Overview

Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide information that is supplemental to, and should be read together with, our consolidated financial statements and the accompanying notes contained in this Annual Report on Form 10-K. Information in this Item 7 is intended to assist the reader in obtaining an understanding of our consolidated financial statements, the changes in certain key items in those financial statements from year to year, the primary factors that accounted for those changes, and any known trends or uncertainties that we are aware of that may have a material effect on our future performance, as well as how certain accounting principles affect our consolidated financial statements. MD&A includes the following sections:

• Our Business

• Business Model and Key Concepts

• Key Challenges

• Strategy and Key Trends

• Recent Developments

• Highlights and Executive Summary

• Outlook Update

• Results of Operations - an analysis of our consolidated results of operations for the three years presented in our consolidated financial statements

• Liquidity and Capital Resources - an analysis of the effect of our operating, financing and investing activities on our liquidity and capital resources

• Off-Balance Sheet Arrangements - a discussion of such commitments and arrangements

• Contractual Obligations - a summary of our aggregate contractual obligations

• Critical Accounting Policies and Estimates - a discussion of accounting policies that require significant judgments and estimates

• New Accounting Pronouncements - a summary and discussion of our plans for the adoption of new accounting standards relevant to us

The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this Annual Report on Form 10-K particularly in "Special Note Regarding Forward-Looking Statements" and Item 1A. "Risk Factors."

Our Business

We are a premier provider of specialized polymer materials, services and solutions with operations in thermoplastic compounds, specialty polymer formulations, color and additive systems, thermoplastic resin distribution and specialty vinyl resins. We also have three equity investments: one in a manufacturer of caustic soda and chlorine; one in a manufacturer of PVC compound products; and one in a formulator of polyurethane compounds. Headquartered in Avon Lake, Ohio, with 2008 sales of $2.7 billion, we have manufacturing sites and distribution facilities in North America, Europe and Asia and joint ventures in North America and South America. We currently employ approximately 4,400 people and offer more than 35,000 polymer solutions to over 10,000 customers across the globe. We provide value to our customers through our ability to link our knowledge of polymers and formulation technology with our manufacturing 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).

Business Model and Key Concepts

The central focus of our business model is to provide specialized material and service solutions to our customers by leveraging our global footprint, product and technology breadth, manufacturing expertise, fully integrated information technology network, broad market reach and raw material procurement strength. These resources enable us to capitalize on dynamic changes in the end markets we serve, which include appliances, building and construction materials, electrical and electronics, healthcare, industrial, packaging, transportation, and wire and cable markets.

Key Challenges

Overall, our business faces a number of issues resulting from the continued economic downturn, especially as it relates to critically affected markets such as building and construction and transportation. Improving profitability during periods of raw material price volatility is another critical challenge. Further, we need to capitalize on the opportunity to accelerate development of products that meet a growing body of environmental laws and regulations such as lead and phthalate restrictions inherent in the Restrictions on the use of Certain Hazardous Substances (RoHS) and the Consumer Product Safety Information Act of 2008.

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Strategy and Key Trends

To address these challenges and achieve our vision, we have implemented a strategy with four core components: specialization, globalization, operational excellence and commercial excellence. Specialization differentiates us through products, services, technology, and solutions that add value. Globalization takes us into growth markets to service our customers with consistency wherever their operations might be. Operational excellence empowers us to respond to the voice of the customer while focusing on continuous improvement. Commercial excellence enables us to deliver value to customers by supporting their growth and profitability.

In the short-term, we are increasing our focus on improving working capital, preserving liquidity and increasing cash flow. In addition to continuing to drive margin improvement, we have established working capital improvement targets for all businesses. In 2009, most of our capital expenditures will be focused on maintenance spending plus implementing the two restructuring initiatives previously announced and short payback projects of about a year or less. These actions will ensure that we continue to invest in capabilities that advance the pace of our transformation but do not adversely impact our liquidity.

Our other areas of focus are cost reductions, capacity reductions and ensuring we have right sized the business for current projected demand. The two restructuring initiatives we have announced underscore this focus. We are also deploying an enterprise-wide Lean Six Sigma program directed at improving profitability and cash flow by applying proven management techniques and strategies to key areas of the business, such as pricing, supply chain and operations management, productivity and quality.

