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, 2009





Commission
File Number:  0-31641





SCI
ENGINEERED MATERIALS, INC.


(Exact
name of registrant as specified in its charter)





Ohio
              31-1210318(State
      or other jurisdiction of
              (I.R.S.
      Employerincorporation
      or organization)
              Identification
      No.)





2839
Charter Street


Columbus,
Ohio 43228


(Address
of principal executive offices)





Registrant’s
telephone number, including area code: (614) 486-0261





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





Securities registered pursuant to
Section 12(g) of the Act:    Common Stock, without par value
(Title of Class)





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities
Act.      Yes  ̈No  þ





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Exchange
Act.       Yes  ̈No
þ





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 past 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 at least the past 90
days.


Yes þ  No ̈





Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K (section 229.405 of
this chapter) 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. þ





Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer or a smaller reporting company.  See definition of “large
accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule
12b-2 of the Exchange Act.


Large
accelerated filer   ̈
Accelerated filer    ̈  Non-accelerated
filer   ̈ Smaller reporting company
þ





Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).  Yes    ̈No þ





The aggregate market value of the
Registrant’s common equity held by non-affiliates of the Registrant was
approximately $10,088,540 on June 30, 2009. For purposes of
this disclosure, shares of common stock held by persons who hold more than 10%
of the outstanding shares of common stock and shares held by executive officers
and directors of the registrant have been excluded because such persons may be
deemed to be affiliates.  This determination of executive officer or
affiliate status is not necessarily a conclusive determination for other
purposes.





There were 3,723,775shares of the
Registrant’s Common Stock outstanding on February 15, 2010.





Documents
Incorporated By Reference


Portions
of our Proxy Statement for the 2010 Annual Meeting of Stockholders are
incorporated by reference in Part III.





Table of
Contents


PagePart
      IItem
      1.
                  Description
      of Business
                  3Item
      1A.
                  Risk
      factors
                  8Item
      1B.
                  Unresolved
      Staff Comments
                  11Item
      2.
                  Properties
                  11Item
      3.
                  Legal
      Proceedings
                  11Item
      4.
                  Submission
      of Matters to a Vote of Security Holders
                  11Part
      IIItem
      5.
                  Market
      for Registrant’s Common Equity, Related Stockholder Matters and
      Issuer Purchases of Equity Securities
                  12Item
      6.
                  Selected
      Financial Data
                  13Item
      7.
                  Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operation
                  14Item
      7A.
                  Quantitative
      and Qualitative Disclosures about Market Risk
                  19Item
      8.
                  Financial
      Statements and Supplementary Data
                  19Item
      9.
                  Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                  19Item
      9A.
                  Controls
      and Procedures
                  19Item
      9B.
                  Other
      Information
                  20Part
      IIIItem
      10.
                  Directors
      and Executive Officers of the Registrant
                  21Item
      11.
                  Executive
      Compensation
                  21Item
      12.
                  Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                  21Item
      13.
                  Certain
      Relationships and Related Transactions
                  21Item
      14.
                  Principal
      Accountant Fees and Services
                  21Item
      15.
                  Exhibits
      and Financial Statement Schedules
                  22Signatures
                  25





Note
Regarding Forward-Looking Statements





This Annual Report on Form 10-K
contains forward-looking statements within the meaning of Section 21E of the
Securities Exchange Act of 1934, as amended, and Section 26A of the Securities
Act of 1933, as amended. The words “anticipate,” “believe,” “expect,”
“estimate,” and “project” and similar words and expressions identify
forward-looking statements, which speak only as of the date hereof. Investors
are cautioned that such statements involve risks and uncertainties that could
cause actual results to differ materially from historical or anticipated results
due to many factors, including, but not limited to, the factors discussed in
“Risk Factors.”  The Company undertakes no obligation to publicly
update or revise any forward-looking statements.




2


PART
I





ITEM
      1.
            DESCRIPTION
      OF BUSINESS





Introduction





SCI
Engineered Materials, Inc. (“SCI” or the “Company”), formerly Superconductive
Components, Inc., an Ohio corporation, was incorporated in 1987.  We
manufacture ceramic and metal sputtering targets for a variety of industrial
applications including Photonics, Thin Film Solar, Thin Film Battery,
Semiconductor, and, to a lesser extent High Temperature Superconductive (“HTS”)
materials.  Our customers use our sputtering targets to produce very
thin coatings for a variety of applications.  Photonics currently
represents our largest market for our targets.  Thin Film Solar is an
industry that is exhibiting rapid growth and we expect this part of our business
to grow quickly.  Thin Film Battery is a developing market where
manufacturers of batteries use our targets to produce very small power supplies
with small quantities of stored energy.  Semiconductor is a developing
market for us.





History
of the Company





The late Dr. Edward Funk, Sc.D., and
his late wife Ingeborg founded SCI in 1987.  Dr. Funk, formerly a
Professor of Metallurgy at The Ohio State University and a successful
entrepreneur, envisioned significant market potential for the newly discovered
High Temperature Superconductivity (HTS) material YBCO (Tc of 90o K). Our
first product was a 99.999% pure, co-precipitated YBCO 1-2-3 powder. Over the
years we expanded our product line by adding other High Tc Powders,
sintered shapes, single crystal substrates, and non-superconducting sputtering
targets.





We
opened a subdivision, Target Materials Inc. (TMI), in 1991 to supply the
increasing worldwide demand for sputtering and laser ablation targets. We became
a full service manufacturer of high performance thin film materials, providing a
wide selection of metals, ceramics, and alloys for sputtering targets,
evaporation sources, and other Physical Vapor Deposition (PVD) applications. We
served the R&D market as well as the Industrial and Decorative Coating
markets.  During this time, we began to manufacture targets for the
Photovoltaic, Flat Panel Display, and Semiconductor industries.





SCI and
TMI were merged in 2002.   We continued to manufacture complex
ceramic, metal, and alloy products for the photovoltaic, thin film battery,
media storage, flat panel display, semiconductor, and photonic
industries.





In May of
2005, we received ISO 9001:2000 registration, an internationally recognized
milestone in our pursuit of quality.  This registration enabled us to
increase our customer base, which has benefited sales since the second quarter
of 2005.





Over the
past two decades, we have developed considerable expertise in the development
and ramp-up of manufacturing novel materials, such as Transparent Conductive
Oxides for Thin Film Solar applications and battery targets as well as Bismuth
Strontium Calcium Copper Oxide (a superconductor powder).  Today, we
serve a diverse base of domestic and multi-national corporations, universities,
and leading research institutions.  We actively seek to partner with
organizations to provide solutions for difficult material
challenges.





Throughout
our history, we have conducted funded research primarily under grants from
entities such as the Department of Energy, the National Science Foundation,
NASA, and the Ohio Department of Development.  These activities are
generally limited to funded research that is consistent with our focus on
commercial applications in our principal markets.





Business




We are a
supplier of materials to the Physical Vapor Deposition (“PVD”)
industry.  Our customers need our materials to produce nano layers of
metals and oxides for advanced material systems.  PVD coatings range
from every day items to complex computer processors.  For example,
every day applications include transparent anti-scratch coatings on eyeglasses,
coatings on kitchen faucets, as well as low emissivity glass for household
windows.  More technically advanced applications of our product
include semiconductors, thin film solar, flat panel displays and an emerging
technology - Thin Film Battery.




3




We are
focused on four distinct markets within the PVD industry.  These
markets are Photonics, Thin Film Solar, Semiconductor and Thin Film
Battery.  The Company continues to pursue niche opportunities,
specifically for the Solar market and Hard Disk Drive (“HDD”) in the
semiconductor market.  We receive requests from potential customers in
other markets within the PVD industry; however, at this time we have chosen not
to pursue them.  This disciplined approach enables us to focus on
those opportunities that are the best fit for our capabilities and also offer
the greatest long-term return.  Considerations include our core
strengths, resource requirements, and time-to-market issues.




The
production and sale of HTS materials was the initial focus of our operations and
these materials continue to be part of our development efforts.  We
continue to work with private companies and government agencies to develop new
and improved products for future applications; however, our principal business
focus is on products positioned for near term commercialization.





Photonics
currently represents the largest market for our materials.  Our
customers are continually identifying new materials that improve the utility of
optical coating.  This includes improvements in their ability to
focus, filter or reflect light, all of which increase the potential demand for
the types and amounts of materials we sell in this market.  Photonic
applications continue to expand as new methods are found to manipulate light
waves to enhance the various properties of light.




