

$ 20.2

(1.0)

(0.1)

(0.3)

5.1

2.4

(1.4)

7.5

(405)

(17.9)

(5.4)

0.3

(23.0)

—

(23)

$ 1.8

$ 1.5

$ —

$ 3.3

3.0

(0.2)

(2.1)

2.5

(1.5)

(2.5)

5.5

(0.2)

(6.1)

$ 2.5

$ —

$ 2.5

0.7

(1.8)

0.1

—

(0.8)

0.8

—

(1.0)

$ 1.4

$ 0.1

$ —

$ 1.5

Note F. FINANCIAL INFORMATION OF EQUITY AFFILIATES

PolyOne’s Resin and Intermediates segment consists primarily of
investments in equity affiliates.

PolyOne owns 24% of Oxy Vinyls, LP (OxyVinyls), a manufacturer
and marketer of PVC resins. The remaining 76% of OxyVinyls is
owned by subsidiaries of Occidental Petroleum Corporation. Oxy-
Vinyls is the second largest producer of PVC resins in North
America.

Summarized financial information for OxyVinyls follows:

OxyVinyls’ income during 2005 includes a charge for
the
impairment of a previously idled chlor-alkali facility, of which Poly-
One’s share was $22.9 million.

PolyOne also owns 50% of SunBelt Chlor-Alkali Partnership
(SunBelt). The remaining 50% of SunBelt is owned by Olin SunBelt
Inc., a wholly owned subsidiary of the Olin Corporation. Summarized
financial information for SunBelt follows:

(In millions)

SunBelt:

Net sales

Operating income

2006

2005

2004

$186.7

$167.0

$105.8

$104.3

$ 92.2

$ 35.6

(In millions)

OxyVinyls:

Net sales

2006

2005

2004

Partnership income as reported by

SunBelt

$ 94.6

$ 81.3

$ 23.5

$2,476.0

$2,502.0

$2,272.5

PolyOne’s ownership of SunBelt

50%

Operating income

$ 272.8

$ 195.8

$ 267.1

Earnings of equity affiliate recorded

Partnership income as
reported by OxyVinyls

PolyOne’s ownership of

OxyVinyls

PolyOne’s proportionate
share of OxyVinyls’
earnings

Amortization of the

difference between
PolyOne’s investment and
its underlying share of
OxyVinyls’ equity

Earnings of equity affiliate
recorded by PolyOne

Current assets

Non-current assets

Total assets

Current liabilities

Non-current liabilities

Total liabilities

$ 244.6

$ 129.9

$ 199.8

Current assets

$ 25.1

$ 28.4

by PolyOne

$ 47.3

$ 40.7

$ 11.7

24%

58.7

31.2

48.0

Non-current assets

Total assets

Current liabilities

Non-current liabilities

Total liabilities

Partnership deficit

113.7

138.8

22.1

121.9

144.0

120.5

148.9

19.4

134.1

153.5

$ (5.2)

$ (4.6)

0.6

59.3

31.8

48.6

$ 382.4

$ 467.3

1,254.9

1,234.8

1,637.3

1,702.1

251.2

290.3

541.5

276.0

376.0

652.0

OxyVinyls purchases chlorine from SunBelt under an agree-
ment that expires in 2094. The agreement requires OxyVinyls to
purchase all of the chlorine that is produced by SunBelt up to a
maximum of 250,000 tons per year at market price, less a dis-
count. OxyVinyls’ chlorine purchases from SunBelt were $72.2 mil-
lion in 2006 and $76.6 million in 2005.

On October 1, 2006, PolyOne purchased the remaining 50%
interest in DH Compounding Company from a subsidiary of The Dow
Chemical Company. DH Compounding Company is now fully consol-
idated in the financial statements of PolyOne. Prior to the acquisi-
tion of DH Compounding Company, it was accounted for as an equity

P O L Y O N E C O R P O R A T I O N

Partnership capital

$1,095.8

$1,050.1

repurchase and are included in interest expense in the Consoli-
dated Statements of Operations. Also during 2006, $0.7 million of
aggregate principal amount of PolyOne’s medium-term notes
became due and were paid.

As of December 31, 2006, PolyOne’s secured borrowings were
not at levels that would trigger the security provisions of the inden-
tures governing its senior notes and debentures and its guarantee
of the SunBelt notes.

Revolving Credit Facility — PolyOne decided not to renew its
revolving credit facility, and, accordingly, it expired on June 6, 2006.
To replace some of the features of this expired facility, PolyOne
entered into a definitive Guarantee and Agreement with Citicorp
USA, Inc. on June 6, 2006. Under this Guarantee and Agreement,
PolyOne guarantees the treasury management and banking ser-
vices provided to it and its subsidiaries, such as subsidiary bor-
rowings, interest rate swaps, foreign currency forwards, letters of
credit, credit card programs and bank overdrafts. This guarantee is
secured by PolyOne’s inventories located in the United States. As of
December 31, 2005, PolyOne had no amounts outstanding under
the revolving credit facility, although the facility served as a back-up
facility for $6.0 million of outstanding letters of credit and for
$5.0 million of loan guarantees related to PolyOne’s Shenzhen
subsidiary. The amount available for borrowing under the revolving
credit facility at December 31, 2005 was $13.8 million.

The weighted-average interest rate on short-term borrowings
was 4.9% at December 31, 2006 and 4.3% at December 31, 2005.
Total
interest paid on long-term and short-term borrowings was
$62.2 million in 2006, $63.5 million in 2005 and $69.2 million
in 2004.

PolyOne is exposed to market risk from changes in interest
rates on debt obligations and from changes in foreign currency
exchange rates. PolyOne periodically enters into interest rate swap
agreements that modify its exposure to interest rate risk by con-
verting fixed-rate obligations to floating rates. PolyOne has six
agreements with a net fair value liability of $5.1 million and $5.8 mil-
lion at December 31, 2006 and 2005, respectively. The weighted-
average interest rate for these six agreements was 9.3% at Decem-
ber 31, 2006 and 8.2% at December 31, 2005. These exchange
agreements are “per fectly effective” as defined by SFAS No. 133,
“Accounting for Derivative Financial Instruments and Hedging Activ-
ities.” There have been no material changes in the market risk faced
by PolyOne from December 31, 2005 to December 31, 2006.

affiliate and was reflected in the All Other segment (owned 50% and
included in the Producer Services operating segment) along with
BayOne Urethane Systems, L.L.C equity affiliate (owned 50% and
included in the Polymer Coating Systems operating segment). The
Vinyl Business operating segment includes the Geon/Polimeros
Andinos equity affiliate (owned 50%).

Combined summarized financial information for these equity
affiliates follows. The amounts shown represent the entire opera-
tions of these businesses. DH Compounding is included in the
following table up to the time of its consolidation into PolyOne on
October 1, 2006.

(In millions)

Net sales

Operating income

Net income

Current assets

Non-current assets

Total assets

Current liabilities

Non-current liabilities

Total liabilities

2006

2005

$122.9

$127.0

$ 12.0

$ 14.4

$ 10.7

$ 12.0

$ 30.7

$ 34.9

14.0

31.1

$ 44.7

$ 66.0

$ 28.7

$ 29.7

2.7

2.8

$ 31.4

$ 32.5

Note G. FINANCING ARRANGEMENTS

Long-term debt at December 31 consisted of the following:

(In millions)

10.625% senior notes due 2010

8.875% senior notes due 2012

7.500% debentures due 2015

Medium-term notes — interest rates from 6.52%

to 7.16% with a weighted average rate of
6.83% at December 31, 2006 and 2005,
respectively — due between 2007 and 2011

6.0% promissory note due in equal monthly

installments through 2009

Total long-term debt

Less current portion

2006

2005

$241.4

$300.0

199.1

198.9

50.0

91.7

90.5

8.0

—

$590.2

$639.4

22.5

0.7

Total long-term debt, net of current portion

$567.7

$638.7

Aggregate maturities of long-term debt for the next five years are:
2007 — $22.5 million; 2008 — $21.9 million; 2009 — $20.5 mil-
lion; 2010 — $259.0 million; 2011 — $17.2 million; and thereaf-
ter — $249.1 million.

During 2006, PolyOne issued a promissory note in the principal
amount of $8.7 million, payable in 36 equal installments at a rate of
6% per annum. This promissory note resulted from the purchase of
the remaining 50% interest in DH Compounding Company. For
further discussion of this purchase, see Note A.

During 2006, PolyOne repurchased $58.6 million aggregate
principal amount of its 10.625% senior notes at a premium of
$4.4 million. The premium is shown as a separate line item in
the Consolidated Statements of Operations. Unamortized deferred
note issuance costs of $0.8 million were expensed due to this

P O L Y O N E C O R P O R A T I O N

was used at December 31, 2006. Continued availability of the
securitization program depends upon compliance with covenants
that are contained in the related agreements. As of December 31,
2006, PolyOne was in compliance with these covenants.

PolyOne receives the remaining proceeds from collection of the
receivables after a deduction for the aggregate yield payable on the
undivided interests in the receivables sold by PFC, a servicer’s fee,
an unused commitment fee (between 0.25% and 0.50%, depending
upon the amount of the unused portion of the facility), fees for any
outstanding letters of credit, and an administration and monitoring
fee ($150,000 per annum).

PolyOne also services the underlying accounts receivable and
receives a service fee of 1% per annum on the average daily amount
of the outstanding interests in its receivables. The net discount and
other costs of the receivables sale facility are included in other
expense, net in the Consolidated Statements of Operations.

Note J. INVENTORIES

(In millions)

At FIFO or average cost, which
approximates current cost:

December 31,

2006

2005

Finished products and in process

$165.4

$155.0

Raw materials and supplies

Reserve to reduce certain inventories

to LIFO cost basis

111.7

277.1

86.8

241.8

(36.3)

(50.0)

$240.8

$191.8

Note K. PROPERTY

(In millions)

December 31,

2006

2005

Land and land improvements

39.8

40.6

Buildings

Machinery and equipment

Less accumulated depreciation and

amortization

263.2

854.9

253.4

827.5

1,157.9

1,121.5

(715.5)

(685.5)

$ 442.4

$ 436.0

The increase in property of $6.4 million was a result of capital
expenditures of $41.1 million, the acquisition of the fixed assets of
DH Compounding Company in the amount of $15.4 million, and an
increase of $9.7 million from foreign currency translation. Offset-
ting these increases was depreciation expense of $55.0 million and
disposals of $4.8 million.

The following table shows the interest rate impact of the swap

agreements at December 31, 2006 and 2005:

Effective

Interest Rate at

December 31,

2006

2005

8.8%

—

6.9%

$100.0 million of medium-term notes

with a weighted-average interest rate
of 6.83%

$100.7 million of medium-term notes

with a weighted-average interest rate
of 6.83%

Note H. LEASING ARRANGEMENTS

PolyOne leases certain manufacturing facilities, warehouse space,
machinery and equipment, automobiles and railcars under operat-
ing leases. Rent expense was $20.5 million in 2006, $19.3 million
in 2005 and $18.3 million in 2004.

Future minimum lease payments under non-cancelable oper-
ating leases with initial lease terms longer than one year at Decem-
ber 31, 2006 were as follows: 2007 — $15.2 million; 2008 —
$12.0 million; 2009 — $9.2 million; 2010 — $7.0 million;
2011 — $6.4 million; and thereafter — $15.2 million.