Long term trends that currently provide opportunities to leverage our strategy include the drive toward sustainability in polymers and their processing, the emergence of biodegradable and bio-based polymers, consumer concern over the use of bisphenol-A (BPA) in infant-care products and developing legislation that bans lead and certain phthalates from toys and child-care items.

Recent Developments

Pension plan changes

On January 15, 2009, the Chair of our Compensation and Governance Committee, pursuant to authority delegated to him by our Board of Directors, approved and adopted changes to the Geon Pension Plan (Geon Plan), the Benefit Restoration Plan (BRP), the voluntary retirement savings plan (RSP) and the Supplemental Retirement Benefit Plan (SRP). Effective March 20, 2009, the amendments to the Geon Plan and the BRP permanently freeze future benefit accruals and provide that participants will not receive credit under the Geon Plan or the BRP for any eligible earnings paid on or after that date. All accrued benefits under the Geon Plan and the BRP will remain intact, and service credits for vesting and retirement eligibility will continue in accordance with the terms of the Geon Plan and the BRP. The amendments to the RSP and SRP provide that transition contributions under the RSP and the SRP will be eliminated after March 20, 2009. These actions are expected to reduce our 2009 annual benefit expense by $3.7 million and future pension fund contribution requirements by $20 million.

Restructuring initiatives and facility closures

In July 2008, we announced the restructuring of certain manufacturing assets, primarily in North America. We are closing certain production facilities, including seven in North America and one in the United Kingdom, resulting in a net reduction of approximately 150 positions. The production facilities' closings are part of our focus on both the operational excellence and specialization component of our transformation strategy. This realignment improves the competitiveness of our operations and supply chain across many product lines and businesses, consistent with current and anticipated customer requirements. We expect to incur one-time pre-tax charges of approximately $28 million related to these actions, of which $20.0 million has been recorded during 2008. In total, these one-time charges will include cash costs of approximately $15 million related to severance and site closure costs with the remaining $13 million of non-cash costs related to asset write-downs and accelerated depreciation, of which $10.0 million has been recorded during 2008. We expect these actions will deliver pre-tax savings of approximately $17 million on an annualized run-rate basis.

In January 2009, we announced that we will enact further cost saving measures that include eliminating approximately 370 jobs worldwide, implementing reduced work schedules for another 100 to 300 employees, closing our Niagara, Ontario facility and idling certain other capacity. Additionally, we are planning other actions that include freezing corporate officer salaries throughout 2009. We expect to incur one-time pre-tax charges of approximately $45 million related to these actions, of which $18.3 million has been recorded during the fourth quarter of 2008. In total, these one-time charges include cash costs of approximately $35 million related to severance and site closure costs with the remaining $10 million of non-cash costs related to asset write-downs and accelerated depreciation. We expect these actions will deliver pre-tax savings of approximately $40 million on an annualized run-rate basis.

See Note 4, Employee Separation and Plant Phaseout, to the accompanying consolidated financial statements for more detailed information related to these restructuring actions.

New Banking Relationship

In November 2008, we began transitioning various treasury management services from Citicorp USA to Bank of America. Implementation of new services is expected to be completed in March 2009. Services being transitioned to Bank of America include a corporate credit card program, foreign exchange hedging, operation of a European cash pool, and administration of our international finance subsidiary.

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Share repurchases

In August 2008, our Board of Directors approved a stock repurchase program authorizing us, depending upon market conditions and other factors, to repurchase up to 10.0 million shares of our common stock, in the open market or in privately negotiated transactions.

During 2008, we repurchased 1.25 million shares of common stock under this program at an average price of $7.12 per common share for approximately $8.9 million. There are 8.75 million shares available for repurchase under the program at December 31, 2008.

Formation of PolyOne companies in Japan and India

In July 2008, we formed PolyOne Japan Kabushiki Kaisha (PolyOne Japan Ltd.). The new company, which includes an office in Tokyo staffed with a business development manager for Japan, is focused on gaining specification with Japanese original equipment manufacturers (OEMs) and importing products for use by Japanese polymer processors. During the same month, we established PolyOne Polymers India Pvt. Ltd. to import, manufacture and sell PolyOne products in India and neighboring markets from new production and lab facilities located in Mumbai. This company provides us with strategic regional access to many large OEMs and polymer processors.