We have
developed new products for the growing Thin Film Solar (“TFS”)
market.  We are well positioned in the TFS area having supplied
materials to that market for about 10 years during the early stages of TFS
development.  Since the beginning of 2007, we have added over $2.2
million of new manufacturing equipment, as well as Engineering and Sales staff
to develop new materials to support the anticipated growth of
Solar.  We were awarded a grant of approximately $700,000 in 2008 and
a second grant in 2009 for approximately $775,000 from the Ohio Department of
Development to assist in the commercialization of TFS.  Our new
materials are Transparent Conductive Oxides (“TCO”).  Every square
foot of a TFS panel is coated with up to 3 layers of TCO, 1 micron
thick.  We continue to increase our visibility in the global arena by
attending various trade shows targeted at the Solar market.  During
the fourth quarter of 2008 we added an exclusive manufacturer’s representative
for Europe and terminated this relationship in January of 2010.  We
believe it is the best interests of our company to use direct sales efforts for
Europe.  In 2009 we added an exclusive representative for Korea and
one for Taiwan and China.  Commercialization and market expansion is
expected to continue in 2010.




Thin Film
Battery is a developing market where manufacturers of batteries use our targets,
especially lithium orthophosphate (Li3PO4) and lithium cobalt oxide (LiCoO) as
key elements to produce power supplies with small quantities of stored
energy.  A typical Thin Film Battery would be produced via PVD with
five or more thin layers.  These batteries are often one centimeter
square but only 15 microns thick.  We are the leading provider of
Li3PO4 and LiCoO to the emerging Thin Film Battery market. Following several
years of industry developments, some Thin Film Battery customers announced their
batteries are commercially available. Our customers anticipate the unique
properties of these batteries to be used in applications in medical devices,
integrated circuits, RFID, smart cards, hand held electronics and many other
applications.





We are
still in the early stages of developing a market presence in the Semiconductor
industry.  We continue to develop innovative products for this
industry.  Thus far we have experienced some success and this market
continues to hold significant potential for us.  In 2008 we applied
for a patent for products targeted at this market.





We had
total annual revenues of $8.0 million, $9.6 million, and $10.8 million in the
years ended December 31, 2009, 2008, and 2007, respectively.  Gross
profit was $1.9 million, $2.2 million, and $2.1 million in the years ended
December 31, 2009, 2008, and 2007, respectively.  Most of the
reductions in revenues during this period were related to a high priced
commodity that experienced a cyclical peak in 2007.  This material
returned to its long-term average during 2009, which reduced revenues but had
less of an effect on gross profit.





Principal
suppliers in 2009 were West Coast Quartz, Lattice Materials and Johnson
Matthey.  In every case, we believe that suitable alternate vendors
can be used to ensure availability of required materials.  As volume
grows, we may enter into alliances or purchasing contracts with these or other
vendors.





Our
largest customer represented approximately 25% of total revenues in 2009 and 47%
in 2008.  We had contract research revenue of $1,005,708 and $157,032
representing 12.6% and 1.6% of total revenue for the years ended December 31,
2009 and 2008, respectively.




4


Marketing
and Sales





In 2009 we significantly expanded our
marketing reach into Asia continuing our efforts which began in
2008.  We added a manufacturing representative for the Korean market
for solar and another for the Taiwanese and Chinese markets for specialty glass
coaters.  In 2008 we formed an exclusive relationship with a
manufacturer’s representative in Europe and terminated this relationship in
January of 2010.  We believe it is in the best interests of our
company to use direct sales efforts for Europe.  Europe and Asia have
high demand for Solar and Semiconductor sputtering targets.  We use
various distribution channels to reach end user markets, including direct sales
by our sales persons, independent manufacturers’ representatives in the United
States, and independent distributors and manufacturers’ representatives for
international markets.  The Internet provides tremendous reach for new
customers to be able to identify us as a source of their product
needs.  We have an operating website www.sciengineeredmaterials.com,
which includes expanded online product inquiry capabilities and additional
product information.





Ceramics





We are
capable of producing ceramic powders via several different processing techniques
including solid state, precipitation and combustion
synthesis.  Ceramic targets can also be produced in a variety of ways
depending on the end user applications.  Production techniques include
sintering, cold isostatic pressing and hot pressing.





Most of our products are manufactured
from component chemicals and metals supplied by various vendors.  If
we suddenly lost the services of a supplier, there could be a disruption in our
manufacturing process until the supplier was replaced.  We have
identified several firms as potential back-up suppliers who would be capable of
supplying these materials to us as necessary.   To date, we have
not experienced an interruption of raw material supply.





Metals





In
addition to the ceramic targets previously mentioned, we produce metal
sputtering targets and backing plates.  The targets are bonded to the
backing plates for application in the PVD industry.  These targets can
be produced by casting, hot pressing and machining of metals and metal alloys
depending on the application.





Applications
for metal targets are highly varied from applying decorative coatings for end
uses such as sink faucets to the production of various electronic, photonic and
semiconductor products.





We
purchase various metals of reasonably high purity (often above 99.9%) for our
applications.  We are not dependent on a single source for these
metals and do not believe losing a vendor would materially affect our
business.





We have
continually added production processes and testing equipment for the many
product compositions that can be used as PVD materials.





Competition





We have a number of domestic and
international competitors in both the ceramic and metal fields, many of whom
have resources far in excess of our resources.  Tosoh, Williams
Advanced Materials, Kurt Lesker and Heraeus are competing suppliers in regard to
targets.  Dowa Chemicals of Japan supplies HTS materials.





Research
and Development





We are
developing sputtering targets for semiconductor applications, which could be
used to produce high K dielectric films via PVD processing.  We are
developing Transparent Conductive Oxide (TCO) and transparent dielectric
materials for Thin Film Solar and wide area coating applications.  We
focus our research and development efforts in areas that build on our expertise
in multi-component ceramic oxides.





Contract research revenues were
$1,005,708 during 2009 and $157,032 during 2008.




During
the fourth quarter of 2009 we were notified we had been awarded a grant in the
amount of $775,400 by the Ohio Department of Development’s Third Frontier
Photovoltaic Program (OTFPVP) to commercialize advanced technology for high
power density rotatable ceramic sputtering targets.  These targets are
used in the manufacture of thin film photovoltaic solar cells.  This
technology will enable manufacturers to operate rotatable sputtering targets at
higher power densities than current technology.  The award was subject
to State of Ohio Controlling Board approval as of December 31,
2009.    This approval was received and the work on the
contract  began in January 2010.


5


During
the third quarter of 2009 we received notification from the Department of Energy
of an Assistance Agreement in the amount of approximately
$750,000.   The award was subsequently reduced to approximately
$650,000.  An amount of $117,076 was approved so the work could begin
in the third quarter of 2009.  The remaining balance is expected to be
approved during the first quarter of 2010.  This grant provides
support for Phase II of a Small Business Innovation Research (SBIR) award
entitled “Homogenous BSCCO-2212 Round Wires for Very High Field Magnet
Applications.”  The work on the contract is expected to continue
through August 2011.





We
received notification during the fourth quarter of 2008 from the Ohio Department
of Development’s Third Frontier Advanced Energy Program of an award in the
amount of more than $700,000.  This award provides support to
commercialize technologies for the manufacture of rotatable ceramic sputtering
targets for the production of transparent conductive oxide-coated glass used in
manufacturing thin film photovoltaic solar cell panels.   The
work on the contract began in January of 2009 and is expected to be completed in
the first quarter of 2011.





During
the third quarter of 2008 we received notification from the Department of Energy
of a Notice of Financial Assistance Award in the amount of approximately
$750,000.  The initial $125,000 was formally approved during
2008.  The remaining balance was approved in February
2009.  This award provides support for Phase II of a Small Business
Innovation Research (SBIR) award entitled “Flux Pinning Additions to Increase Jc
Performance in BSCCO-2212 Round Wire for Very High Field
Magnets.”  The work on the contract began during the third quarter of
2008 and is expected to continue through August 2010.





We
received notification during the second quarter of 2008 from the Department of
Energy of a Notice of Financial Assistance Award in the amount of
$99,961.  This award provides support for Phase I of an SBIR award
entitled “Homogenous BSCCO-2212 Round Wires for Very High Field Magnet
Applications.”  The work on the contract began during the third
quarter of 2008 and was completed during the second quarter of
2009.





During the second quarter of 2007 we
received notification from the Department of Energy of a Notice of Financial
Assistance Award in the amount of $97,900.  This award provided
support for Phase I of a Small Business Innovative Research (SBIR) award
entitled “Flux Pinning Additions to Increase Jc Performance in BSCCO-2212 Round
Wire for Very High Field Magnets.”  The work on the contract began
during the third quarter of 2007 and was completed during the first quarter of
2008.




We intend
to continue to seek funded research opportunities within our core competencies
that maintain and expand technical understanding within our
company.





We have certain proprietary knowledge
and trade secrets related to the manufacture of ceramic oxide PVD materials and
patents covering some HTS products.