Note I. SALE OF ACCOUNTS RECEIVABLE

Accounts receivable at December 31 consist of the following:

(In millions)

Trade accounts receivable

Retained interest in securitized accounts

receivable

Allowance for doubtful accounts

2006

2005

$160.7

$139.6

161.6

187.3

(5.9)

(6.4)

$316.4

$320.5

Under the terms of its receivables sale facility, PolyOne sells its
accounts receivable to PolyOne Funding Corporation (PFC), a wholly
owned, bankruptcy-remote subsidiary. At December 31, 2006 and
2005, accounts receivable totaling $161.6 million and $187.3 mil-
lion, respectively, were sold by PolyOne to PFC. PFC, in turn, may sell
an undivided interest in these accounts receivable to certain inves-
tors and realize proceeds of up to $175 million. The maximum
proceeds that PFC may receive under the facility is limited to 85% of
the eligible accounts receivable that are sold to PFC. At Decem-
ber 31, 2006, PFC had not sold any of its undivided interests in
accounts receivable. At December 31, 2005, PFC had sold $7.9 mil-
lion of its undivided interests in accounts receivable. PolyOne
retained an interest in the $161.6 million and $187.3 million of
trade receivables at December 31, 2006 and 2005, respectively,
that were sold by PolyOne to PFC. As a result, these retained
interests are included in accounts receivable on the Consolidated
Balance Sheets at December 31, 2006 and 2005.

The receivables sale facility also makes up to $40 million
available for the issuance of standby letters of credit as a sub-limit
within the $175 million limit under the facility, of which $10.9 million

P O L Y O N E C O R P O R A T I O N

Note L. OTHER BALANCE SHEET LIABILITIES

Accrued Expenses

Non-current Liabilities

December 31,

(In millions)

2006

2005

2006

2005

Employment costs

$49.5

$39.4

$ 11.0

$ 12.8

Environmental

Taxes

Post-retirement benefits

Interest

Pension

Employee separation and

plant phaseout

Insurance accruals

Other

5.0

7.6

9.3

6.9

4.5

1.5

0.1

8.7

7.3

8.2

8.9

7.7

4.8

2.5

0.1

3.5

54.5

47.9

—

125.1

135.4

—

1.7

8.2

—

1.8

16.4

$93.1

$82.4

$200.5

$214.3

Note M. EMPLOYEE BENEFIT PLANS

PolyOne has several pension plans, of which only two continue to
accrue benefits for certain U.S. employees. These two plans gen-
erally provide benefit payments using a formula that is based upon
employee compensation and length of service. Length of service for
determining benefit payments was frozen as of December 31,
2002. All U.S. defined-benefit pension plans were closed to new
participants as of December 31, 1999.

PolyOne also sponsors several unfunded defined-benefit post-
retirement plans that provide subsidized health care and life

insurance benefits to certain retirees and a closed group of eligible
employees. As of April 1, 2006, all post-retirement health care
plans are contributor y. Retiree contributions are adjusted periodi-
cally, and these plans contain other cost-sharing features such as a
maximum cap on the Company’s cost, deductibles and cost shar-
ing. Life insurance plans are generally non-contributor y. Only certain
employees hired prior to December 31, 1999 are eligible to par-
ticipate in the Company’s post-retirement health care and life
insurance plans.

PolyOne uses December 31 as the measurement date for all of
its plans. Effective December 31, 2005, PolyOne adopted the
RP2000 mortality table to better estimate the future liabilities
under its defined-benefit pension plans.

As discussed in Note C, the Company adopted the provisions of
SFAS No. 158 as of December 31, 2006 and, accordingly, recog-
nized an increase of $6.4 million on a pre-tax basis and a decrease
of $0.4 million on an after-tax basis to its accumulated other
comprehensive loss for the unfunded status of its pension and
post-retirement health care benefit plans. In addition, PolyOne
recorded an adjustment of $2.7 million to increase accumulated
other comprehensive loss to record its proportionate share of
OxyVinyls’ adoption of SFAS No. 158. The Company also recognized
the prior service cost and net actuarial gains and losses of these
plans in accumulated other comprehensive income. Future changes
to the funded status of these plans will be recognized through
accumulated other comprehensive income (AOCI) in the year the
change occurs.

P O L Y O N E C O R P O R A T I O N

The following table illustrates the impact of the adoption of SFAS No. 158 on a pre-tax basis at December 31, 2006:

(In millions)

Before application of SFAS No. 158:
Assets

Prepaid cost

Intangible assets

Deferred income taxes

Liabilities and shareholders’ equity

Liability for pension benefits

AOCI

Total shareholders’ equity

Adjustments:
Assets

Prepaid cost

Intangible assets

Deferred income taxes

Liabilities and shareholders’ equity

Liability for pension benefits

AOCI

Change in AOCI related to adoption of SFAS No. 158 of equity affiliate

Total shareholders’ equity

After application of SFAS No. 158:
Assets

Prepaid cost

Intangible assets

Deferred income taxes

Liabilities and shareholders’ equity

Liability for pension benefits

AOCI

Change in AOCI related to adoption of SFAS No. 158 of equity affiliate

Total shareholders’ equity

Pension

Health Care

Benefits

$ 61.6

$ —

0.1

35.2

—

32.3

167.5

109.6

(124.4)

—

$ (60.9)

$ —

(0.1)

0.6

—

6.2

(37.9)

(23.1)

—

(23.1)

(16.7)

16.7

(2.7)

14.0

0.7

—

35.8

$ —

—

38.5

129.6

(147.5)

—

(147.5)

92.9

16.7

(2.7)

14.0

The following tables present the change in benefit obligation, change in plan assets and components of funded status for defined-benefit

pension and post-retirement health care benefit plans. Actuarial assumptions that were used are also included.

P O L Y O N E C O R P O R A T I O N

(In millions)

Change in benefit obligation:

Pension Benefits

Health Care Benefits

2006

2005

2006

2005

Projected benefit obligation — beginning of year

$ 536.6

$ 526.2

$102.6

$ 112.5

Service cost

Interest cost

Participant contributions

Benefits paid

Acquired businesses and plan amendments

Change in discount rate and other

Projected benefit obligation — end of year

Projected salary increases

Accumulated benefit obligation

Change in plan assets:

Plan assets — beginning of year

Actual return on plan assets

Company contributions

Plan participants’ contributions

Benefits paid

Other

Plan assets — end of year

Funded status at end of year

1.1

29.4

—

1.3

28.9

—

0.4

5.1

6.3

0.4

5.9

4.6

(36.5)

(36.2)

(14.9)

(16.9)

1.1

(16.8)

7.9

8.5

(6.6)

(8.8)

4.9

$ 514.9

$ 536.6

$ 92.9

$ 102.6

23.0

26.1

—

$ 491.9

$ 510.5

$ 92.9

$ 102.6

$ 370.0

$ 377.6

$ — $

46.2

5.3

—

23.9

5.5

—

8.6

6.3

—

12.3

4.6

(36.5)

(36.2)

(14.9)

(16.9)

1.0

(0.8)

$ 386.0

$ 370.0

$ — $

—

$(128.9)

$(166.6)

$ (92.9)

$(102.6)

Plan assets of $386.0 million and $370.0 million at December 31,
2006 and 2005, respectively, relate to PolyOne’s funded pension
plans that have an accumulated benefit obligation (ABO) of $443.3 mil-
lion and $462.4 million at December 31, 2006 and 2005, respectively.

Amounts included in the Consolidated Balance Sheets are as follows:
(In millions)

Other non-current assets

Current liabilities

Long-term liabilities

Amounts recognized in AOCI:
(In millions)

Net loss

Prior service cost (credit)

Equity affiliate’s adoption of SFAS No. 158

Change in AOCI under SFAS No. 158:
(In millions)

AOCI in prior year

Increase (decrease) prior to SFAS No. 158

Increase (decrease) due to SFAS No. 158

Increase related to adoption of SFAS No. 158 of equity affiliate

Other adjustments

AOCI in current year

As of December 31, 2006 and 2005, PolyOne is 87% and 80% funded,
respectively, in regards to these plans and their respective ABO.

Pension Benefits

Health Care Benefits

2006

0.7

4.5

$125.1

2005

$ —

4.8

$135.4

2006

$ —

$ 9.3

$83.6

2005

$ —

8.9

$107.9

Pension Benefits

Health Care Benefits

2005

2006

$148.1

(0.6)

—

$147.5

$169.0

2006

$ 25.1

(41.8)

2.7

$(14.0)

2005

$—

Pension Benefits

Health Care Benefits

2006

$169.0

(44.9)

23.1

—

0.3

2005

2006

2005

—

(16.7)

2.7

—

$147.5

$169.0

$(14.0)

P O L Y O N E C O R P O R A T I O N

As of December 31, 2006 and 2005, PolyOne had plans with a projected benefit obligation and an accumulated benefit obligation in

excess of the related plan assets. Information for these plans is presented below:

(In millions)

Projected benefit obligation

Accumulated benefit obligation

Fair value of plan assets

Weighted-average assumptions used to determine benefit obligation at December 31:

Discount rate

Rate of compensation increase

Assumed health care cost trend rates at December 31:

Health care cost trend rate assumed for next year

Rate to which the

cost trend rate is assumed to decline (the ultimate trend

rate)

Year that the rate reaches the ultimate trend rate

Pension Benefits

Health Care Benefits

2006

2005

2006

2005

$512.8

$534.2

$92.9

$102.6

490.0

383.3

508.1

366.6

92.9

$102.6

—

Pension Benefits

Health Care Benefits

2006

2005

2004

2006

2005

2004

6.07% 5.66% 5.58% 6.02% 5.56% 5.43%

3.5%

—

11%

—

— 5.25% 5.25% 5.25%

— 2013

2012

2011

Assumed health care cost trend rates have an effect on the amounts reported for the health care plans. A one percentage point change

in assumed health care cost trend rates would have the following impact:

(In millions)

Effect on total of service and interest cost

Effect on post-retirement benefit obligation

One Percentage

Point Increase

Point Decrease

$0.3

5.9

$(0.3)

(5.3)

An expected return on plan assets of 8.50% will be used to calculate the 2007 pension expense. The expected long-term return rate on
pension assets was determined after considering the historical experience of long-term asset returns by asset category, the expected
investment portfolio mix by category of asset and estimated future long-term investment returns.

The following table summarizes the components of net period benefit cost that was recognized during each of the years in the three-year

period ended December 31, 2006. Actuarial assumptions that were used are also included.

(Dollars in millions)

Components of net periodic benefit costs:

Service cost

Interest cost

Expected return on plan assets

Curtailment and settlement charges

Amortization of prior service cost

Amortization of net loss (gain)

Pension Benefits

Health Care Benefits

2006

2005

2004

2006

2005

2004

$ 1.1

$ 1.3

$ 1.1

$ 0.4

$ 0.5

29.4

28.9

29.6

(30.2)

(31.7)

(26.3)

—

0.4

—

0.1

—

5.1

—

5.9

—

(5.8)

(4.5)

8.2

—

13.3

13.0

10.7

1.6

1.2

(0.8)

$ 13.6

$ 11.9

$ 15.2

$ 1.3

$ 3.0

$ 7.9

P O L Y O N E C O R P O R A T I O N

Weighted-average assumptions used to determine net periodic benefit cost for the years

ended December 31:

Discount rate

Expected long-term return on plan assets

Rate of compensation increase

Assumed health care cost trend rates at December 31:

Health care cost trend rate assumed for next year

Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)

Year that the rate reaches the ultimate trend rate

Pension Benefits

Health Care Benefits

2006

2005

2004

2006

2005

2004

5.66% 5.58% 6.25% 5.56% 5.43% 6.25%

8.50% 8.75% 8.75%

3.5%

—

10%

— 5.25% 5.25% 5.25%

— 2012

2011

2010

The amortization amounts expected to be recognized during

the year ended December 31, 2007 are as follows:

(In millions)

Pension Benefits

Health Care Benefits

Amount of net prior service cost

(credit)

Amount of net loss

$(0.1)

$ 9.2

$(5.8)

$ 1.4

PolyOne’s pension asset investment strategy is to diversify the
asset portfolio among and within asset categories to enhance the
portfolio’s risk-adjusted return. PolyOne’s expected portfolio asset
mix also considers the duration of plan liabilities and historical and
expected returns of the asset investments. PolyOne’s pension
asset investment allocation guidelines are to invest 40% to 75%
in equity securities, 15% to 40% in debt securities (including cash
equivalents) and 8% to 22% in alternative investments. These
alternative investments include funds of multiple asset investment
strategies and funds of hedge funds.