Purchase of GLS business

In January 2008, we acquired 100% of the outstanding capital stock of GLS, the leading North American provider of TPE compounds for consumer, packaging and medical applications for a cash purchase price of $148.9 million including acquisition costs and net of cash received. The acquisition complements our global Engineered Materials business portfolio and accelerates our shift to specialization by combining GLS's specialty TPE technology, compounding expertise and brands with our extensive global infrastructure and commercial presence.

Development agreements signed

Several agreements with technology partners were signed in 2008. We established a market development agreement with Eastman Chemical Company designating PolyOne as the exclusive compounder of filled systems with Eastman's new-generation TritanTM copolyester in North America. We can now combine Eastman TritanTM copolyester with performance-enhancing additives to develop fully compounded systems that offer a BPA-free alternative to polycarbonate. We began a formal collaboration agreement with Archer Daniels Midland to help develop bio-based plasticizers for use in polymer formulations, which builds on our earlier license agreement with Battelle concerning bio-plasticizer technology. Our TPE business completed an agreement with The Dow Chemical Company to compound thermoplastic elastomer materials based on Dow's Infuse OBC Olefin Block Copolymers.

Sustainability strategy defined

During 2008, we issued our Sustainability Promise and No Surprises PledgeSM to assure customers that we are dedicated to solutions that are environmentally responsible. To further support this sustainability commitment, we defined a set of standards from which we established a family of products and services branded "PolyOne Sustainable Solutions." These brands meet criteria for renewability, recyclability, reusability, eco-conscious composition and resource efficiency. In September 2008, we received the Frost & Sullivan Green Excellence of the Year Award for our work in sustainability.

Highlights and Executive Summary

2008 proved to be a volatile year for our company. The year began with a sense that the U.S. housing market would reach a bottom in late 2008 or early 2009 with the United States entering a mild recession, and Europe and Asia experiencing only a moderate economic slowdown. During the first half of the year, raw material and energy costs rapidly escalated and in mid-summer oil approached a high of nearly $150 per barrel. In July 2008, we announced a manufacturing realignment to reduce capacity and headcount, primarily in North America. Around the same time, we saw the first signs of weakness in Europe. In September, credit markets came to a stand still as the U.S. government searched for a solution to the banking crisis. The financial markets reacted unfavorably to all of this news and sent equity markets to lows not seen since 2003. With this global economic backdrop, our customers immediately reduced demand. In the fourth quarter of 2008, our year-over-year sales declined $89.5 million, or 14.2%. Volume declined 24%. Lower raw material costs offered some relief but were not enough to offset the significant declines in demand. Fourth quarter 2008 operating income was a loss of $174.7 million which included a $170 million goodwill impairment charge and a portion of the pre-tax costs of a second restructuring initiative announced in January 2009, of which $18.3 million was recorded in the fourth quarter. In the fourth quarter of 2008, we increased valuation allowances against our deferred tax assets by $166.7 million. The non-cash charge to income tax expense consists of $104.5 million related to U.S. federal and state and local deferred tax assets and $1.4 million related to foreign deferred tax assets. $60.8 million related to pension and post-retirement health care liabilities was recorded as a reduction of accumulated other comprehensive income.

Despite the challenging economic conditions, 2008 was a year of continuing progress in the transformation of PolyOne. Significant declines in demand required us to take aggressive actions that we had not planned at the outset of 2008, however, the benefits of such actions will be significant in terms of their positive impact on our future profitability and attainment of our transformation goals.

Selected financial data, a discussion of the aforementioned impact of these events on PolyOne, and a comparative review of performance in 2008 and 2007 versus prior years are provided below. An outlook update is provided thereafter.