New
Product Initiatives





We
continue to develop TCO target materials for the fast growing Thin Film Solar
market in partnership with both original equipment manufacturers and Thin Film
Solar Cell panel fabricators.  Due to our flexibility in manufacturing both
planar and rotatable target material designs, we are able to provide TCO
compositions tailored to customer requests.  In addition, we have obtained
a grant from the Ohio Department of Development’s Third Frontier Advanced Energy
Program (TFAEP) to aid us in the commercialization of our rotatable target
production capabilities.  The TFAEP grant will enable us to expedite the
expansion of our rotatable target manufacturing capacity to meet anticipated
customer demand.





We are
exploring opportunities in the area of high dielectric constant (Hi-K) gate
dielectrics for solid state memory applications.  We have developed
contacts within the R&D departments of several companies developing next
generation memory products and have been supplying materials for their research
efforts.  We foresee the development of a market for these
materials as devices continue to shrink in size.





We
continue to pursue research and development opportunities with respect to new
and innovative materials and processes to be used in connection with the
production of Thin Film Batteries.  Presently, there are approximately five
manufacturers of Thin Film Batteries in the United States, each in various
stages of development from prototype to commercial activity.  In addition
there are several firms and research institutes conducting tests on Thin Film
Batteries.  We believe this market may potentially become large with growth
expected during the next two years.  There are numerous applications for
Thin Film Batteries, including, but not limited to, active RFID tags, battery on
chip, portable electronics, medical implant devices, and remote sensors. 
Given the many potential uses for Thin Film Batteries, we anticipate that the
market for materials it produces will grow in direct correlation to the Thin
Film Battery market itself.




6


We
currently face competition from other producers of materials used in connection
with the manufacture of Thin Film Batteries. We believe that we have certain
competitive advantages in terms of quality.  We intend to actively market
our materials to Thin Film Battery producers in the upcoming year in order to
maintain our strong presence in this market.  Currently, we are the leading
supplier of targets to this market.





At
present, we have several customers for the materials we produce for Thin Film
Batteries.  Since we have begun producing materials for the Thin Film
Battery market, we have experienced no problems securing the supplies needed to
produce the materials.  We do not anticipate supply problems in the near
future.  However, changes in production methods and advancing technologies
could render our current products obsolete and new production protocols may
require supplies that are less available in the marketplace, which may cause a
slowing or complete halt to production as well as expanding costs which we may
or may not be able to pass on to our customers.





Intellectual
Property





We have received a patent for
Fine-Particle Bi-Sr-Ca-Cu-O Having High Phase Purity made by a Chemical
Precipitation and Low-Pressure Calcination method from the United States Patent
and Trademark Office.  We also have received a patent for a process to join
two individual strongly linked super-conductors utilizing a melt processing
technique.





At
present, we have applied for a patent for the manufacture of a precious metal
composite target that will significantly reduce the amount of precious metal
required to produce such targets that are used in the semiconductor and
photonics industries.  We have several customers interested in this
invention and are pursuing both domestic (US) and foreign coverage.





In the
future, we may submit additional patent applications covering various
applications, which have been developed by us.  Because the publication of
U.S. patent applications can be delayed for up to one year, they tend to lag
behind actual discoveries and we may not be the first creator of inventions
covered by pending patent applications or the first to file patent applications
for such inventions.  Additionally, other parties may independently develop
similar technologies, duplicate our technologies or, if patents are issued to us
or rights licensed by us, design around the patented aspects of any technologies
we developed or licensed.





We rely
on a combination of patent and trademark law, license agreements, internal
procedures and nondisclosure agreements to protect our intellectual
property.  Unfortunately, these may be invalidated, circumvented or
challenged.  In addition, the laws of some foreign countries in which our
products may be produced or sold may not protect our intellectual property
rights to the same extent as the laws of the United States.





Employees





We had 25
full-time employees as of December 31, 2009.  One of these employees
held a PhD in Material Science.  We have never experienced work
stoppage and consider our relations with employees to be good.  The
employees do not have a bargaining unit.





Environmental
Matters





We handle all materials according to
Federal, State and Local environmental regulations and include
Material Safety Data Sheets (MSDS) with all shipments to customers.  We
maintain a collection of MSDS sheets for all raw materials used in the
manufacture of products and maintenance of equipment and insure that all
personnel follow the handling instructions contained in the MSDS for each
material.  We contract with a reputable fully permitted hazardous waste
disposal company to dispose of the small amount of hazardous waste materials
generated.





Collections
and Write-offs





We collected receivables in an average
of 26 days in 2009.  We have occasionally been forced to write-off
negligible amount of accounts receivable as uncollectible.  We
consider credit management critical to our success.


7


Seasonal
Trends





We have not experienced and do not
expect to experience seasonal trends in future business operations.





ITEM
      1A.
            RISK
      FACTORS





We desire
to take advantage of the “safe harbor” provisions of the Private Securities
Litigation Reform Act of 1995.  The following factors have affected or
could affect actual results and could cause such results to differ materially
from those expressed in any forward-looking statements
made.  Investors should consider carefully the following risks and
speculative factors inherent in and affecting the business of SCI and an
investment in our common stock.





We
have experienced significant operating losses in the past and may have losses in
the future.





We
reported net loss applicable to common shares of $521,649 for 2009 and net
income applicable to common shares of $100,177 for 2008.  For the year
ended December 31, 2009, we had $457,417 in non-cash expenses, which included
$427,139 in non-cash expenses for the following items: stock based compensation
for stock options issued in January of 2009 and charges related to the extension
of the expiration date of common stock warrants in May of 2009.  These
non-cash stock based compensation expense included a one time charge of $175,376
for options that vested immediately and ongoing charges of
$175,376.  The ongoing non-cash charges will continue through 2010 and
then decline beginning in the first quarter of 2011.  The non-cash
financing expense related to the extension of the expiration date of common
stock warrants was a one time charge of $76,387.  A deferred tax
benefit was recognized in the amount of $156,000 during 2009.  For the
twelve months ended December 31, 2008, we had $77,348 in non-cash stock based
compensation expense.  The increase in these non-cash charges of
$380,069 had a material effect on our Statement of Operations in
2009.  Our accumulated deficit since inception in 1987 was $7,899,095
at December 31, 2009.





While we were profitable in the three
years prior to 2009, we have financed our historical losses primarily from
additional investments and loans by our major shareholders and private offerings
of common stock and warrants to purchase common stock.  We cannot
assure you, however, that we will operate at a profit or that we will be able to
raise additional capital in the future to fund our operations.





We have limited marketing and sales
capabilities.





In 2009 we expanded our marketing reach
into Asia continuing our efforts which began in 2008.  We also added a
manufacturing representative for the Korean market and another for the Taiwanese
and Chinese markets.  In late 2008, we formed an exclusive
relationship with a manufacturer’s representative in Europe, which we terminated
in January 2010.  As previously mentioned, we hired a full time sales
engineer in 2007 to expand our marketing activities, especially in the solar
area of the photonics market and in the semiconductor market.  We must
continue to develop appropriate marketing, sales, technical, customer service
and distribution capabilities, or enter into agreements with third parties to
provide these services to successfully market our products.  A failure
to develop these capabilities or obtain third-party agreements could adversely
affect us.





Our
success depends on our ability to retain key management personnel.





Our success depends in large part on
our ability to attract and retain highly qualified management, administrative,
manufacturing, sales, and research and development personnel.  Due to
the specialized nature of our business, it may be difficult to locate and hire
qualified personnel.   The loss of services of one of our
executive officers or other key personnel, or our failure to attract and retain
other executive officers or key personnel could have a material adverse effect
on our business, operating results and financial condition.  Although
we have been successful in planning for and retaining highly capable and
qualified successor management in the past, there can be no assurance that we
will be able to do so in the future.





We
may need to seek additional capital in the future, which may reduce the value of
our common stock.





We
reported net loss applicable to common shares of $521,649 for 2009 and net
income applicable to common shares of $100,177 for 2008, and $307,682 for
2007.  We incurred operating losses prior to
2006.    We could be required to seek additional capital in
the future for growth and working capital purposes.  There is no
assurance that new capital will be available or that it will be available on
terms that will not result in substantial dilution or reduction in value of our
common stock.  On January 8, 2010, warrant holders exercised 150,000
common stock purchase warrants resulting in proceeds of
$375,000.


8


Our
competitors have far greater financial and other resources than we
have.





The
market for Physical Vapor Deposition materials is a substantial market with
significant competition in both ceramic and metal materials.  While we
believe that our products enjoy certain competitive advantages in design,
function, quality, and availability, considerable competition exists from
well-established firms such as Williams Advanced Materials, Kurt Lesker, Heraeus
and Tosoh, all of which have more financial resources than us.  We
cannot provide assurance that developments by others will not render our
products or technologies obsolete or less competitive.