PolyOne’s weighted-average asset allocations at December 31,

2006 and 2005 were as follows:

Asset Category

Equity securities

Debt securities

Other

Plan Assets at

December 31,

2006

2005

62%

63%

100%

The estimated future benefit payments for PolyOne’s pension

and health care plans are as follows:

(In millions)

2007

2008

2009

2010

2011

Medicare

Pension

Health Care

Part D

Benefits

Subsidy

$ 35.4

$ 9.2

$1.4

35.2

36.1

35.8

9.3

9.4

9.3

1.5

1.6

8.2

2012 through 2016

185.0

43.0

The Company currently estimates that 2007 employer contri-
butions will be $15.9 million to all qualified and nonqualified pen-
sion plans and $9.2 million to all health care benefit plans. The

P O L Y O N E C O R P O R A T I O N

Company anticipates that it will make a payment of approximately
$11.1 million to its U.S. qualified defined-benefit plans in 2007.
This amount is included in the total estimate of $15.9 million to all
of the Company’s qualified and non-qualified pension plans.

PolyOne sponsors a voluntary retirement savings plan (RSP).
Under the provisions of this plan, eligible employees can generally
receive defined Company contributions of 2% of their eligible earn-
ings plus Company matching contributions based on the first 6% of
their eligible earnings contributed to the plan. In addition, PolyOne
may make discretionary contributions to this plan for eligible
employees based on a specific percentage of each employee’s
compensation.

Following are PolyOne’s contributions to the RSP:

(In millions)

Retirement savings match

Defined retirement benefit

2006

2005

2004

$ 5.4

$5.1

$4.2

4.7

4.8

5.4

$10.1

$9.9

$9.6

Note N. COMMITMENTS AND RELATED-PARTY INFORMATION

Environmental — PolyOne has been notified by federal and state
environmental agencies and by private parties that it may be a
potentially responsible party (PRP) in connection with the investi-
gation and remediation of a number of environmental waste dis-
posal sites. While government agencies frequently assert that PRPs
are jointly and severally liable at these sites, in PolyOne’s experi-
ence interim and final allocations of liability costs are generally
made based on the relative contribution of waste. PolyOne believes
that its potential continuing liability with respect to these 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
to ensure safe and lawful activities at its operations. PolyOne
believes that compliance with current governmental regulations
at all levels will not have a material adverse effect on its financial
condition. Based on estimates prepared by its environmental engi-
neers and consultants, PolyOne had accruals totaling $59.5 million
at December 31, 2006 and $55.2 million at December 31, 2005 to
cover probable future environmental expenditures relating to pre-
viously contaminated sites. The accrual represents PolyOne’s best
estimate of the remaining probable remediation costs, based upon
information and technology that is 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,
2006. However, such additional costs, if any, cannot be currently
estimated. PolyOne’s estimate of this liability may be revised as
new regulations or technologies are developed or additional infor-
mation is obtained. For 2006, 2005 and 2004, PolyOne incurred
environmental expense of $2.5 million, $0.2 million and $10.3 mil-
lion, respectively, of which $2.5 million in 2006, $0.9 million in
2005 and $8.7 million in 2004 related to inactive or formerly owned
sites. Environmental expense is presented net of insurance recov-
eries of $8.1 million in 2006, $2.2 million in 2005 and $1.8 million
in 2004. The insurance recoveries all relate to inactive or formerly
owned sites.

Guarantees — PolyOne guarantees $67.0 million of SunBelt’s
outstanding senior secured notes in connection with the construc-
tion of a chlor-alkali facility in McIntosh, Alabama. This debt matures
in 2017.

Related-Party Transactions — PolyOne purchases a substan-
tial portion of its PVC resin and all of its vinyl chloride monomer
(VCM) raw materials under supply agreements with OxyVinyls. These
agreements have an initial term of 15 years commencing May 1,
1999, and PolyOne has the right to renew these agreements for two
five-year periods. PolyOne has also entered into various service
agreements with OxyVinyls. Net amounts owed to OxyVinyls, prima-
rily for raw material purchases, totaled $17.3 million at Decem-
ber 31, 2006 and $28.0 million at December 31, 2005. PolyOne’s
purchases of raw materials from OxyVinyls were $369 million during
2006, $368 million during 2005 and $273 million during 2004.

Note O. OTHER EXPENSE, NET

(In millions)

Currency exchange loss

2006

2005

2004

$(1.3)

$(0.1)

$ (3.0)

Foreign exchange contracts gain (loss)

1.1

0.6

Discount on sale of trade receivables

(1.9)

(5.5)

Retained post-employment benefit cost
related to discontinued operations

Other income (expense), net

—

(0.7)

(1.3)

1.0

(1.1)

(6.1)

(3.6)

0.6

$(2.8)

$(5.3)

$(13.2)

Note P. INCOME TAXES

A summar y of income tax expense (benefit) follows:

(In millions)

Current:

Federal

State

Foreign

Total current

Deferred:

Federal

State

Foreign

Total deferred

2006

2005

2004

$ 2.5

$0.3

$ —

2.2

2.9

0.7

3.6

0.4

12.6

$ 7.6

$4.6

$13.0

$(14.2)

$ — $ —

(1.6)

2.2

—

2.0

—

0.7

$(13.6)

$2.0

$ 0.7

Total tax expense (benefit)

$ (6.0)

$6.6

$13.7

The income tax rate (benefit) for financial reporting purposes

differed from the federal statutor y rate as follows:

2006

2005

2004

Federal statutor y income tax rate

35.0% 35.0% 35.0%

Alternative minimum tax

State tax, net of federal benefit

Valuation allowance

Provision for repatriation of foreign earnings

Differences in rates of foreign operations

Other, net

Effective income tax rate

2.1

1.2

0.4

0.7

—

0.7

(50.1)

(31.0)

12.5

8.8

(1.2)

(0.8)

2.0

—

(0.1)

(12.1)

2.6

(2.9)

(5.0)%

9.6% 33.2%

Components of PolyOne’s deferred tax liabilities and assets at

December 31, 2006 and 2005 were as follows:

(In millions)

Deferred tax liabilities:

Tax over book depreciation

Intangibles

Equity investments

Other, net

Total deferred tax liabilities

Deferred tax assets:

2006

2005

$ 45.9

$ 52.2

5.0

4.8

118.1

131.0

7.3

6.0

$176.3

$194.0

Post-retirement benefits other than pensions

$ 38.5

$ 38.6

Employment cost and pension

Discontinued operations impairment

Environmental

Net operating loss carryforward

State taxes

Income (loss) before income taxes and discontinued operations
consists of the following:

Alternative minimum tax credit carryforward

Foreign net operating losses and tax credit

(In millions)

Domestic

Foreign

carryforward

2006

2005

2004

Other, net

$101.5

$52.6

$(10.9)

Total deferred tax assets

18.4

16.2

52.2

Tax valuation allowance

$119.9

$68.8

$ 41.3

Net deferred tax assets

39.9

—

20.8

94.1

1.6

8.5

1.4

16.0

44.5

15.7

19.4

146.6

5.9

6.1

1.2

13.1

$220.8

$291.1

(1.4)

(76.9)

$ 43.1

$ 20.2

P O L Y O N E C O R P O R A T I O N

In accordance with the provisions of SFAS No. 109, “Account-
ing for Income Taxes,” the Company recorded a $75.5 million
reversal of valuation allowance in 2006. This amount is comprised
of a $44.3 million current year utilization of net operating loss
carryforwards, $15.4 million as a component of other comprehen-
sive income associated with changes in accumulated other com-
prehensive income related to the pension and post retirement
health care benefit liabilities, and a $15.8 million reversal of the
valuation allowance as a reduction to expense associated with the
Company’s determination that it is more likely than not that the
deferred tax asset will be realized.

The reduction in the valuation allowance in 2005 is primarily

the result of utilizing net operating loss carryforwards.

PolyOne provided for U.S. federal and foreign withholding tax on
$22.0 million, or 11% of foreign subsidiaries’ undistributed earn-
ings as of December 31, 2006. Undistributed earnings for which no
federal or foreign withholding tax has been provided are intended to
be reinvested indefinitely and it is not practicable to estimate the
amount of additional taxes which may be payable upon distribution.

PolyOne paid income taxes, net of refunds, of $9.0 million in
2006, $10.2 million in 2005 and $8.0 million in 2004. PolyOne has
a U.S. net operating loss carryforward of $269.0 million, of which
$95.0 million will expire in 2022, $87.6 million in 2023, $86.1 mil-
lion in 2024, and the remaining $0.3 million in 2025. In addition,
PolyOne has an alternative minimum tax credit carryforward of
$8.5 million that has no expiration date.

NOTE Q. SHARE-BASED COMPENSATION

Share-based compensation cost is based on the value of the por-
tion of share-based payment awards that are ultimately expected to
vest during the period. Share-based compensation cost recognized
in the Company’s Consolidated Statement of Operations for the
year ended December 31, 2006 includes (a) compensation cost for
share-based payment awards granted prior to, but not yet vested,
as of January 1, 2006 based on the grant date fair value estimated
in accordance with the pro forma provisions of SFAS No. 123, plus
(b) compensation cost for share-based payment awards granted on
or subsequent to January 1, 2006 based on the grant date fair value
estimated in accordance with the provision of SFAS No. 123(R).
Because share-based compensation expense recognized in the
Consolidated Statement of Operations for the year ended Decem-
ber 31, 2006 is based on awards ultimately expected to vest, it has
been reduced for estimated for feitures. SFAS No. 123(R) requires
that for feitures be estimated at the time of grant and revised, if
necessary, in subsequent periods if actual for feitures differ from
those estimates. In the Company’s pro forma information that was
required under SFAS No. 123 for the years ended December 31,
2005 and 2004, the Company accounted for for feitures as they
occurred.

PolyOne has one active share-based compensation plan, which
is described below. The pre-tax compensation cost that was recog-
nized for the year ended December 31, 2006 was $4.5 million. For

the years ended December 31, 2005 and 2004, PolyOne recog-
nized a benefit of $0.6 million and expense of $2.7 million, respec-
tively. This compensation cost or benefit is included in selling and
administrative expenses in the Consolidated Statements of
Operations.

2005 Equity and Performance Incentive Plan

In May 2005, PolyOne’s shareholders approved the PolyOne Cor-
poration 2005 Equity and Per formance Incentive Plan (2005 EPIP).
All future grants and awards to PolyOne employees will be issued
only from this plan until there are no shares remaining under the
plan. As a result, all previous equity-based plans were frozen in May
2005. The 2005 EPIP provides for the award of a broad variety of
share-based compensation alternatives,
including non-qualified
stock options, incentive stock options, restricted stock, restricted
stock units, per formance shares, per formance units and SARs. Five
million shares of common stock have been reserved for grants and
awards under the 2005 EPIP. It is anticipated that all share-based
grants and awards that are earned and exercised will be issued from
shares of PolyOne common stock that are held in treasury.

Stock Appreciation Rights

During 2006, the Compensation and Governance Committee of the
Company’s Board of Directors authorized the issuance of
1,141,000 SARs. The awards were approved and communicated
as follows:

Date of issuance

Jan. 4, 2006

Feb. 21, 2006 May 25, 2006

Aug. 30, 2006

Oct. 4, 2006

Number of SARs

854,400

174,900

56,700

35,000

20,000

Grant date stock price

6.51 $

9.19 $

9.02 $

8.48 $

8.12

Expiration date

Jan. 4, 2013

Feb. 21, 2013 May 25, 2013

Aug. 30, 2013

Oct. 4, 2013

Vesting is based on a service period of one year and the
achievement of certain stock price targets. This condition is con-
sidered a market-based measure under SFAS No. 123(R) and is
considered in determining the grant’s fair value. This fair value is
not subsequently revised for actual market price achievement, but
rather is a fixed expense subject only to service-related for feitures.
The awards vest in one-third increments based on stock price
achievement of $7.50, $8.50 and $10.00 per share, but may
not be exercised earlier than one year from the date of the grant.
The SARs have seven-year exercise periods.