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Selected Financial Data


         (In millions)                        2008          2007          2006


         Sales                              $ 2,738.7     $ 2,642.7     $ 2,622.4
         Operating income                   $  (129.3 )   $    33.9     $   190.6
         Net income (loss)                  $  (272.9 )   $    11.4     $   122.9


         Cash and cash equivalents          $    44.3     $    79.4     $    66.2
         Accounts Receivable Availability       121.4         151.2         111.5

         Liquidity                          $   165.7     $   230.6     $   177.7

         Debt, short- and long-term         $   434.3     $   336.7     $   595.4

2008 vs. 2007

Aggregate sales increased $96.0 million, or 3.6%, in 2008 as compared to 2007. The acquisition of GLS, favorable impact from foreign exchange and higher prices driven by an improved sales mix and the result of offsetting rising raw material and energy costs helped counterbalance the adverse impact of lower volume driven by a significant slowing in global economic activity in the late third quarter and the fourth quarter of 2008. This turndown in economic activity and the underlying financial credit crisis that precipitated it had a significant negative impact on our businesses, particularly the Performance Products and Solutions segment. The International Color and Engineered Materials business, while benefiting from favorable foreign exchange rates, saw demand contract in the third quarter and then more dramatically in the fourth quarter of 2008 as the economies in Europe and Asia slowed and declining exports from Asia offset any sales increase during the prior quarters in 2008.

Operating income declined by $163.2 million driven by a $170 million goodwill impairment charge taken in the fourth quarter of 2008, $39.7 million of restructuring charges, and year-over-year declines in Performance Products and Solutions and International Color and Engineered Materials segment operating income. The acquisition of GLS, margin and mix improvements and the impact from foreign exchange were favorable items that partially offset the overall decrease.

The $284.3 million decline in net income was due to the items described previously and the recording of a $105.9 million tax valuation allowance. See Note 15, Income Taxes, in the accompanying consolidated financial statements for a more detailed discussion.

Liquidity declined $64.9 million due to a lower available pool of receivables to borrow against and a year-over-year decline in cash and cash equivalents driven by a higher investment in working capital, pension funding, and lower dividends from our equity affiliates. The increase in total debt resulted from the financing activities necessary to support the acquisition of GLS.

2007 vs. 2006

Aggregate sales increased $20.3 million, or 0.8%, in 2007 compared to 2006. This increase was primarily due to sales growth in Asia, higher prices necessary to offset increased raw material and energy costs, and the impact of favorable exchange rates. Offsetting these favorable items was an 8.3% and 6.8% decline in sales in our Specialty Color, Additives and Inks, and Performance Products and Solutions segments, respectively. These declines were due mainly to the pruning of unprofitable business and the slowdown in the North American building and construction market. Operating income declined 82.2% as a result of the impact of the slowdown in the North American building and construction and margin compression in our Performance Products and Solutions and Resin and Intermediates segments. In 2007, we also recorded environmental remediation and impairment charges and legal settlements of $68.3 million as compared to a benefit of $20.6 million of similar items in 2006. The $52.9 million increase in liquidity was driven by a larger eligible pool of receivables for securitization and an increase in cash and cash equivalents due to a year-over-year improvement in working capital of $70.5 million, a favorable foreign exchange impact of $6.6 million on cash, and the sales of assets. The year-over-year decline in debt was primarily due to the repurchase of $241.4 million aggregate principal amount of our 10.625% senior notes due 2010 at a premium of $12.8 million. This repurchase transaction was financed by the sale of our 24% ownership interest in OxyVinyls in the third quarter of 2007.

Outlook Update

It appears that 2009 will be a challenging year as we project sales will fall below 2008 levels. We expect continued economic weakness in the near term and accordingly we have taken actions to reduce capacity and costs. In July of 2008 we announced our manufacturing realignment and the related closure of eight facilities. As the economy has deteriorated further and the downturn extended internationally, we determined that another phase of cost reductions would be necessary to ensure that PolyOne remains competitive. In January 2009 we announced those additional actions that included eliminating 370 jobs worldwide; implementing reduced work schedules for another 100 to 300 employees based on demand; closing our Niagara, Ontario facility and idling certain other capacity. Additionally and among other actions, we have announced that we have frozen corporate officer salaries throughout 2009 and deferred other salary adjustments. Combined, the Company expects all of the aforementioned actions will deliver pre-tax savings of approximately $57 million on an annualized run-rate basis.