Our revenues
depend on patents and proprietary rights that may not be
enforceable.





We rely on a combination of patent and
trademark law, license agreements, internal procedures and nondisclosure
agreements to protect our intellectual property.  These may be
invalidated, circumvented or challenged.  In addition, the laws of
some foreign countries in which our products may be produced or sold may not
protect our intellectual property rights to the same extent as the laws of the
United States.  Our failure to protect our proprietary information
could adversely affect us.





Rights we have to patents and
pending patent applications may be challenged.





We have received, from the United
States Patent and Trademark Office, a patent for Fine-Particle Bi-Sr-Ca-Cu-O
Having High Phase Purity made by a Chemical Precipitation and Low-Pressure
Calcination method, and have also received a patent for a process to join two
individual strongly linked super-conductors utilizing a melt processing
technique.  We have applied for a patent for the manufacture of a
precious metal composite target that will significantly reduce the amount of
precious metal required to produce such targets that are used in the
semiconductor and photonics industries.  We have several customers
interested in this invention and are pursuing both domestic (US) and foreign
coverage.  In the future, we may submit additional patent applications
covering various applications.  The patent application we filed and
patent applications that we may file in the future may not result in patents
being issued, and any patents issued may not afford meaningful protection
against competitors with similar technology, and may be challenged by third
parties.





Because
U.S. patent applications are maintained in secret until patents are issued, and
because publications of discoveries in the scientific or patent literature tend
to lag behind actual discoveries by several months, we may not be the first
creator of inventions covered by issued patents or pending patent applications
or the first to file patent applications for such
inventions.  Moreover, other parties may independently develop similar
technologies, duplicate our technologies or, if patents are issued to us or
rights licensed by us, design around the patented aspects of any technologies we
developed or licensed. We may have to participate in interference proceedings
declared by the U.S. Patent and Trademark Office to determine the priority of
inventions, which could result in substantial costs. Litigation may also be
necessary to enforce any patents held by or issued to us or to determine the
scope and validity of others' proprietary rights, which could result in
substantial costs.





The rapid
technological changes of our industry may adversely affect us if we do not keep
pace with advancing technology.





The Physical Vapor Deposition market is
characterized by rapidly advancing technology.  Our success depends on
our ability to keep pace with advancing technology and processes and industry
standards.  We have focused our development efforts on sputtering
targets.  We intend to continue to develop and integrate advances in
the thin film coatings industry.  However, our development efforts may
be rendered obsolete by research efforts and technological advances made by
others, and materials other than those we currently use may prove more
advantageous.





Additional
development of our products may be necessary due to uncertainty regarding
development of markets.





Some of our products are in the early
stages of commercialization and we believe that it will be several years before
these products will have significant commercial end-use applications, and that
significant additional development work may be necessary to improve the
commercial feasibility and acceptance of these products.  There can be
no assurance that we will be able to commercialize any of the products currently
under development.




9


To date,
there has been no widespread commercial use of High Temperature Superconductive
(HTS) products.  Additionally, the market for the Thin Film Battery
materials is still in its early stages.  Some of our materials are in
early stages of development for Thin Film Solar applications.  The
Thin Film Solar market is expected to grow significantly during the next few
years.





The market for our common stock is
limited, and as such our shareholders may have difficulty reselling their shares
when desired or at attractive market prices.





Our stock price and our listing may
make it more difficult for our shareholders to resell shares when desired or at
attractive prices.  In 2001, our stock began trading on The Over the
Counter Bulletin Board (“OTC Bulletin Board”).  Nevertheless, our
common stock has continued to trade in low volumes and at low
prices.  Some investors view low-priced stocks as unduly speculative
and therefore not appropriate candidates for investment.  Many
institutional investors have internal policies prohibiting the purchase or
maintenance of positions in low-priced stocks.  This has the effect of
limiting the pool of potential purchases of our common stock at present price
levels.  Shareholders may find greater percentage spreads between bid
and asked prices, and more difficulty in completing transactions and higher
transaction costs when buying or selling our common stock than they would if our
stock were listed on a major stock exchange, such as The New York Stock Exchange
or The Nasdaq National Market.





Our common stock has been subject to
the Securities and Exchange Commission’s “penny stock” regulations, which may
limit the liquidity of common stock held by our
shareholders.





At the present time, our common stock
trades on the OTC Bulletin Board.  Based on its trading price, our
common stock is considered a “penny stock” for purposes of federal securities
laws,  and therefore has been subject to regulations, which affected
the ability of broker-dealers to sell our securities.  Broker-dealers
who recommend a “penny stock” to persons (other than established customers and
accredited investors) must make a special written suitability determination and
receive the purchaser’s written agreement to a transaction prior to
sale.





If penny stock regulations apply to our
common stock, it may be difficult to trade the stock because compliance with the
regulations can delay and/or preclude certain trading
transactions.  Broker-dealers may be discouraged from effecting
transactions in common stock because of the sales practice and disclosure
requirements for penny stock. This could adversely affect the liquidity and/or
price of our common stock, and impede the sale of the common stock in the
secondary market.





Our
Articles of Incorporation authorize us to issue additional shares of
stock.





We are authorized to issue up to
15,000,000 shares of common stock, which may be issued by our board of directors
for such consideration, as they may consider sufficient without seeking
shareholder approval.  The issuance of additional shares of common
stock in the future may reduce the proportionate ownership and voting power of
current shareholders.





Our Articles of Incorporation authorize
us to issue up to 260,000 shares of preferred stock.  The issuance of
preferred stock in the future could create additional securities which would
have dividend and liquidation preferences prior in right to the outstanding
shares of common stock.  These provisions could also impede a
non-negotiated change in control.





We
have not paid dividends on our common stock in the past and do not expect to do
so in the future.





We cannot assure you that our
operations will result in sufficient revenues to enable us to operate at
profitable levels or to generate positive cash flow sufficient to pay
dividends.  We have never paid dividends on our common shares in the
past and do not expect to do so in the foreseeable future.  We intend
to retain future earnings for use in the business.


10


ITEM
      1B.
            UNRESOLVED
      STAFF COMMENTS.





Not applicable.





ITEM
      2.
            PROPERTIES.





Our office and manufacturing facilities
are located at 2839 Charter Street, Columbus, Ohio, where we occupy
approximately 32,000 square feet.  We moved our operations into this
facility in 2004.  The lease on the property expires on August 16,
2014.   We believe these facilities are in good condition and
will be adequate for our needs for the immediate future.  We
anticipate the need for additional manufacturing and warehouse space in
2011.





We are current on all operating lease
liabilities.





ITEM
      3.
            LEGAL
      PROCEEDINGS.





Not
applicable.





ITEM
      4.
            SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY
HOLDERS.





Not applicable.


11


PART
II





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





Market
for Common Stock





Our common stock currently trades on
the OTC Bulletin Board under the symbol “SCIA.”  The following table
sets forth for the periods indicated the high and low bid quotations for our
common stock.





High
                  
                  
                  LowFiscal
      2009Quarter
      Ended March 31, 2009
                  
                  $
                  6.00
                  
                  
                  $
                  2.75Quarter
      Ended June 30, 2009
                  
                  
                  3.50
                  
                  
                  
                  2.60Quarter
      Ended September 30, 2009
                  
                  
                  3.80
                  
                  
                  
                  1.75Quarter
      Ended December 31, 2009
                  
                  
                  3.75
                  
                  
                  
                  2.00Fiscal
      2008Quarter
      Ended March 31, 2008
                  
                  
                  5.90
                  
                  
                  
                  2.50Quarter
      Ended June 30, 2008
                  
                  
                  5.75
                  
                  
                  
                  3.00Quarter
      Ended September 30, 2008
                  
                  
                  6.00
                  
                  
                  
                  4.10Quarter
      Ended December 31, 2008
                  
                  
                  6.00
                  
                  
                  
                  2.10





The quotations provided herein may
reflect inter-dealer prices without retail mark-up, markdown, or commissions,
and may not represent actual transactions.





As discussed above, at the present
time, our common stock trades on the OTC Bulletin Board.  Based on its
trading price, our common stock is considered a “penny stock” for purposes of
federal securities laws, and therefore has been subject to certain regulations,
which are summarized below.





The Securities Enforcement and Penny
Stock Reform Act of 1990 requires special disclosure relating to the market for
penny stocks in connection with trades in any stock defined as a “penny
stock.”  Specifically, Rules 15g-1 through 15g-9 under the Securities
Exchange Act of 1934 (the “Exchange Act”) impose sales practice and disclosure
requirements on NASD broker-dealers who make a market in a “penny
stock.”  Securities and Exchange Commission regulations generally
define a penny stock to be an equity security that has a market price of less
than $5.00 per share and is not listed on The NASDAQ SmallCap Stock Market or a
major stock exchange. These regulations affect the ability of broker-dealers to
sell the Company’s securities and also may affect the ability of purchasers of
the Company’s
common stock to sell their shares in the secondary market.