The option pricing model used by PolyOne to value the SARs
granted during 2006 was a Monte Carlo simulation method. Under
this method, the fair value of awards on the date of grant is an
estimate and is affected by the Company’s stock price, as well as by
assumptions regarding a number of highly complex and subjective
variables that are presented in the following table. Expected vola-
tility was determined by the six-year historical weekly average mar-
ket price volatility for PolyOne’s common stock and the implied
volatility rates for exchange-traded options. The expected term of
options granted was set equal to halfway between the vesting and
expiration dates for each grant. Dividends were not included in this

P O L Y O N E C O R P O R A T I O N

calculation because PolyOne does not currently pay dividends. The risk-free rate of return for periods within the contractual life of the option is
based on U.S. Treasury rates that were in effect at the time of the grant. Forfeitures were estimated at 3% per year based on PolyOne’s
historical experience. Following is a summary of the assumptions related to the SAR grants issued during 2006, 2005 and 2004:

Expected volatility

Expected dividends

Expected term (in years)

Risk-free rate

Value of SARs granted

2006

44.0%

—

2005

42.0%

—

2004

42.4%

—

3.7 — 4.3

5.2 — 5.5

5.4 — 6.4

4.26% — 4.91%

3.8%

3.45 — 4.07%

$2.63 — $3.82

$4.05 — $4.31

$3.36

In January 2005, the Compensation and Governance Committee authorized the issuance of 474,300 SARs. The fair value of the SARs
was $4.18 per share and was calculated using the Black-Scholes-Mer ton valuation method. The SARs will be settled in shares of PolyOne
common stock and vest in one-third increments when PolyOne’s common stock price increases by 10%, 20% and 30% above the $8.94 per
share base price. The SARs have a seven-year exercise period that expires on January 4, 2012.

A summary of SAR activity under the 2005 EPIP as of December 31, 2006 and during 2006 is presented below:

Stock Appreciation Rights

Outstanding at January 1, 2006

Granted

Exercised

Forfeited or expired

Outstanding at December 31, 2006

Vested at December 31, 2006

Exercisable at December 31, 2006

Weighted-Average

Remaining

Value

(in thousands)

Exercise Price

Contractual Term

(in millions)

Weighted-Average

Aggregate Intrinsic

1,528

1,141

(564)

(465)

1,640

980

275

$7.40

7.13

6.13

6.53

$7.90

$7.84

$9.52

5.6 years

5.7 years

4.5 years

$0.8

$0.5

$ —

The weighted-average grant date fair value of SARs granted during 2006 was $2.99. SARs granted during 2005 amounted to 474,300
and had a weighted-average grant date fair value of $4.18. SARs granted during 2004 amounted to 52,500 and had a weighted-average grant
date fair value of $3.36. The total intrinsic value of SARs that were exercised during 2006, 2005 and 2004 was $1.5 million, $0.2 million and
$1.0 million, respectively.

As of December 31, 2006, there was $0.5 million of total unrecognized compensation cost related to SARs that is expected to be

recognized over a weighted-average period of one year.

Stock Options

PolyOne’s incentive stock plans provide for the award or grant of options to purchase shares of PolyOne common stock. Options granted
generally become exercisable at the rate of 35% after one year, 70% after two years and 100% after three years. The term of each option
cannot extend beyond 10 years from the date of grant. All options are granted at 100% or greater of market value on the date of the grant.
PolyOne also has a stock option plan for non-employee directors under which options are granted.

A summary of option activity as of December 31, 2006 and changes during 2006 is presented below:

Stock Options

Outstanding at January 1, 2006

Granted

Exercised

Forfeited or expired

Outstanding at December 31, 2006

Vested and exercisable at December 31, 2006

Weighted-Average

Remaining

Intrinsic Value

(in thousands)

Exercise Price

Contractual Term

(in millions)

Weighted-Average

Aggregate

9,115

—

(443)

(1,287)

7,385

$11.55

—

6.76

13.57

$11.47

2.8 years

$1.1

No options were granted in 2006 or 2005. Options granted in 2004 amounted to 109,000 and had a weighted-average grant date fair

value of $7.08.

The total intrinsic value of stock options that were exercised during 2006, 2005 and 2004 was $0.9 million, $0.1 million and

$0.1 million, respectively.

P O L Y O N E C O R P O R A T I O N

Cash received during 2006, 2005 and 2004 from the exercise
of stock options was $3.1 million, $0.5 million and $0.3 million,
respectively.

Performance Shares

In January 2005, the Compensation and Governance Committee
authorized the issuance of per formance shares to selected exec-
utives and other key employees. The per formance shares vest only
to the extent that management goals for cash flow, return on
invested capital, and the level of earnings before interest, taxes,
depreciation and amortization in relation to debt are achieved for
the period commencing January 1, 2005 and ending December 31,
2007. The fair value of each per formance share is equal to the
grant date market price.

At December 31, 2006, there were 564,526 per formance
share awards outstanding with a weighted-average grant date fair
value of $8.94 per share. During 2006, compensation cost of
$1.0 million was recognized for these awards. As of December 31,
2006, based on projected per formance attainment for the remain-
ing life of the awards, the unrecognized compensation cost of these
awards was approximately $0.6 million.

Restricted Stock Awards

On February 21, 2006, PolyOne issued 200,000 shares of
restricted stock as part of the compensation package for its new
Chief Executive Officer. In addition, 5,000 and 15,000 shares of
restricted stock were issued to executives during the third and
fourth quarter of 2006, respectively. The value of the restricted
shares was established using the market price of PolyOne’s com-
mon stock on the date of the grant. Compensation expense is being
recorded on a straight-line basis over the three-year cliff vesting
period of the restricted stock. As of December 31, 2006, all
220,000 shares remain unvested with a weighted-average grant
date fair value of $8.76 per share and a weighted-average remain-
ing contractual
term of 32 months. Compensation expense
recorded during 2006 was $0.5 million. Unrecognized compensa-
tion cost for restricted stock awards at December 31, 2006 was
$1.4 million. No shares of restricted stock were issued in 2005 or
2004.

Note R. SEGMENT INFORMATION

A segment is a component of an enterprise whose operating results
are regularly reviewed by the enterprise’s chief operating decision
maker to make decisions about resources to be allocated to the
segment and assess its per formance, and for which discrete finan-
cial information is available. PolyOne determines and discloses its
segments in accordance with SFAS No. 131, “Disclosures about
Segments of an Enterprise and Related Information,” which defines
how to determine segments.

The Company’s historical presentation of segment information
consisted of six reportable segments: Vinyl Compounds, Specialty
Resins, North American Color and Additives, International Color and
and
Engineered Materials,

Distribution,

PolyOne

Resin

Intermediates, and an All Other segment. The All Other segment
consisted of the North American Engineered Materials and Polymer
Coating Systems operating segments. Effective with the first quar-
ter of 2006, Producer Services, a new operating segment, was
formed from portions of the North American Color and Additives and
the North American Engineered Materials operating segments. As a
result, North American Color and Additives no longer meets the
quantitative thresholds that would require separate disclosure as a
reportable segment and is included in the All Other segment. Pro-
ducer Services also does not meet the quantitative thresholds as
defined in SFAS No. 131 and is also included in the All Other
segment. During the fourth quarter of 2006, PolyOne changed its
management structure, which resulted in the Specialty Resins
reportable segment being subsumed into the Vinyl Compounds
reportable segment to create a new operating and reportable seg-
ment, Vinyl Business.

Effective December 31, 2006, all disclosures reflect four
reportable segments: Vinyl Business, International Color and Engi-
neered Materials, PolyOne Distribution, and Resin and Intermedi-
ates. Additionally, the operating segments that do not meet the
threshold for separate disclosure as reportable segments are
reported in an All Other segment. Segment information for prior
periods has been restated to conform to the 2006 presentation.

PolyOne sold its Elastomers and Per formance Additives busi-
ness in August 2004. It was previously reported as a separate
segment, and its historical financial results are presented as dis-
continued operations. PolyOne sold its Engineered Films business
in February 2006. Its historical financial results are also presented
as discontinued operations.

Operating income is the primary measure that is reported to
the chief operating decision maker for purposes of making deci-
sions about allocating resources to the segment and assessing its
per formance. Operating income at the segment level does not
include: corporate general and administrative costs that are not
allocated to segments; intersegment sales and profit eliminations;
charges related to specific strategic initiatives such as the consol-
idation of operations; restructuring activities, including employee
separation costs resulting from personnel reduction programs,
plant closure and phaseout costs; executive separation agree-
ments; share-based compensation costs; asset impairments; envi-
ronmental remediation costs for facilities no longer owned or closed
in prior years; gains and losses on the divestiture of joint ventures
and equity investments; and certain other items that are not
included in the measure of segment profit or loss that is reported
to and reviewed by the chief operating decision maker. These costs
are included in “Corporate and eliminations.”

Segment assets are primarily customer receivables, invento-
ries, net property, plant and equipment, and goodwill. Intersegment
sales are generally accounted for at prices that approximate those
for similar transactions with unaffiliated customers. Corporate and
eliminations includes cash, sales of accounts receivable, retained
assets and liabilities of discontinued operations, and other unallo-
cated corporate assets and liabilities. The accounting policies of

P O L Y O N E C O R P O R A T I O N

each segment are consistent with those described in Note C. Fol-
lowing is a description of each of the Company’s four reportable
segments and the All Other segment.

Vinyl Business — The Vinyl Business segment is a global
leader offering an extensive array of products and services for vinyl
coating, molding and extrusion processors. Product offerings
include rigid, flexible and dry blend vinyl compounds as well as
industry-leading dispersion, blending, and specialty suspension
grade vinyl resins to a wide variety of manufacturers of plastic parts
and consumer-oriented products. Vinyl Business also offers a wide
range of polymer services to meet the ever changing needs of the
segment’s multi-market customer base. These services include
materials testing and component analysis, color management,
custom compound development, colorant and additive services,
design assistance, structural analyses, process simulations,
extruder screw design and specialty products.

Vinyl is one of the most widely used plastics, utilized in a wide
range of applications in building and construction, wire and cable,
consumer and recreation markets, automotive, packaging and
healthcare. Vinyl resin can be combined with a broad range of
additives, resulting in per formance versatility, particularly when fire
resistance, chemical resistance or weatherability is required. The
Vinyl Business segment is structured to meet the stringent quality,
service and innovation requirements of this diverse and highly
competitive marketplace.

International Color and Engineered Materials — The Interna-
tional Color and Engineered Materials operating segment combines
the strong regional heritage of the Company’s color additive master-
batches and engineered materials operations to create global
capabilities with plants, sales and service facilities located through-
out Europe and Asia.

Working in conjunction with the Company’s North American
Color and Additives and North American Engineered Materials seg-
ments, International Color and Engineered Materials provide solu-
tions that meet international customers’ demands for both global
and local manufacturing, service and technical support.

PolyOne Distribution — The PolyOne Distribution operating seg-
ment distributes more than 3,500 grades of engineering and com-
modity grade resins including PolyOne-produced compounds to the
North American market. These products are sold to over 5,000
custom injection molders and extruders who, in turn, convert them
into plastic parts that are sold to end-users in a wide range of
industries. Representing over 20 major suppliers, PolyOne Distri-
bution offers customers a broad product portfolio, just-in-time deliv-
ery from 24 stocking locations and local technical support.