While we are not altering our four-pillar strategy, our pace of investment in the business has slowed. In 2009, our focus will be on improving free cash flow and reducing working capital investment to preserve liquidity. Our capital expenditures will be focused on maintenance spending plus implementing the two restructuring initiatives previously described.

We have a very limited amount of immediate or near term debt payment obligations and our only immediate long-term debt payment requirements are the medium term notes of which $20 million is due in both 2009 and 2010. We expect pension plan expense to increase approximately $27 million over 2008 due to a 30% decline

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in pension asset values during 2008. The required level of funding in 2009 will be approximately $11 million for pension obligations.

In addition to changes in broader economic conditions, raw material and energy costs are expected to remain volatile and could impact the magnitude and direction of our preliminary viewpoint.

Results of Operations

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 2, Discontinued Operations, in the accompanying consolidated financial statements.

                                                                                                                  Variances-Favorable (Unfavorable)
                                                                                                            2008 versus 2007             2007 versus 2006
                                                                                                                          %                            %
(Dollars in millions, except per share data)                  2008           2007           2006          Change        Change         Change        Change


Sales                                                       $ 2,738.7      $ 2,642.7      $ 2,622.4      $   96.0           3.6 %     $   20.3           0.8 %
Cost of sales                                                 2,442.1        2,381.7        2,321.9         (60.4 )        (2.5 )%       (59.8 )        (2.6 )%

Gross margin                                                    296.6          261.0          300.5          35.6          13.6 %        (39.5 )       (13.1 )%
Selling and administrative                                      287.1          254.8          221.9         (32.3 )       (12.7 )%       (32.9 )       (14.8 )%
Impairment of goodwill                                          170.0              -              -        (170.0 )          NM              -             -
Income from equity affiliates and minority interest              31.2           27.7          112.0           3.5          12.6 %        (84.3 )       (75.3 )%

Operating income (loss)                                        (129.3 )         33.9          190.6        (163.2 )      (481.4 )%      (156.7 )       (82.2 )%
Interest expense, net                                           (37.2 )        (46.9 )        (63.1 )         9.7          20.7 %         16.2          25.7 %
Premium on early extinguishment of long-term debt                   -          (12.8 )         (4.4 )        12.8         100.0 %         (8.4 )      (190.9 )%
Other expense, net                                               (4.6 )         (6.6 )         (2.8 )         2.0          30.3 %         (3.8 )      (135.7 )%

(Loss) income before income taxes and discontinued
operations                                                     (171.1 )        (32.4 )        120.3        (138.7 )      (428.1 )%      (152.7 )      (126.9 )%
Income tax (expense) benefit                                   (101.8 )         43.8            5.3        (145.6 )      (332.4 )%        38.5         726.4 %

(Loss) income before discontinued operations                   (272.9 )         11.4          125.6        (284.3 )          NM         (114.2 )       (90.9 )%
Loss from discontinued operations and loss on sale, net
of income taxes                                                     -              -           (2.7 )           -             -            2.7         100.0 %

Net (loss) income                                           $  (272.9 )    $    11.4      $   122.9      $ (284.3 )          NM       $ (111.5 )       (90.7 )%


Basic and diluted (loss) earnings per common share:
Before discontinued operations                              $   (2.94 )    $    0.12      $    1.36
Discontinued operations                                             -              -          (0.03 )

Basic and diluted (loss) earnings per common share          $   (2.94 )    $    0.12      $    1.33

NM - Not meaningful

Sales

Aggregate sales increased $96.0 million, or 3.6%, in 2008 as compared to 2007. The components of this increase include 6.3% from acquisitions and other, 1.7% due to the favorable impact of foreign exchange, a 9.7% favorable impact from price and mix, which offset an unfavorable impact of 14.1% due to the decline in volume. The impact of the decline in volume was evident across all of our operating segments but of greatest magnitude in our businesses tied to the North American building and construction and transportation end markets.

Aggregate sales increased $20.3 million, or 0.8%, in 2007 compared to 2006. The components of this increase include a 2.3% favorable impact from foreign exchange and a 1.4% favorable impact from price and mix. These components offset a 2.8% unfavorable impact from the decline in volume. The most significant . . .