Under the penny stock regulations, a
broker-dealer selling penny stock to anyone other than an established customer
or “accredited investor,” generally, an individual with net worth in excess of
$1,000,000 or an annual income exceeding $200,000, or $300,000 together with his
or her spouse, must make a special suitability determination for the purchaser
and must receive the purchaser’s written consent to the transaction prior to
sale, unless the broker-dealer or the transaction is otherwise exempt. In
addition, the penny stock regulations require the broker-dealer to deliver,
prior to any transaction involving a penny stock, a disclosure schedule prepared
by the Commission relating to the penny stock market, unless the broker-dealer
or the transaction is otherwise exempt. A broker-dealer is also required to
disclose commissions payable to the broker-dealer and the registered
representative and current quotations for the securities. Finally, a
broker-dealer is required to send monthly statements disclosing recent price
information with respect to the penny stock held in a customer’s account and
information with respect to the limited market in penny stocks.




12


As long as the penny stock regulations
apply to the Company’s stock, it may be difficult to trade such stock because
compliance with the regulations can delay and/or preclude certain trading
transactions.  Broker-dealers may be discouraged from effecting
transactions in the Company’s stock because of the sales practice and disclosure
requirements for penny stock. This could adversely affect the liquidity and/or
price of the Company’s common stock, and impede the sale of the Company’s
stock.





Holders
of Record





As of December 31, 2009, there were
approximately 460 holders of record of our common stock and 3,571,775 shares
outstanding.  There were approximately 50 holders of Series B
Preferred shares and as of December 31, 2009 there were 24,297 shares
outstanding.





Dividends





We have never paid cash dividends on
our common stock and do not expect to pay any dividends in the foreseeable
future.  We intend to retain future earnings for use in the
business.





Equity
Compensation Plan Information





The following table sets forth
additional information as of December 31, 2009, concerning shares of our common
stock that may be issued upon the exercise of options, warrants and rights under
our existing equity compensation plans and arrangements, divided between plans
approved by our shareholders and plans or arrangements not submitted to the
shareholders for approval.  The information includes the number of
shares covered by, and the weighted average exercise price of, outstanding
options and other rights and the number of shares remaining available for future
grants excluding the shares to be issued upon exercise of outstanding options,
warrants, and other rights.





Number of Securities to
                          be issued upon exercise
                          of outstanding options,
                          warrants and rights
                          (a)
                        
                        
                        Weighted-average exercise
                          price of outstanding
                          options, warrants and rights
                          (b)
                        
                        
                        Number of securities
                          remaining available for
                          issuance under equity
                          compensation plans
                          (excluding securities
                          reflected in column (a))
                          (c)Equity
      compensation plans approved by security holders (1)
                        
                        
                        1,115,750
                        
                        
                        $
                        4.08
                        
                        
                        
                        13,500Equity
      compensation plans not approved by security holders (2)
                        
                        
                        17,500
                        
                        
                        $
                        2.88
                        
                        
                        
                        —Total
                        
                        
                        1,133,250
                        
                        
                        $
                        4.07
                        
                        
                        
                        13,500







(1)
            Equity
      compensation plans approved by shareholders include our 2006 Stock Option
      Plan.


(2)     
  Includes 17,500 stock purchase warrants that can be used to purchase
17,500 shares of our common stock, which were issued by us in exchange for
consideration in the form of goods and services.





ITEM
      6.
            SELECTED
      FINANCIAL DATA.





Not applicable.


13


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





Overview




SCI
Engineered Materials, Inc. (“SCI” or the “Company”), formerly Superconductive
Components, Inc., an Ohio corporation, was incorporated in 1987.  We
manufacture ceramic and metal sputtering targets for a variety of industrial
applications including: Photonics, Thin Film Solar, Thin Film Battery,
Semiconductor, and, to a lesser extent HTS materials.  Photonics
currently represents the largest market for our targets.  Thin Film
Solar is an industry that is exhibiting rapid growth and we expect this market
to grow quickly.  Thin Film Battery is a developing market where
manufacturers of batteries use our targets to produce very small power supplies
with small quantities of stored energy.    Semiconductor is
a developing market for us.  We added to our sales staff in late 2007
for the purpose of focusing on opportunities for our products in the Solar
industry.  We also added staff to our Technology group during the
second half of 2007 for the development of innovative
products.  During the fourth quarter of 2008 we added an exclusive
manufacturer’s representative for Europe, and as mentioned earlier, we
terminated this relationship in January 2010.  Late in the second
quarter of 2009 we received an order from a solar customer that was in excess of
$1 million.  Nearly the entire amount shipped before December 31,
2009.  Late in the fourth quarter this same customer placed another
order greater than $1 million.  This entire order is expected to ship
during the first half of 2010.




Executive
Summary




For the
year ended December 31, 2009, we had $457,417 in non-cash expenses, which
included $427,139 in non-cash expenses for the following items: stock based
compensation for stock options issued in January of 2009 and charges related to
the extension of the expiration date of common stock warrants in May of
2009.  These non-cash stock based compensation expense included a
one-time charge of $175,376 for options that vested immediately and ongoing
charges of $175,376.  These ongoing non-cash charges will continue
through 2010 and then decline beginning in the first quarter of
2011.  The non-cash financing expense related to the extension of the
expiration date of common stock warrants was a one time charge of
$76,387.  A deferred tax benefit was recognized in the amount of
$156,000 during 2009. For the twelve months ended December 31, 2008, we had
$77,348 in non-cash stock based compensation expense.  The increase in
these non-cash charges of $380,069 had a material effect on our Statement of
Operations in 2009.





For the
year ended December 31, 2009, we had revenues of $8,010,235.  This was
a decrease of $1,609,660, or 16.7% when compared to 2008.  The decline
in total revenue can be attributed to a significant reduction in a high priced
raw material and the economic downturn as customers decreased spending and
reduced inventory levels.  After two years of unusually high prices
above the long-term average price of this raw material, the price returned to
its long-term average.  On September 17, 2009 we filed a Form 8-K
announcing a major customer informed us that it intended to purchase this high
value raw material directly and ship it to us for
processing.  However, since the September 17, 2009 filing the customer
has asked us, at times, to purchase this raw material for
them.  Should the customer purchase this raw material on a consistent
basis and ship it to us for processing it is anticipated that it would not
materially impact net income but it would result in lower revenue than previous
periods.  Revenue exclusive of this high value raw material increased
approximately $1,241,000, or 29.0% in 2009 versus 2008.  Contract
research revenue increased to $1,005,708 for 2009 from $157,032 for 2008, an
increase of $848,676, reflecting the position of our company in key
technologies.  This increase in contract research revenue combined
with revenue from new markets helped offset the decrease in our automotive
market revenue.





Gross
profit was $1,869,879 for year ended December 31, 2009 compared to $2,211,477
for 2008.  This decrease was due to the lower product revenue
mentioned earlier.  Gross margin was 23.3% of total revenues for the
2009 compared to 23.0% in 2008.





Given
current market conditions, we continued to invest in expanding production
capabilities, R&D, marketing and sales.  This should allow us to
gain market share now and to be poised to receive large orders in targeted
applications when the current business downturn recovers.





Benefits from these investments have
been orders that were shipped to customers in the Thin Film Solar
industry.  The revenue from shipments to the solar industry totaled
more than $2.2 million during 2009 compared to approximately $760,000 during
2008.  Late in the second quarter of 2009 we received some orders from
our traditional markets that had been slow during the first six months of 2009.
This led to revenue in the second half of 2009 of $4,798,647, which was an
increase of 49.4% over the first six months.  This could be an
indication that restocking inventories or increased business levels began in the
second half of 2009.


14


For the
year ended December 31, 2009, we had net loss applicable to common shares of
$521,649 compared to net income of $100,177 for 2008.  The decrease
can be attributed to additional operating expenses of approximately $191,000
along with the decline in product revenue and gross profit mentioned
above.  Non-cash stock based compensation expense increased
approximately $304,000 in 2009 versus 2008.  A non-cash financing
expense related to the extension of the expiration date for warrants was
approximately $76,000 and $0 for the twelve months ended December 31, 2009 and
2008, respectively.  We recognized a deferred tax benefit of $156,000
in 2009 and $0 in 2008.





Subsequent
to the end of the year, on January 8, 2010 a total of 150,000 common stock
warrants, which were originally in the estates of Dr. Edward R. Funk Sc.D., and
Ingeborg V. Funk, founders of our company, were exercised at a price of $2.50
per share.  The cash proceeds received were $375,000.