Resin and Intermediates — The Resin and Intermediates seg-
ment consists almost entirely of two joint ventures that are reported
on the equity method. The Company holds a 24% equity interest in
OxyVinyls and a 50% equity interest in SunBelt. OxyVinyls, a pro-
ducer of PVC resin, VCM, chlorine and caustic soda, is a partnership
with Occidental Chemical Corporation and is PolyOne’s principal
supplier of PVC resin. SunBelt, a producer of chlorine and caustic

soda, is a partnership with Olin Corporation. OxyVinyls is North
America’s second largest and the world’s third largest producer of
PVC resin. In 2006, OxyVinyls had production capacity of approxi-
mately 4.3 billion pounds of PVC resin, 6.2 billion pounds of VCM,
which is an intermediate chemical in the production of PVC, 580
thousand tons of chlorine and 667 thousand tons of caustic soda.
The 6.2 billion pounds of vinyl chloride monomer capacity includes
approximately 2.4 billion pounds owned by OxyMar, a partnership
that is 50% owned by OxyVinyls. In 2006, SunBelt had production
capacity of approximately 320 thousand tons of chlorine and 358
thousand tons of caustic soda. Most of the chlorine manufactured
by OxyVinyls and SunBelt is consumed by OxyVinyls to produce PVC
resin. Caustic soda is sold on the merchant market to customers in
the pulp and paper, chemical, construction and consumer products
industries.

All Other — The Company’s All Other segment includes the
North American Color and Additives, North American Engineered
Materials, Producer Services and Polymer Coating Systems oper-
ating segments. A description of these operating segments follows.

North American Color and Additives — The North American
Color and Additives operating segment is a leading provider of
specialized colorants and additive concentrates that offer an inno-
vative array of colors, special effects and per formance-enhancing
solutions. The segment’s color masterbatches contain a high con-
centration of color pigments and/or additives that are dispersed in a
polymer carrier medium and are sold in pellet, liquid, flake or powder
form. When combined with non pre-colored base resins, the colo-
rants help customers achieve a vast array of specialized colors and
effects targeted at the demands of today’s highly design-oriented
consumer and industrial end markets.

North American Color and Additive masterbatches encompass
a wide variety of per formance enhancing characteristics and are
commonly categorized by the function they per form, such as UV
stabilization, anti-static, chemical blowing, antioxidant and lubri-
cant, and processing enhancement.

Colorant and additives masterbatches are used in most types
of plastics manufacturing processes, including injection molding,
extrusion, sheet, film, rotational molding and blow molding through-
out the plastics industry, particularly in packaging, automotive,
consumer, outdoor decking, pipe, and wire and cable. They are
also incorporated into such end-use products as stadium seating,
toys, housewares, vinyl siding, pipe, food packaging and medical
packaging.

North American Engineered Materials — The North American
Engineered Materials operating segment is a leading provider of
custom plastic compounding services and solutions for processors
of thermoplastic materials across a wide variety of markets and end-
use applications. The North American Engineered Materials’ prod-
uct portfolio, among the broadest in the industry, includes standard
and custom formulated high-per formance polymer compounds that
are manufactured using a full range of thermoplastic compounds
and elastomers, which are then combined with advanced polymer
additive, reinforcement, filler and colorant technologies.

P O L Y O N E C O R P O R A T I O N

The depth of North American Engineered Materials’ compound-
ing expertise helps expand the per formance range and structural
properties of traditional engineering-grade thermoplastic resins to
meet the unique per formance requirements of the segment’s cus-
tomers. Product development and application reach is further
enhanced by the capabilities of the North American Engineered
Materials’ Solutions Center, which produces and evaluates proto-
type and sample parts to help assess end-use per formance and
guide product development. The segment’s manufacturing capabil-
ities, which include a new facility located in Avon Lake, Ohio, are
targeted at meeting customers’ demand for speed, flexibility and
critical quality.

Producer Services — The Producer Services operating seg-
ment offers custom compounding services to resin producers
and processors that design and develop their own compound rec-
ipes. Producer Services also offers a complete product line of
custom black masterbatch products for use in the pressure pipe
industry. Customers often require high quality, cost effective and

Financial information by reportable segment is as follows:

confidential services. As a strategic and integrated supply chain
partner, Producer Services offers resin producers a method to
develop custom products for niche markets by using PolyOne’s
compounding expertise and multiple manufacturing platforms.

Polymer Coating Systems — The Polymer Coating Systems
operating segment provides custom-formulated liquid systems that
meet a variety of customer needs and chemistries, including vinyl,
natural rubber and latex, polyurethane, and silicone. The products
and services are designed to meet the specific requirements of
customers’ applications by providing unique solutions to their mar-
ket needs. Products also include proprietar y fabric screen-printing
inks, powders, latexes, specialty additives and colorants. Polymer
Coating Systems sells into diversified markets that include recre-
ational and athletic apparel, automotive, construction, flooring,
material handling, filtration, outdoor furniture, and medical/health
care. PolyOne also has a 50% interest in BayOne, a joint venture
between PolyOne and Bayer Corporation, which sells polyurethane
systems into many of the same markets.

Year ended December 31, 2006

Sales to External

Operating

Depreciation and

Capital

(in millions)

Vinyl Business

International Color and Engineered

Materials

PolyOne Distribution

Resin and Intermediates

All Other

Corporate and eliminations

Total

Customers

Intersegment Sales

Total Sales

Income (Loss)

Amortization

Expenditures

$ 788.3

$ 137.5

$ 925.8

$ 65.3

$17.8

$ 5.1

$ 412.3

539.9

724.1

—

570.1

—

8.7

—

28.5

(174.7)

539.9

732.8

22.3

19.2

—

102.5

598.6

(174.7)

(0.2)

(18.9)

13.7

1.5

0.2

18.8

5.1

13.6

0.3

—

17.8

4.3

379.6

164.6

270.9

374.5

171.7

$2,622.4

—

$2,622.4

$190.2

$57.1

$41.1

$1,773.6

Year Ended December 31, 2005

Sales to External

Operating

Depreciation and

Capital

(in millions)

Vinyl Business

International Color and Engineered

Materials

PolyOne Distribution

Resin and Intermediates

All Other

Corporate and eliminations

Total

Customers

Intersegment Sales

Total Sales

Income (Loss)

Amortization

Expenditures

$ 790.4

$ 136.3

$ 926.7

$ 59.8

$14.3

$ 6.0

$ 438.7

473.2

672.0

—

515.0

—

7.2

—

28.1

(171.6)

473.2

679.2

—

543.1

(171.6)

16.2

19.5

90.9

(4.5)

(41.6)

13.1

1.3

0.2

19.6

2.2

12.6

0.3

—

7.3

5.9

334.2

178.8

259.9

350.6

125.5

$2,450.6

—

$2,450.6

$140.3

$50.7

$32.1

$1,687.7

Total

Assets

Total

Assets

Total

Assets

Year Ended December 31, 2004

Sales to External

Operating

Depreciation and

Capital

(in millions)

Vinyl Business

International Color and Engineered

Materials

PolyOne Distribution

Resin and Intermediates

All Other

Corporate and eliminations

Total

P O L Y O N E C O R P O R A T I O N

Customers

Intersegment Sales

Total Sales

Income (Loss)

Amortization

Expenditures

$ 708.5

$ 122.9

$ 831.4

$ 67.8

$14.2

$ 4.2

$ 443.5

466.4

599.8

—

493.0

—

6.5

—

26.9

(156.3)

466.4

606.3

—

519.9

(156.3)

34.1

17.8

53.7

(0.4)

(44.6)

13.0

1.3

0.2

20.4

1.8

11.7

0.1

—

7.1

0.8

368.9

160.6

247.7

376.0

149.8

$2,267.7

—

$2,267.7

$128.4

$50.9

$23.9

$1,746.5

In October 2006, PolyOne purchased the remaining 50% of its
equity investment in DH Compounding Company from a wholly-
owned subsidiary of The Dow Chemical Company for $10.2 million.
This equity investment was previously reflected in the “Investment
in equity affiliates” line of the Consolidated Balance Sheets. DH
Compounding Company is now fully consolidated in the Consoli-
dated Balance Sheet as of December 31, 2006, and the results of
operations were included in the Consolidated Statement of Oper-
ations beginning October 1, 2006. DH Compounding is included in
our Producer Services operating segment.

The Vinyl Business segment includes Geon/Polimeros Andinos
equity affiliate (owned 50%). For 2006, the All Other segment
includes earnings of DH Compounding Company equity affiliate

(owned 50% by Producer Services) for the nine months ended
September 30, 2006 and BayOne Urethane Systems, L.L.C equity
affiliate (owned 50% by Polymer Coating Systems). For 2005 and
2004, the All Other segment includes DH Compounding Company
equity affiliate (owned 50% by Producer Services) and BayOne
Urethane Systems, L.L.C equity affiliate (owned 50% by Polymer
Coating Systems).

Earnings of equity affiliates are included in the related seg-
ment’s operating income and the investment in equity affiliates is
included in the related segment’s assets. Amounts related to equity
affiliates included in the segment information, excluding amounts
related to losses on divestitures of equity investments, are as
follows:

(In millions)

Earnings of equity affiliates:

Producer Services

Polymer Coating Systems

Vinyl Business

Resin and Intermediates

Subtotal

Minority interest

Total

Investment in equity affiliates:

Producer Services

Polymer Coating Systems

Vinyl Business

Resin and Intermediates

Total

2006

2005

2004

1.5

3.5

0.9

106.5

112.4

(0.8)

2.1

3.3

1.1

72.4

78.9

—

2.4

2.6

0.9

60.3

66.2

(1.5)

$111.6

$ 78.9

$ 64.7

$ — $ 11.0

$ 11.7

1.5

14.2

0.7

13.3

1.8

12.9

260.4

248.9

236.9

$276.1

$273.9

$263.3

PolyOne’s sales are primarily to customers in the United States, Europe, Canada and Asia, and the majority of its assets are located in
these same geographic areas. Following is a summar y of sales and long-lived assets based on the geographic areas where the sales
originated and where the assets are located:

(In millions)

Net sales:

United States

Europe

Canada

Asia

Other

Long-lived assets:

United States

Europe

Canada

Asia

Other

2006

2005

2004

$1,743.6

$1,648.0

$1,500.9

442.6

287.6

135.7

12.9

404.4

283.2

101.5

13.5

418.5

254.4

81.4

12.5

$ 567.2

$ 545.1

$ 580.9

169.9

158.9

176.0

62.1

26.3

2.7

63.4

23.5

2.7

62.9

18.9

2.7

P O L Y O N E C O R P O R A T I O N

Note S. WEIGHTED-AVERAGE SHARES USED IN COMPUTING EARNINGS PER SHARE

(In millions)

Weighted-average shares — basic:

Weighted-average shares outstanding

Less unearned portion of restricted stock awards included in outstanding shares

Weighted-average shares — diluted:

Weighted-average shares outstanding — basic

Plus dilutive impact of stock options and stock awards

2006

2005

2004

92.5

91.9

91.6

0.1

—

92.4

91.9

91.6

92.4

91.9

91.6

0.4

0.1

0.2

92.8

92.0

91.8

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

Outstanding stock options with exercise prices greater that the
average price of the common shares are anti-dilutive and are not
included in the computation of diluted earnings per share. The
number of anti-dilutive options and awards was 7.4 million, 8.9 mil-
lion and 10.2 million at December 31, 2006, 2005 and 2004,
respectively.

Note T. FINANCIAL INSTRUMENTS

PolyOne enters into intercompany lending transactions denomi-
nated in various foreign currencies and is subject to financial

exposure from foreign exchange rate movement from the date a
loan is recorded to the date it is settled or revalued. To mitigate this
risk, PolyOne enters into foreign exchange contracts. Gains and
losses on these contracts generally offset gains or losses on the
assets and liabilities being hedged and are recorded as other
income or expense in the Consolidated Statements of Operations.
PolyOne does not hold or issue financial instruments for trading
purposes.

The following table summarizes the contractual amounts of
PolyOne’s foreign exchange contracts at December 31, 2006 and
2005. Foreign currency amounts are translated at exchange rates
as of December 31, 2006 and 2005, respectively. The “Buy”
amounts represent the U.S. dollar equivalent of commitments to
purchase foreign currencies, and the “Sell” amounts represent the
U.S. dollar equivalent of commitments to sell foreign currencies.

Currency (in millions)

U.S. dollar

Euro

British pound sterling

Canadian dollar

Other

December 31, 2006

December 31, 2005

Buy

Sell

Buy

Sell

$83.9

$22.7

$88.2

$57.8

0.6

—

21.7

—

85.2

—

12.7

8.3

32.1

3.9

86.9

—

PolyOne used the following methods and assumptions to estimate the fair value of financial instruments:

Cash and cash equivalents — The carrying amounts approximate fair value.

Long- and short-term debt — The carrying amounts of PolyOne’s short-term borrowings approximate fair value. The fair value of
PolyOne’s senior notes, debentures and medium-term notes is based on quoted market prices. The carrying amount of PolyOne’s borrowings
under its variable-interest rate revolving credit agreements and other long-term borrowings approximates fair value.

Foreign exchange contracts — The fair value of short-term foreign exchange contracts is based on exchange rates at December 31,

2006. The fair value of long-term foreign exchange contracts is based on quoted market prices for contracts with similar maturities.

Interest rate swaps — The fair value of interest rate swap agreements, obtained from the respective financial institutions, is based on
current rates of interest and is computed as the net present value of the remaining exchange obligations under the terms of the contract.

P O L Y O N E C O R P O R A T I O N

The carrying amounts and fair values of PolyOne’s financial instruments at December 31, 2006 and 2005 are as follows:

(In millions)

Cash and cash equivalents

Long-term debt

10.625% senior notes

7.500% debentures

8.875% senior notes

Medium-term notes

Other borrowings

Foreign exchange contracts

Interest rate swaps

2006

2005

Carrying

Amount

Fair

Value

Carrying

Amount

Fair

Value

$ 66.2

$ 32.8

241.4

255.9

300.0

324.7

50.0

43.8

50.0

45.1

199.1

199.5

198.9

199.0

91.7

95.0

90.5

94.9

8.0

(1.7)

(5.1)

8.1

(1.7)

(5.1)

—

0.6

—

0.6

(5.8)

Note U. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

(In millions, except per share data)

Fourth

Third

Second

First

Fourth

Third

Second

First

Sales

$595.2

$666.2

$686.4

$674.6

$606.8

$611.6

$620.4

$611.8

Operating costs and expenses, net

572.8

629.8

622.9

606.7

568.8

607.2

567.2

567.1

2006 Quarters

2005 Quarters

Operating income

Income (loss) before discontinued operations

Discontinued operations

Net income (loss)
Basic and diluted earnings (loss) per share:(1)

22.4

15.0

(0.6)

36.4

19.6

—

63.5

42.4

—

67.9

48.9

(2.1)

38.0

20.4

1.3

4.4

(16.2)

(3.3)

53.2

33.0

44.7

25.0

(1.7)

(11.6)

$ 14.4

$ 19.6

$ 42.4

$ 46.8

$ 21.7

$ (19.5)

$ 31.3

$ 13.4

Before discontinued operations

$ 0.16

$ 0.21

$ 0.46

$ 0.53

$ 0.22

$ (0.18)

$ 0.36

$ 0.27

Net income (loss)

$ 0.15

$ 0.21

$ 0.46

$ 0.51

$ 0.24

$ (0.21)

$ 0.34

$ 0.15

(1) Per share amounts for the quarter and the full year have been computed separately. The sum of the quarterly amounts may not equal the annual

amounts presented because of differences in the average shares outstanding during each period.

P O L Y O N E C O R P O R A T I O N

SCHEDULE II

POLYONE CORPORATION AND SUBSIDIARIES
SCHEDULE II – VALUATION AND QUALIFYING ACCOUNTS
FOR THE Years Ended December 31, 2006, 2005 AND 2004
(In millions)

Year ended December 31, 2006

Reserves for doubtful accounts

Accrued liabilities for environmental matters

Year ended December 31, 2005

Reserves for doubtful accounts

Accrued liabilities for environmental matters

Year ended December 31, 2004

Reserves for doubtful accounts

Accrued liabilities for environmental matters

Notes:

(A) Accounts written off.

Balance at
Beginning
of Period

Charged to
Costs and
Expenses

Charged
to Other
Accounts(C)

Other
Deductions

Other
Additions

Balance at
End of
Period

$ 6.4

$55.2

$ 8.0

$64.5

$10.4

$54.7

$ 3.3

$ 2.5

$ 2.8

$ 0.2

$ 1.5

$10.3

$ —

$0.3

$ —

$1.6

$(3.8)(A)
$ 1.8(B)

$(4.4)(A)
$(9.8)(B)

$(3.9)(A)
$(2.1)(B)

$—

$ 5.9

$59.5

$ 6.4

$55.2

$ 8.0

$64.5

(B) Cash payments during the year, net of insurance recoveries.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUN-
TANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure controls and procedures

PolyOne’s management, with the participation of the Chief Execu-
tive Officer and the Chief Financial Officer, has evaluated the
effectiveness of the design and operation of PolyOne’s disclosure
controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934) as of Decem-
ber 31, 2006. Based on this evaluation, the Chief Executive Officer
and the Chief Financial Officer have concluded that such disclosure
controls and procedures are effective as of December 31, 2006.

Management’s annual report on internal control over financial
reporting

The following report is provided by management in respect of
PolyOne’s internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of
1934):

1. PolyOne’s management is responsible for establishing and
maintaining adequate internal control over financial reporting.

2. PolyOne’s management has used the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) framework to
evaluate the effectiveness of internal control over financial

P O L Y O N E C O R P O R A T I O N

reporting. Management believes that the COSO framework is
a suitable framework for its evaluation of financial reporting
because it is free from bias, permits reasonably consistent
qualitative and quantitative measurements of PolyOne’s internal
control over financial reporting, is sufficiently complete so that
those relevant factors that would alter a conclusion about the
effectiveness of PolyOne’s internal control over financial report-
ing are not omitted and is relevant to an evaluation of internal
control over financial reporting.

3. Management has assessed the effectiveness of PolyOne’s
internal control over financial reporting as of December 31,
2006 and has concluded that such internal control over financial
reporting is effective. There were no material weaknesses in
by
financial
internal
management.

identified

reporting

control

over

4. Ernst & Young LLP, who audited the consolidated financial state-
ments of PolyOne for the year ended December 31, 2006, also
issued an attestation report on management’s assessment of
PolyOne’s internal control over financial reporting under Auditing
Standard No. 2 of the Public Company Accounting Oversight
Board. This attestation report is set forth on page 30 of this
Annual Report on Form 10-K and incorporated by reference into
this Item 9A.

Changes in internal control over financial reporting

The following changes occurred in PolyOne’s internal control over
financial reporting during the quarter ended December 31, 2006
that have materially affected, or are reasonably likely to materially
affect, its internal control over financial reporting.

PolyOne took remedial actions related to a material weakness
over the proper application of SFAS No. 131, “Disclosures about
Segments of an Enterprise and Related Information,” to determine
operating and reportable segments and, as a result, the determi-
nation of reporting units under SFAS No. 142, “Goodwill and Other
Intangible Assets,” that resulted in a restatement of PolyOne’s
previously issued consolidated financial statements. The remedial
actions taken by PolyOne are as follows:

(cid:129) Key personnel involved in the financial reporting process
have enhanced the controls by which the SFAS No. 131
authoritative guidance is applied and monitored on a regular
basis. These enhancements include a quarterly review of
management structure and reports, quantitative thresholds
and aggregation data.

(cid:129) PolyOne’s Disclosure Committee reviews the criteria to
determine appropriate segment reporting on a quarterly
basis.

ITEM 9B. OTHER INFORMATION

None.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPO-

RATE GOVERNANCE

The information regarding PolyOne’s directors, including the iden-
tification of the audit committee and the audit committee financial
expert, is incorporated by reference to the information contained in
PolyOne’s Proxy Statement to be filed on or about March 26, 2007
with respect to the 2007 Annual Meeting of Shareholders (2007
Proxy Statement). Information concerning executive officers is con-
tained in Part I of this Annual Repor t under the heading “Executive
Officers of the Registrant.”

The information regarding Section 16(a) beneficial ownership
reporting compliance is incorporated by reference to the material
under the heading “Section 16(a) Beneficial Ownership Reporting
Compliance” in PolyOne’s 2007 Proxy Statement.

The information regarding any changes in procedures by which
shareholders may recommend nominees to PolyOne’s Board of
Directors is incorporated by reference to the information contained
in PolyOne’s 2007 Proxy Statement.

PolyOne has adopted a code of ethics that applies to its
principal executive officer, principal financial officer and principal
accounting officer. PolyOne’s code of ethics is posted under the
Investor Relations tab of its website at www.polyone.com. PolyOne
will post any amendments to, or waivers of, its code of ethics that
apply to its principal executive officer, principal financial officer and
principal accounting officer on its website.

ITEM 11. EXECUTIVE COMPENSATION

The information regarding executive officer and director compen-
sation is incorporated by reference to the information contained in
PolyOne’s 2007 Proxy Statement.

The information regarding compensation committee interlocks
and insider participation and the compensation committee report is
incorporated by reference to the information contained in PolyOne’s
2007 Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL

OWNERS AND MANAGEMENT AND RELATED SHARE-
HOLDER MATTERS

The information regarding security ownership of certain beneficial
owners and management and securities authorized for issuance
under PolyOne’s equity compensation plans is incorporated by
reference to the information contained in PolyOne’s 2007 Proxy
Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSAC-
TIONS, AND DIRECTOR INDEPENDENCE

The information regarding certain relationships and related trans-
actions and director independence is incorporated by reference to
the information contained in PolyOne’s 2007 Proxy Statement.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Information regarding fees paid to and services provided by Poly-
One’s independent registered public accounting firm during the
fiscal years ended December 31, 2006 and 2005 and the pre-
approval policies and procedures of the Audit Committee of Poly-
One’s Board of Directors is incorporated by reference to the infor-
mation contained in PolyOne’s 2007 Proxy Statement.

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)(1) Financial Statements:

The following consolidated financial statements of PolyOne

Corporation are included in Item 8:

Consolidated Statements of Operations for the years ended

December 31, 2006, 2005 and 2004

Consolidated Balance Sheets at December 31, 2006 and

2005

Consolidated Statements of Cash Flows for the years ended

December 31, 2006, 2005 and 2004

Consolidated Statements of Shareholders’ Equity for the years

ended December 31, 2006, 2005 and 2004

Notes to Consolidated Financial Statements

P O L Y O N E C O R P O R A T I O N

(a)(2) Financial Statement Schedules:

The following financial statements of subsidiaries not consol-
idated and 50% or less owned entities, as required by Item 15(c) are
incorporated by reference to Exhibits 99.1 and 99.2 to this Annual
Repor t on Form 10-K:

Consolidated financial statements of Oxy Vinyls, LP as of
December 31, 2006 and for each of the years in the three
year period then ended.

Consolidated financial statements of SunBelt Chlor Alkali Part-
nership as of December 31, 2006 and for each of the years
in the three year period then ended.

The following consolidated financial statement schedule of

PolyOne Corporation is included in Item 8:

Schedule II — Valuation and Qualifying Accounts

All other schedules for which provision is made in the appli-
cable accounting regulation of the SEC are not required under the
related instructions or are inapplicable and, therefore, omitted.

P O L Y O N E C O R P O R A T I O N

(a)(3) Exhibits.