All of
our employees are committed to fighting through the economic
downturn.  During the second quarter and the majority of the third
quarter of 2009 we reduced hours in most departments and members of management
agreed to salary reductions to help reduce costs.  Due to the increase
in orders and production, all production personnel returned to full time status
in September of 2009 and management salary reductions were rescinded in October
2009.




During the fourth quarter of 2009 we
were notified we had been awarded a grant in the amount of $775,400 by the Ohio
Department of Development’s Third Frontier Photovoltaic Program (OTFPVP) to
commercialize advanced technology for high power density rotatable ceramic
sputtering targets.  These targets are used in the manufacture of thin
film photovoltaic solar cells.  This technology will enable
manufacturers to operate rotatable sputtering targets at higher power densities
than current technology.  The award was subject to State of Ohio
Controlling Board approval at December 31, 2009.    This
approval was received during January 2010.





During the third quarter of 2009 we
received notification from the Department of Energy of an Assistance Agreement
in the amount of approximately $750,000.   The award was
subsequently reduced to approximately $650,000.  An amount of $117,076
was approved so the work could begin in the third quarter of
2009.  The remaining balance is expected to be approved during the
first quarter of 2010.  This grant provides support for Phase II of a
Small Business Innovation Research (SBIR) award entitled “Homogenous BSCCO-2212
Round Wires for Very High Field Magnet Applications.”  The work on the
contract is expected to continue through August 2011.





In July
2009, the Company was selected by a customer as a subcontractor for an award
recently granted by the Ohio Department of Development.  This award is
entitled “Ohio-Based Manufacturing of Thin-Film Photovoltaics” and provides
support for the development of alternate transparent conductive
oxides.    The work on the contract began during the third
quarter of 2009 and is projected to be completed during 2010.  The
amount of the subcontract work to be performed by the Company is
$125,000.





We
received notification during the fourth quarter of 2008 from the Ohio Department
of Development’s Third Frontier Advanced Energy Program (TFAEP) of an award in
the amount of $708,715.  This grant provides support to commercialize
technologies for the manufacture of rotatable ceramic sputtering targets for the
production of transparent conductive oxide-coated glass used in manufacturing
thin film photovoltaic solar cell panels.   The work on the
contract began in January of 2009 and is expected to continue through January
2011.





During
the third quarter of 2008 we received notification from the Department of Energy
of a Notice of Financial Assistance Award in the amount of approximately
$750,000.  The initial $125,000 was formally approved during
2008.  The remaining balance was approved in February
2009.  This grant provides support for Phase II of a Small Business
Innovation Research (SBIR) award entitled “Flux Pinning Additions to Increase Jc
Performance in BSCCO-2212 Round Wire for Very High Field
Magnets.”  The work on the contract began during the third quarter of
2008 and is expected to continue through August 2010.





We
received notification during the second quarter of 2008 from the Department of
Energy of a Notice of Financial Assistance Award in the amount of
$99,961.  This award provided support for Phase I of an SBIR award
entitled “Homogenous BSCCO-2212 Round Wires for Very High Field Magnet
Applications.”  The work on the contract began during the third
quarter of 2008 and was completed during the first quarter of 2009.





Orders received in 2009 were
$10,772,584 compared to $11,675,439 in 2008.  This decrease can be
attributable to the reduction in the high priced raw material previously
mentioned.     Orders exclusive of the high priced raw
material increased $2,103,538, to $7,718,239 or 37.5%.


15





Results
of Operations





Critical
Accounting Policies




The
preparation of financial statements and related disclosures in conformity with
accounting principles generally accepted in the United States requires
management to make judgments, assumptions and estimates that affect the amounts
reported in the Financial Statements and accompanying notes.Note
2 to the Financial Statements in the Annual Report on Form 10-K for the year
ended December 31, 2009 describes the significant accounting policies and
methods used in the preparation of the Financial
Statements.  Estimates are used for, but not limited to, the
accounting for the allowance for doubtful accounts, inventory allowances,
property and equipment depreciable lives, patents and licenses useful lives and
assessing changes in which impairment of certain long-lived assets may
occur.  Actual results could differ from these
estimates.  The following critical accounting policies are impacted
significantly by judgments, assumptions and estimates used in the preparation of
the Financial Statements.  The allowance for doubtful accounts is
based on our assessment of the collectability of specific customer accounts and
the aging of the accounts receivable.  If there is a deterioration of
a major customer’s credit worthiness or actual defaults are higher than our
historical experience, our estimates of the recoverability of amounts due us
could be adversely affected.  Inventory purchases and commitments are
based upon future demand forecasts.  If there is a sudden and
significant decrease in demand for our products or there is a higher risk of
inventory obsolescence because of rapidly changing technology and customer
requirements, we may be required to increase our inventory allowances and our
gross margin could be adversely affected.   Depreciable and
useful lives estimated for property and equipment, licenses and patents are
based on initial expectations of the period of time these assets and intangibles
will provide benefit to us.  Changes in circumstances related to a
change in our business, change in technology or other factors could result in
these assets becoming impaired, which could adversely affect the value of these
assets.





Year
2009 As Compared to Year 2008





Revenues





Revenues
were $8,010,235 in 2009, a decrease of $1,609,660, or 16.7%, from
2008.  The decline in total revenue can be attributed to a significant
reduction in a high priced raw material and the economic downturn as customers
decreased spending and reduced inventory levels.  After two years of
unusually high prices above the long-term average price of this raw material,
the price returned to its long-term average.  On September 17, 2009 we
filed a Form 8-K announcing a major customer informed us that it intended to
purchase this high value raw material directly and ship it to us for
processing.  However, since the September 17, 2009 filing the customer
has asked us, at times, to purchase this raw material for
them.  Should the customer purchase this raw material on a consistent
basis and ship it to us for processing it is anticipated that it would not
materially impact net income but it would result in lower revenue than previous
periods.  Revenue exclusive of this high value raw material increased
approximately $1,241,000, or 29.0% in 2009 versus 2008.  Cost changes
for this high value raw material are fully reflected in the final selling price,
which insulates us from market risk associated with the raw
material.  We anticipate the cost of this high value raw material will
increase during 2010.





Gross Profit





Gross
profit was $1,869,879 for year ended December 31, 2009 compared to $2,211,477
for 2008.  This decrease was due to the lower product revenue
mentioned earlier.  Gross margin was 23.3% of total revenues for the
2009 compared to 23.0% in 2008.





Marketing and Sales Expense





Marketing
and Sales expense for the twelve months ended December 31, 2009 increased 10.3%
to $647,859 from $587,202 for the same period in 2008.  The increase
was due to increased non-cash stock based compensation expense of approximately
$43,000, higher expenses related to trade shows of approximately $14,000 as well
as increased commissions to our outside manufacturing sales representatives of
approximately $49,000.  A portion of this increase was offset by a
reduction in compensation.  Marketing and Sales expense for the three
months ended December 31, 2009 increased 6.6% to $155,303 from $145,648 for the
same period in 2008.





We
anticipate increased trade show expenses in 2010 as we continue to expand our
marketing efforts in foreign markets.




16




General
and Administrative Expense





General
and administrative expense for the year ended December 31, 2009 increased to
$1,237,672 from $966,979 for the year ended December 31, 2008, or
28.0%.  The increase was primarily the result of non-cash stock based
compensation expense of approximately $280,000 compared to approximately $40,000
for 2008, as well as expenses related to Sarbanes Oxley which were approximately
$60,000 for 2009 versus approximately $5,000 for 2008.  A portion of
this increase was offset by a reduction in compensation. General and
administrative expense for the three months ended December 31, 2009 increased to
$260,242 from $215,417 for the three months ended December 31, 2008, or
20.8%.  The increase was primarily the result of non-cash compensation
expense of approximately $24,000 compared to $4,000 during the fourth quarter of
2008, as well as expenses related to Sarbanes Oxley which were $18,577 for the
three months ended December 31, 2009 versus $0 for the same period in
2008.





Research
and Development Expense





Research
and development expense for the year of 2009 was $314,386 compared to $454,424
for 2008, a decrease of 30.8%.  Research and development expense for
the three months ended December 31, 2009 was $49,980 compared to $98,639 for the
same period in 2008, a decrease of 49.3%.  The decrease in expense was
a result of compensation that was assigned to Cost of Contract Research of
approximately $60,000 for the fourth quarter of 2009 and $222,000 for the year
ended December 31, 2009.  Research and Development Expense would have
increased to approximately $536,000 for the year ended December 31, 2009 had
this expense not been assigned to Cost of Contract Research.  We
continue to incur expenses associated with the development efforts in the
Photonic, Thin Film Solar, Thin Film Battery and Semiconductor markets, as well
as our cost share for research expenses related to the SBIRs and Third Frontier
grants.





Other
Income and Expense





Interest
income was $6,394 and $24,271 for the years ended December 31, 2009 and 2008,
respectively.   Interest income was $706 and $4,527 for the three
months ended December 31, 2009 and 2008, respectively.   The
decrease in interest rates reduced the amount of interest earned.





Interest
expense was $108,712 and $102,763 for the years ended December 31, 2009 and
2008, respectively and $24,655 and $23,276 for the three months ended December
31, 2009 and 2008, respectively.  The increase was due to additional
capital lease obligations incurred for the purchase of production equipment for
increased production capacity.  We received loan proceeds in the
amount of $400,000 from the Ohio Department of Development in
2008.  These proceeds were used to reduce the balance on outstanding
capital lease obligations.  The favorable interest rate on this loan
(3%) helped offset the interest expense related to new capital lease
obligations.





The
non-cash financing expense associated with the extension of the warrant
expiration date previously mentioned was approximately $76,000 during 2009
versus $0 in 2008.





Income
Tax Benefit





Income
tax benefit for the years ended December 31, 2009 and December 31, 2008 was
$(59,000) and $0 respectively.    A deferred tax benefit of
$156,000 and an expense of $97,000 were recorded in 2009.





INCOME
(LOSS) APPLICABLE TO COMMON SHARES





Loss
applicable to common shares was $521,649, or $(0.15) per common share compared
to net income of $100,177, or $0.02 per common share for the twelve months ended
December 31, 2009 and 2008, respectively.  The loss or income
applicable to common shares includes net loss or net income from operations and
the accretion of Series B preferred stock dividends.  Dividends on the
Series B preferred stock accrue at 10% annually on the outstanding
shares.  Accrued dividends on the Series B preferred stock was $24,430
and $24,373 for the years ended December 31, 2009 and 2008,
respectively.  Basic net (loss) income per common share before
dividends on preferred stock and based on (loss) income applicable to common
shares was ($0.14) and $0.04 for the twelve months ended December 31, 2009 and
2008, respectively.




The
weighted averaged shares outstanding were 3,562,960 at December 31,
2009.  All outstanding common stock equivalents were anti-dilutive for
the twelve months ended December 31, 2009 due to the net loss.  Basic
and diluted net income for the twelve months ended December 31, 2008 was $0.03
and $0.02 per common share based on 3,530,486 and 4,035,065 weighted average
shares outstanding, respectively.




17




The
following schedule represents our outstanding common shares during the period of
2010 through 2019 assuming all outstanding stock options and stock warrants are
exercised during the year of expiration.  If each shareholder
exercises his or her options or warrants, it could increase our common shares by
1,672,807 to 5,244,582 by December 31, 2019.  Exercise prices for
options and warrants range from $1.00 to $6.00 at December 31,
2009.  Assuming all such options and warrants are exercised in the
year of expiration, the effect on shares outstanding is illustrated as
follows:





Options
      and
                      
                      
                      PotentialWarrants
      due
                      
                      
                      Sharesto expire
                      
                      
                      Outstanding2010
                      
                      
                      594,557
                      
                      
                      
                      4,166,3322011
                      
                      
                      62,500
                      
                      
                      
                      4,228,8322012
                      
                      
                      169,000
                      
                      
                      
                      4,397,8322013
                      
                      
                      30,250
                      
                      
                      
                      4,428,0822014
                      
                      
                      180,000
                      
                      
                      
                      4,608,0822015
                      
                      
                      140,000
                      
                      
                      
                      4,748,0822016
                      
                      
                      37,000
                      
                      
                      
                      4,785,0822017
                      
                      
                      -
                      
                      
                      
                      4,785,0822018
                      
                      
                      9,500
                      
                      
                      
                      4,794,5822019
                      
                      
                      450,000
                      
                      
                      
                      5,244,582





Liquidity
and Working Capital





At
December 31, 2009, working capital was $1,555,897 compared to $1,786,360 at
December 31, 2008, a decrease of $230,463.  Net cash provided by
operating activities was approximately $262,000 for the twelve months ended
December 31, 2009.  Net cash provided by operating activities was
approximately $457,000 for the twelve months ended December 31,
2008.  Significant non-cash items including depreciation, accretion
and amortization, stock based compensation expense, financing expense of warrant
extension, deferred taxes, disposal/impairment of equipment, inventory reserve
on excess and obsolete inventory, and allowance for doubtful accounts were
approximately $786,000 and $418,000, for the twelve months ended December 31,
2009 and 2008, respectively.  Inventory reserves are established for
obsolete inventory, excess inventory quantities based on our estimate of net
realizable value and for lower-of-cost or market.  We believe the
inventory reserve, after its assessment of obsolete inventory, at December 31,
2009, of $49,597 will be adequate for excess inventory and a lower of
cost-or-market analysis.   Accounts receivable, inventory,
prepaid expenses and other assets increased approximately $690,000 for the
twelve months ended December 31, 2009.   This increase was due to
higher customer prepaid purchase orders. Accounts receivable, inventory, prepaid
expenses and other assets increased approximately $806,000 for the twelve months
ended December 31, 2008.    Accounts payable, accrued
expenses and customer deposits increased approximately $663,000 during
2009.  The increase was due primarily to customer deposits
received.  Accounts payable, accrued expenses and customer deposits
decreased approximately $722,000 during 2008.





Cash of approximately $168,000 and
$140,000 was used for investing activities for the twelve months ended December
31, 2009 and 2008, respectively.  The amounts invested were used to
purchase machinery and equipment for increased production capacity, new product
lines and leasehold improvements for the facility.  Proceeds on sale
of equipment totaled $0 and $2,000 during 2009 and 2008,
respectively.





Cash of
approximately $385,000 was used for financing activities during the twelve
months ended December 31, 2009.  Principal payments to third parties
for capital lease obligations approximated $382,000. Proceeds received from the
exercise of common stock options were $21,206.  A cash payment related
to Series B preferred stock dividend was $24,430.  We incurred new
capital lease obligations of approximately $556,000 for new production equipment
during 2009.





Cash of
approximately $100,000 was used for financing activities during the twelve
months ended December 31, 2008.  Principal payments to third parties
for capital lease obligations approximated $537,000.  Proceeds
received from the exercise of common stock warrants were approximately
$68,000.  Proceeds received from the exercise of common stock options
were $10,250.  Cash payments for services provided for the
registration of common stock were approximately $17,000.  A cash
payment related to Series B preferred stock dividend was approximately
$25,000.  Proceeds received from The Ohio Department of Development
were $400,000.  We incurred new capital lease obligations of
approximately $339,000 for new production equipment during 2008.




18




While certain of our major shareholders
have advanced funds in the form of subordinated debt, accounts payable and
guaranteeing bank debt in the past, there is no commitment by these individuals
to continue funding us or guaranteeing bank debt in the future.  We
will continue to seek new financing or equity financing
arrangements.  However, we cannot be certain that it will be
successful in efforts to raise additional new funds.





On January 8, 2010 a total of 150,000
common stock warrants, which were originally in the estates of Dr. Edward R.
Funk Sc.D., and Ingeborg V. Funk, founders of our company, were exercised at a
price of $2.50 per share.  The cash proceeds received were
$375,000.





Inflation





We believe that there has not been a
significant impact from inflation on our operations during the past three fiscal
years.





Future
Operating Results





We plan to place some of our larger
purchase commitments for raw materials on an annualized basis because they can
be purchased in larger quantities at reduced prices.  In general, we
attempt to limit inventory price increases by making an annual commitment, and
drawing the material either as required, or on a monthly or quarterly
basis.  Such annual commitments may reach $500,000 in 2010 and greater
in 2011 depending on sales volume increases.  The terms of payment for
such commitments are worked out with the vendor on a case-by-case basis, but in
all cases are cancelable at our discretion without penalty.





Safe
Harbor Statement under the Private Securities Litigation Reform Act of
1995





This document contains forward-looking
statements that reflect the views of management with respect to future events
and financial performance.  These forward-looking statements are
subject to certain uncertainties and other factors that could cause actual
results to differ materially from such statements.  See “Risk Factors”
above.  These uncertainties and other factors include, but are not
limited to, the words “anticipates,” “believes,” “estimates,” “expects,”
“plans,” “projects,” “targets” and similar expressions which identify
forward-looking statements.  You should not place undue reliance on
these forward-looking statements, which speak only as of the date the statements
were made.  We undertake no obligation to publicly update or revise
any forward-looking statements.





ITEM 7A.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.





Not applicable





ITEM 8.
            FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA.





Our
balance sheets as of December 31, 2009 and 2008, the related statements of
operations, stockholders’ equity and cash flows for the years ended December 31,
2009 and 2008, together with the independent certified public accountants’
report thereon appear beginning on Page F-1.





ITEM
      9.
            CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE.


None.





ITEM 9A.
            CONTROLS
      AND PROCEDURES.