Exhibit

3.1

3.1a

3.2

4.1

4.2

4.3

(k)

(b)

(k)

(f)

(d)

(m)

Description

Articles of Incorporation

Amendment to the second article of the Articles of Incorporation, as * filed with the Ohio Secretary of State November 25, 2003

Regulations

Indenture dated as of December 1, 1995 between the Company and NBD Bank, Trustee

Form of Indenture between the Company and NBD Bank, as trustee, governing the Company’s Medium Term Notes

Indenture, dated April 23, 2002, between the Company and The Bank of New York, as Trustee, including the form of the Company’s
8.875% Senior Notes due May 2012

4.4

(n)

Indenture, dated May 6, 2003, between the Company, as Issuer, and The Bank of New York, as trustee, including the form of the
Company’s 105⁄8% Senior Notes due May 15, 2010

10.1

10.1a

10.1b

10.2

10.3

10.4

10.5

10.6

10.7

10.8

10.8a

10.8b

10.9a

10.9b

10.9c

10.9d

(a) +

(k) +

(j) +

(b) +

(k) +

(b) +

(r) +

(k) +

(p) +

(s) +

(x) +

Long-Term Incentive Plan, as amended and restated

Form of Award Agreement for Per formance Shares

Form of Award of Stock Appreciation Rights

Incentive Stock Plan, as amended and restated through August 31, 2000

1995 Incentive Stock Plan, as amended and restated through August 31, 2000

1998 Interim Stock Award Incentive Plan, as amended and restated through August 31, 2000

1999 Incentive Stock Plan, as amended and restated through August 31, 2000

2000 Stock Incentive Plan

Amendment No. 1 to the Amendment and Restatement of Supplemental Retirement Benefit Plan, effective as of May 31, 2003

Benefit Restoration Plan (Section 401(a)(17))

Third Amendment to Benefit Restoration Plan (Section 401(a)(17)), effective as of May 31, 2003

Fourth Amendment to Benefits Restoration Plan, effective January 1, 2005

Senior Executive Annual Incentive Plan (amended as of February 28, 2001 by Exhibit A [Definition of Change of Control] to
Exhibit 10.9b below)

Strategic Improvement Incentive Plan Overview and Form of Award

Senior Executive Annual Incentive Plan, effective January 1, 2006

2005 Equity and Per formance Incentive Plan (amended and restated by the Board as of July 21, 2005)

10.10a (b) +

Non-Employee Directors Deferred Compensation Plan effective December 9, 1993, as amended and restated as of February 26,
2004

10.10b (r) +

Amendment to Non-Employee Directors Deferred Compensation Plan effective January 1, 2005

10.11a (k) +

Form of Management Continuity Agreement

10.11b * +

Schedule of Executives with Management Continuity Agreements

10.11c

(b) +

Supplemental Retirement Benefit Plan, effective as of January 1, 2004

10.11d (r) +

Amendment to Supplemental Retirement Benefit Plan, effective January 1, 2005

10.11e (t) +

Separation Agreement Term Sheet between the Company and Thomas A. Waltermire, dated October 6, 2005

10.11f

(u) +

Agreement between the Company and William F. Patient, effective October 6, 2005

10.11g

(w) +

Separation Agreement between the Company and Thomas A. Waltermire dated December 21, 2005

10.11h (y) +

Letter Agreement by and between the Company and Stephen D. Newlin effective as of February 13, 2006

10.11i

(z)

Form of Director and Officer Indemnification Agreement

10.11j

* +

Schedule of Directors and Executive Officers with Indemnification Agreements

10.11k

(aa)+

PolyOne Executive Severance Plan, effective May 25, 2006

10.12a (l)

10.12b (o)

10.12c

(q)

10.12d (v)

$50 million Five Year Credit Agreement dated October 30, 2000, among the Company, Citicorp USA, Inc. and the other banks
signatory thereto, as amended and restated as of May 6, 2003

Amendment No. 2, dated as of September 25, 2003, to the foregoing $50 million Five Year Credit Agreement, as amended and
restated as of May 6, 2003

Amendment No. 3 and Waiver, dated as of August 5, 2004, to the foregoing Amended and Restated Credit Agreement, reducing the
aggregate commitment to $30 million

Amendment No. 4, dated as of July 26, 2005, to the Amended and Restated Credit Agreement among the Company, as borrower,
and Citicorp USA, Inc. as administrative agent for the lender parties thereto

P O L Y O N E C O R P O R A T I O N

Exhibit

Description

10.12e (l)

10.12f

(o)

10.12g

(q)

10.12h (v)

10.12i

10.12j

(bb)

10.12k

(bb)

10.12l

(bb)

10.13

10.14

10.15

(f)

U.S. $225 million Trade Receivables Purchase Agreement, dated as of May 6, 2003, among PolyOne Funding Corporation, as the
Seller, the Company, as the Servicer, the Banks and other Financial Institutions party thereto, as Purchasers, Citicorp USA, Inc., as
the Agent, and National City Commercial Finance, Inc., as the Syndication Agent

Amendment No. 1, dated as of September 25, 2003, to the foregoing Trade Receivables Purchase Agreement, dated as of May 6,
2003

Amendment No. 2, dated as of August 5, 2004, to the foregoing Trade Receivables Purchase Agreement, reducing to $175 million
the amount of eligible receivables available to be sold

Guarantee and Agreement, dated as of June 6, 2006, between PolyOne, as guarantor, and the beneficiary banks party thereto

Second Amended and Restated Security Agreement, dated as of June 6, 2006, between PolyOne, as grantor, and U.S. Bank
Trust National Association, as collateral trustee

Amended and Restated Collateral Trust Agreement, dated as of June 6, 2006, between PolyOne, as grantor, and U.S. Bank
Trust National Association, as collateral trustee

Amended and Restated Intercreditor Agreement, dated as of June 6, 2006, between PolyOne, as grantor, and Citicorp USA, Inc., as
bank agent, U.S. Bank Trust National Association, as collateral trustee, and PolyOne Funding Corporation

Amended and Restated Instrument Guaranty dated as of December 19, 1996

Amended and Restated Plant Services Agreement between the Company and The B.F. Goodrich Company

Amended and Restated Assumption of Liabilities and Indemnification Agreement dated March 1, 1993 and amended and restated
April 27, 1993

10.16a (e)

Partnership Agreement, by and between 1997 Chloralkali Venture Inc. and Olin Sunbelt, Inc.

10.16b (g)

Amendment to aforesaid Partnership Agreement (Addition of Section 5.03 of Article 5)

10.16c

10.17

10.18

(g)

(e)

10.19

(g)

Amendment to aforesaid Partnership Agreement (Addition of Section 1.12)

Chlorine Sales Agreement, by and between Sunbelt Chlor Alkali Partnership and the Company

Intercompany Guarantee Agreement between the Company on the one hand and Olin Corporation and Sunbelt Chlor Alkali
Partnership on the other hand

Guarantee by the Company of the Series G Sunbelt Chlor Alkali Partnership Guaranteed Secured Senior Notes Due 2017, dated
December 22, 1997

10.20

(h)

Master Transaction Agreement dated December 22, 1998 between The Geon Company and Occidental Chemical Corporation

Limited Partnership Agreement of Oxy Vinyls, LP

Asset Contribution Agreement — PVC Partnership (Geon)

Parent Agreement (Oxy Vinyls, LP)

Parent Agreement (PVC Powder Blends, LP) and Business Opportunity Agreement

Stock Purchase Agreement among O’Sullivan Films Holding Corporation, O’Sullivan Management, LLC, and Matrix Films, LLC,
dated as of February 15, 2006

Subsidiaries of the Company

Consent of Independent Registered Public Accounting Firm — Ernst & Young LLP

Consent of Independent Registered Public Accounting Firm — KPMG LLP

Consent of Independent Registered Public Accounting Firm — Ernst & Young LLP

Certification of Stephen D. Newlin, Chairman, President and Chief Executive Officer, pursuant to SEC Rules 13a-14(a) and
15d-14(a), adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Certification of W. David Wilson, Senior Vice President and Chief Financial Officer, pursuant to SEC Rules 13a-14(a) and 15d-14(a),
adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Certification pursuant to 18 U.S.C. § 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, as signed by
Stephen D. Newlin, Chairman, President and Chief Executive Officer

Certification pursuant to 18 U.S.C. § 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, as signed by W.
David Wilson, Senior Vice President and Chief Financial Officer

Audited Financial Statements of Oxy Vinyls, LP

Audited Financial Statements of SunBelt Chlor Alkali Partnership

10.21

10.22

10.23

10.24

(i)

10.25

(cc)

21.1

23.1

23.2

23.3

31.1

31.2

32.1

32.2

99.1

99.2

Indicates management contract or compensatory plan, contract or arrangement in which one or more directors or executive officers of the
Registrant may be participants

Filed herewith

P O L Y O N E C O R P O R A T I O N

(a)

(b)

(c)

(d)

(e)

(f)

(g)

(h)

(i)

(j)

(k)

(l)

Incorporated by reference to the corresponding Exhibit filed with M.A. Hanna Company’s definitive proxy statement dated March 23, 2000, SEC
File No. 1-05222.

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-K for the year ended December 31, 2004, SEC File
No. 1-16091.

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 8-K dated January 11, 2005, SEC File No. 1-16091.

Incorporated by reference to the corresponding Exhibit filed with M.A. Hanna Company’s Form S-3 Registration Statement No. 333-05763,
dated June 12, 1996.

Incorporated by reference to the corresponding Exhibit filed with The Geon Company’s Form 10-Q for the Quarter ended September 30, 1996,
SEC File No. 1-11804.

Incorporated by reference to the corresponding Exhibit filed with The Geon Company’s Form 10-K for the Year ended December 31, 1996, SEC
File No. 1-11804.

Incorporated by reference to the corresponding Exhibit filed with The Geon Company’s Form 10-K for the Year ended December 31, 1997, SEC
File No. 1-11804.

Incorporated by reference to the corresponding Exhibit filed with The Geon Company’s Special Meeting Proxy Statement dated March 30, 1999,
SEC File No. 1-11804.

Incorporated by reference to the corresponding Exhibit filed with The Geon Company’s Form 8-K filed on May 13, 1999, SEC File No. 1-11804.

Incorporated by reference to the corresponding Exhibit filed with Amendment No. 3 to The Geon Company’s Form S-4 Registration Statement
No. 333-37344, dated July 28, 2000.

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-K for the Year ended December 31, 2000, SEC File
No. 1-16091.

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-Q for the Quarter ended March 31, 2003, SEC File
No. 1-16091.

(m)

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form S-4 Registration Statement No. 333-87472, dated May 2,
2002.

(n)

(o)

(p)

(q)

(r)

(s)

(t)

(u)

(v)

(w)

(x)

(y)

(z)

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form S-4 Registration Statement No. 333-105125, dated
May 9, 2003.

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-Q for the Quarter ended September 30, 2003, SEC File
No. 1-16091

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-K for the Year ended December 31, 2001, SEC File
No. 1-16091

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-Q for the quarter ended September 30, 2004, SEC File
No. 1-16091

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-K for the year ended December 31, 2004, SEC File
No. 1-16091

Incorporated by reference to the Company’s corresponding Exhibit filed with the Form 8-K dated May 24, 2005, SEC file No. 1-16091

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 8-K dated October 11, 2005, SEC File No. 1-16091

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 8-K filed on October 14, 2005, SEC File No. 1-16091

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-Q for the quarter ended September 30, 2005, SEC File
No. 1-16091

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 8-K on December 21, 2005, SEC File No. 1-16091

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-Q for the quarter ended June 30, 2005, File
No. 1-16091

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 8-K on February 17, 2006, SEC File No. 1-16091

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 8-K on July 5, 2006, SEC File No. 1-16091.

(aa)

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-Q for the quarter ended June 30, 2006, SEC File
No. 1-16091.

(bb)

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 8-K on June 8, 2006, SEC File No. 1-16091.

(cc)

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-K for the year ended December 31, 2005, SEC File
No. 1-16091.

P O L Y O N E C O R P O R A T I O N

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized on February 28, 2007.

SIGNATURES

POLYONE CORPORATION

By: /s/ W. DAVID WILSON

W. David Wilson
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on

behalf of the Registrant and in the capacities indicated, as of February 28, 2007.

Signature

Title

Chairman, President, Chief Executive Officer and Director
(Principal Executive Officer)

Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

Director

/s/ STEPHEN D. NEWLIN

Stephen D. Newlin

/s/ W. DAVID WILSON

W. David Wilson

/s/ J. DOUGLAS CAMPBELL

J. Douglas Campbell

/s/ CAROL A. CARTWRIGHT

Carol A. Cartwright

/s/ GALE DUFF-BLOOM

Gale Duff-Bloom

/s/ WAYNE R. EMBRY

Wayne R. Embry

/s/ RICHARD H. FEARON

Richard H. Fearon

/s/ ROBERT A. GARDA

Robert A. Garda

/s/ GORDON D. HARNETT

Gordon D. Harnett

/s/ EDWARD J. MOONEY

Edward J. Mooney

/s/ FARAH M. WALTERS

Farah M. Walters

P O L Y O N E C O R P O R A T I O N

EXHIBIT INDEX

Exhibit

3.1
3.1a

3.2

4.1
4.2

4.3

4.4

10.1
10.1a

10.1b

10.2

10.3
10.4

10.5

10.6
10.7

10.8

10.8a
10.8b

10.9a

10.9b

10.9c

10.9d
10.10a

10.10b

10.11a
10.11b

10.11c

10.11d
10.11e

10.11f

10.11g
10.11h

10.11i

10.11j
10.11k

Description

Articles of Incorporation
Amendment to the second article of the Articles of Incorporation, as * filed with the Ohio Secretary of State November 25, 2003

Regulations

Indenture dated as of December 1, 1995 between the Company and NBD Bank, Trustee
Form of Indenture between the Company and NBD Bank, as trustee, governing the Company’s Medium Term Notes

Indenture, dated April 23, 2002, between the Company and The Bank of New York, as Trustee, including the form of the Company’s
8.875% Senior Notes due May 2012
Indenture, dated May 6, 2003, between the Company, as Issuer, and The Bank of New York, as trustee, including the form of the
Company’s 105⁄8 % Senior Notes due May 15, 2010

Long-Term Incentive Plan, as amended and restated
Form of Award Agreement for Per formance Shares

Form of Award of Stock Appreciation Rights

Incentive Stock Plan, as amended and restated through August 31, 2000

1995 Incentive Stock Plan, as amended and restated through August 31, 2000
1998 Interim Stock Award Incentive Plan, as amended and restated through August 31, 2000

1999 Incentive Stock Plan, as amended and restated through August 31, 2000

2000 Stock Incentive Plan
Amendment No. 1 to the Amendment and Restatement of Supplemental Retirement Benefit Plan, effective as of May 31, 2003

Benefit Restoration Plan (Section 401(a)(17))

Third Amendment to Benefit Restoration Plan (Section 401(a)(17)), effective as of May 31, 2003
Fourth Amendment to Benefits Restoration Plan, effective January 1, 2005

Senior Executive Annual Incentive Plan (amended as of February 28, 2001 by Exhibit A [Definition of Change of Control] to
Exhibit 10.9b below)
Strategic Improvement Incentive Plan Overview and Form of Award

Senior Executive Annual Incentive Plan, effective January 1, 2006

2005 Equity and Per formance Incentive Plan (amended and restated by the Board as of July 21, 2005)
Non-Employee Directors Deferred Compensation Plan effective December 9, 1993, as amended and restated as of February 26,
2004

Amendment to Non-Employee Directors Deferred Compensation Plan effective January 1, 2005

Form of Management Continuity Agreement
Schedule of Executives with Management Continuity Agreements

Supplemental Retirement Benefit Plan, effective as of January 1, 2004

Amendment to Supplemental Retirement Benefit Plan, effective January 1, 2005
Separation Agreement Term Sheet between the Company and Thomas A. Waltermire, dated October 6, 2005

Agreement between the Company and William F. Patient, effective October 6, 2005

Separation Agreement between the Company and Thomas A. Waltermire dated December 21, 2005
Letter Agreement by and between the Company and Stephen D. Newlin effective as of February 13, 2006

Form of Director and Officer Indemnification Agreement

(k)
(b)

(k)

(f)
(d)

(m)

(n)

(a)+
(c)+

(c)+

(k)+

(k)+
(k)+

(k)+

(j)+
(b)+

(k)+

(b)+
(r)+

(k)+

(p)+

(s)+

(x)+
(b)+

(r)+

(k)+
*+

(b)+

(r)+
(t)+

(u)+

(w)+
(y)+

(z)

Schedule of Directors and Executive Officers with Indemnification Agreements

*+
(aa)+ PolyOne Executive Severance Plan, effective May 25, 2006

10.12a

(l)

10.12b

(o)

10.12c

(q)

10.12d

(v)

10.12e

(l)

10.12f

(o)

10.12g

(q)

$50 million Five Year Credit Agreement dated October 30, 2000, among the Company, Citicorp USA, Inc. and the other banks
signatory thereto, as amended and restated as of May 6, 2003
Amendment No. 2, dated as of September 25, 2003, to the foregoing $50 million Five Year Credit Agreement, as amended and
restated as of May 6, 2003

Amendment No. 3 and Waiver, dated as of August 5, 2004, to the foregoing Amended and Restated Credit Agreement, reducing the
aggregate commitment to $30 million
Amendment No. 4, dated as of July 26, 2005, to the Amended and Restated Credit Agreement among the Company, as borrower,
and Citicorp USA, Inc. as administrative agent for the lender parties thereto

Amendment No. 1, dated as of September 25, 2003, to the foregoing Trade Receivables Purchase Agreement, dated as of May 6,
2003
Amendment No. 2, dated as of August 5, 2004, to the foregoing Trade Receivables Purchase Agreement, reducing to $175 million
the amount of eligible receivables available to be sold

P O L Y O N E C O R P O R A T I O N

Exhibit

Description

10.12h

(v)

10.12i

10.12j

(bb)

10.12k

(bb)

10.12l

(bb)

Amended and Restated Receivables Purchase Agreement dated as of July 26, 2005, among PolyOne Funding Corporation, as
seller, the Company, as servicer, Citicorp USA, Inc., as agent for the purchaser parties thereto, and National City Business Credit,
Inc., as syndication agent
Guarantee and Agreement, dated as of June 6, 2006, between PolyOne, as guarantor, and the beneficiary banks party thereto

Second Amended and Restated Security Agreement, dated as of June 6, 2006, between PolyOne, as grantor, and U.S. Bank
Trust National Association, as collateral trustee
Amended and Restated Collateral Trust Agreement, dated as of June 6, 2006, between PolyOne, as grantor, and U.S. Bank
Trust National Association, as collateral trustee

Amended and Restated Plant Services Agreement between the Company and The B.F. Goodrich Company

Amended and Restated Assumption of Liabilities and Indemnification Agreement dated March 1, 1993 and amended and restated
April 27, 1993

Partnership Agreement, by and between 1997 Chloralkali Venture Inc. and Olin Sunbelt, Inc.

Amendment to aforesaid Partnership Agreement (Addition of Section 5.03 of Article 5)
Amendment to aforesaid Partnership Agreement (Addition of Section 1.12)

Chlorine Sales Agreement, by and between Sunbelt Chlor Alkali Partnership and the Company

Intercompany Guarantee Agreement between the Company on the one hand and Olin Corporation and Sunbelt Chlor Alkali
Partnership on the other hand
Guarantee by the Company of the Series G Sunbelt Chlor Alkali Partnership Guaranteed Secured Senior Notes Due 2017, dated
December 22, 1997

Master Transaction Agreement dated December 22, 1998 between The Geon Company and Occidental Chemical Corporation
Limited Partnership Agreement of Oxy Vinyls, LP

Asset Contribution Agreement — PVC Partnership (Geon)

Parent Agreement (Oxy Vinyls, LP)
Parent Agreement (PVC Powder Blends, LP) and Business Opportunity Agreement

Stock Purchase Agreement among O’Sullivan Films Holding Corporation, O’Sullivan Management, LLC, and Matrix Films, LLC,
dated as of February 15, 2006
Subsidiaries of the Company

Consent of Independent Registered Public Accounting Firm — Ernst & Young LLP

Consent of Independent Registered Public Accounting Firm — KPMG LLP

Consent of Independent Registered Public Accounting Firm — Ernst & Young LLP
Certification of Stephen D. Newlin, Chairman, President and Chief Executive Officer, pursuant to SEC Rules 13a-14(a) and
15d-14(a), adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Certification of W. David Wilson, Vice President and Chief Financial Officer, pursuant to SEC Rules 13a-14(a) and 15d-14(a),
adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Certification pursuant to 18 U.S.C. § 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, as signed by
Stephen D. Newlin, Chairman, President and Chief Executive Officer

Certification pursuant to 18 U.S.C. § 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, as signed by W.
David Wilson, Vice President and Chief Financial Officer

Audited Financial Statements of Oxy Vinyls, LP

Audited Financial Statements of SunBelt Chlor Alkali Partnership

(f)

(e)

(g)
(g)

(e)

(g)

(h)
(i)

(i)

(i)
(i)

(cc)

*
*

Indicates management contract or compensatory plan, contract or arrangement in which one or more directors or executive officers of the
Registrant may be participants

Filed herewith

Incorporated by reference to the corresponding Exhibit filed with M.A. Hanna Company’s definitive proxy statement dated March 23, 2000, SEC
File No. 1-05222.

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-K for the year ended December 31, 2004, SEC File
No. 1-16091.

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 8-K dated January 11, 2005, SEC File No. 1-16091.

Incorporated by reference to the corresponding Exhibit filed with M.A. Hanna Company’s Form S-3 Registration Statement No. 333-05763,
dated June 12, 1996.

Incorporated by reference to the corresponding Exhibit filed with The Geon Company’s Form 10-Q for the Quarter ended September 30, 1996,
SEC File No. 1-11804.

P O L Y O N E C O R P O R A T I O N

10.13

10.14

10.15

10.16a

10.16b
10.16c

10.17

10.18

10.19

10.20
10.21

10.22

10.23
10.24

10.25

21.1

23.1

23.2

23.3
31.1

31.2

32.1

32.2

99.1

99.2

(a)

(b)

(c)

(d)

(e)

(f)

(g)

(h)

(i)

(j)

(k)

(l)

Incorporated by reference to the corresponding Exhibit filed with The Geon Company’s Form 10-K for the Year ended December 31, 1996, SEC
File No. 1-11804.

Incorporated by reference to the corresponding Exhibit filed with The Geon Company’s Form 10-K for the Year ended December 31, 1997, SEC
File No. 1-11804.

Incorporated by reference to the corresponding Exhibit filed with The Geon Company’s Special Meeting Proxy Statement dated March 30, 1999,
SEC File No. 1-11804.

Incorporated by reference to the corresponding Exhibit filed with The Geon Company’s Form 8-K filed on May 13, 1999, SEC File No. 1-11804.

Incorporated by reference to the corresponding Exhibit filed with Amendment No. 3 to The Geon Company’s Form S-4 Registration Statement
No. 333-37344, dated July 28, 2000.

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-K for the Year ended December 31, 2000, SEC File
No. 1-16091.

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-Q for the Quarter ended March 31, 2003, SEC File
No. 1-16091.

(m)

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form S-4 Registration Statement No. 333-87472, dated May 2,
2002.

(n)

(o)

(p)

(q)

(r)

(s)

(t)

(u)

(v)

(w)

(x)

(y)

(z)

(aa)

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form S-4 Registration Statement No. 333-105125, dated
May 9, 2003.

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-Q for the Quarter ended September 30, 2003, SEC File
No. 1-16091

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-K for the Year ended December 31, 2001, SEC File
No. 1-16091

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-Q for the quarter ended September 30, 2004, SEC File
No. 1-16091

Incorporated by reference to the corresponding Exhibit filed with the Company’s Form 10-K for the year ended December 31, 2004, SEC File
No. 1-16091

Incorporated by reference to the Company’s corresponding Exhibit filed with the Form 8-K dated May 24, 2005 SEC File No. 1-16091