Evaluation
of Disclosure Controls and Procedures





Based on
an evaluation under the supervision and with the participation of our
management, our principal executive officer and principal financial officer have
concluded that the our disclosure controls and procedures as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934,
as  amended ("Exchange Act") were effective as of December 31, 2009 to
ensure that information required to be disclosed in reports that are filed or
submitted under the Exchange Act is (i) recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission rules and forms and (ii) accumulated and communicated to our
management, including our principal executive officer and principal financial
officer, as appropriate to allow timely decisions regarding required
disclosure.




19




Inherent
Limitations Over Internal Controls





Our
internal control over financial reporting 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. Our internal control over financial reporting
includes those policies and procedures that: (i) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of our assets;  (ii) 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 are being made only in accordance
with authorizations of management and directors; and (iii) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of assets that could have a material effect on the financial
statements.





Management, including our Chief
Executive Officer and Chief Financial Officer, does not expect that our internal
controls will prevent or detect all errors and all fraud. A control system, no
matter how well designed and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of internal controls can provide absolute assurance that all control issues and
instances of fraud, if any, have been detected. Also, any evaluation of the
effectiveness of controls in future periods are subject to the risk that those
internal controls may become inadequate because of changes in business
conditions, or that the degree of compliance with the policies or procedures may
deteriorate.





Management's
Annual Report on Internal Control over Financial Reporting





Our management is responsible for
establishing and maintaining adequate internal control over financial reporting
(as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as
amended). Management conducted an evaluation of the effectiveness of our
internal control over financial reporting based on the criteria set forth in
Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission ("COSO"). Based on this evaluation,
management has concluded that our internal control over financial reporting was
not effective as of December 31, 2009. The matter involving internal controls
over financial reporting that management considered to be a material weakness
under the standards of the Public Company Accounting Oversight Board (PCAOB) was
insufficient segregation of duties consistent with control
objectives.  Management is aware of the risks associated with the lack
of segregation of duties due to the small number of employees currently working
with general administrative and financial matters.  Due to our size
and nature, segregation of all conflicting duties may not always be possible and
may not be economically feasible.  However, to the extent possible,
the initiation of transactions, the custody of assets and the recording of
transactions should be performed by separate individuals.





In order to remediate this weakness,
we will need to hire additional employees.  Although we will
periodically reevaluate this situation, at this point we consider that the risks
associated with such lack of segregation of duties and the potential benefits of
adding employees to segregate such duties are not cost
justified.  Until we are able to hire additional employees, we will
continue to report to the Audit Committee and the Board of Directors at least
monthly (and more often as necessary).  We believe this will continue
to mitigate this weakness.  This reporting includes balance sheets,
statements of operations, statements of cash flows, and other detail supporting
these statements.





Additionally,
there were no changes in our internal controls that could materially affect the
disclosure controls and procedures subsequent to the date of their
evaluation.  As a result, no corrective actions were required or
undertaken.





ITEM 9B.
            OTHER
      INFORMATION





None.




20




PART
III





ITEM
      10.
            DIRECTORS
      AND EXECUTIVE OFFICERS OF THE
REGISTRANT.





The information required by this item
is included under the captions, “Election of Directors,” “Executive Officers” and “Section 16(a) Beneficial Ownership
Reporting Compliance” in our proxy statement relating to our 2010 Annual
Meeting of Shareholders scheduled to be held on June 9, 2010, and is
incorporated herein by reference.





We have a
Business Conduct Policy applicable to all employees of
SCI.  Additionally, the Chief Executive Officer ("CEO") and all senior
financial officers, including the principal financial officer, the principal
accounting officer or controller, or any person performing a similar function
(collectively, the "Senior Financial Officers") are bound by the provisions of
our code of ethics relating to ethical conduct, conflicts of interest, and
compliance with the law.  The code of ethics is posted on our website
at http://www.sciengineeredmaterials.com/investors
/main/corpgov.htm.





We intend to satisfy the disclosure
requirement under Item 10 of Form 8-K regarding any amendment to, waiver of, any
provision of this code of ethics by posting such information on our website at
the address and location specified above.





ITEM 11.
            EXECUTIVE
      COMPENSATION.





The information required by this item
is included under the caption “Executive Compensation” in our
proxy statement relating to our 2010 Annual Meeting of Shareholders scheduled to
be held on June 9, 2010, and is incorporated herein by reference.





ITEM
      12.
            SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS.





The information required by this item
is included under the captions “Ownership of Common Stock by
Directors and Executive Officers”and “Ownership of Common Stock by
Principal Shareholders” in our proxy statement relating to our 2010
Annual Meeting of Shareholders scheduled to be held on June 9, 2010, and is
incorporated herein by reference.





ITEM 13.
            CERTAIN
      RELATIONSHIPS AND RELATED
TRANSACTIONS.





The information required by this item
is included under the caption “Certain Relationships and Related
Transactions” in our proxy statement relating to our 2010 Annual Meeting
of Shareholders scheduled to be held on June 9, 2010, and is incorporated herein
by reference.





ITEM 14.
            PRINCIPAL
      ACCOUNTANT FEES AND SERVICES.





The information required by this item
is included under the caption “Fees of the Registered independent
public accounting firm for the year ended December 31, 2009”in our proxy
statement relating to our 2010 Annual Meeting of Shareholders scheduled to be
held on June 9, 2010, and is incorporated herein by reference.




21




ITEM 15.
            EXHIBITS
      AND FINANCIAL STATEMENT SCHEDULES.





Exhibit
                
                ExhibitNumber
                
                Description3(a)
                
                Certificate
      of Second Amended and Restated Articles of Incorporation of
      Superconductive Components, Inc. (Incorporated by reference to Exhibit
      3(a) to the Company’s initial Form 10-SB, filed on September 28,
      2000)3(b)
                
                Restated
      Code of Regulations of Superconductive Components, Inc. (Incorporated by
      reference to Exhibit 3(b) to the Company’s initial Form 10-SB, filed on
      September 28, 2000)3(c)
                
                Amendment
      to Articles of Incorporation recording the change of the corporate name to
      SCI Engineered Materials, Inc.  (Incorporated by reference to
      Exhibit 3.1 to the Company’s Quarterly Report on Form 10-QSB filed
      November 7, 2007).4(a)
                
                Superconductive
      Components, Inc. 2006 Stock Incentive Plan (Incorporated by reference to
      Appendix A to the Company’s Definitive Proxy Statement for the 2006 Annual
      Meeting of Shareholders held on June 9, 2006, filed May 1,
      2006).4(b)
                
                Description
      of the Material Terms of the Stock Option Grant and Cash Bonus Plan for
      Executive Officers (Incorporated by reference to the Company’s Current
      Report on Form 8-K, dated June 19, 2006, filed June 23,
    2006)4(c)
                
                Form
      of Incentive Stock Option Agreement under the Superconductive Components,
      Inc. 2006 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1
      to the Company’s Current Report on Form 8-K dated June 19, 2006, filed
      June 23, 2006).4(d)
                
                Form
      of Non-Statutory Stock Option Agreement under the Superconductive
      Components, Inc. 2006 Stock Incentive Plan (Incorporated by reference to
      Exhibit 10.2 to the Company’s Current Report on Form 8-K dated June 19,
      2006, filed June 23, 2006).4(e)
                
                Description
      of the Material Terms of the Stock Option Grant for Executive Officers and
      Board of Directors (Incorporated by reference to the Company’s Current
      Report on Form 8-K dated January 2, 2009, filed January 6,
      2009).10(a)
                
                Employment
      Agreement entered into as of February 26, 2002, between Daniel Rooney and
      the Company (Incorporated by reference to Exhibit 10(a) to the Company’s
      Registration Statement on Form SB-2 (Registration No. 333-131605), filed
      on February 6, 2006, and amended by Pre-effective Amendment No. 1 filed
      March 23, 2006)10(b)
                
                Lease
      Agreement between Superconductive Components, Inc. and Duke Realty Ohio
      dated as of September 29, 2003, with Letter of Understanding dated
      February 17, 2004 (Incorporated by reference to Exhibit 10(a) to the
      Company’s Quarterly Report on Form 10-QSB, filed on March 31,
      2004)10(c)
                
                Fourth
      Amended and Restated 1995 Stock Option Plan (Incorporated by reference to
      Exhibit 4(a) to the Company’s Registration Statement on Form S-8
      (Registration No. 333-97583), filed on August 2,
  2002)




22




10(d)
              
              License
      Agreement with Sandia Corporation dated February 26, 1996 (Incorporated by
      reference to Exhibit 10(f) to the Company’s Form 10-SB Amendment No. 1,
      filed on January 3, 2001)10(e)
              
              Nonexclusive
      License with The University of Chicago (as Operator of Argonne National
      Laboratory) dated October 12, 1995 (Incorporated by reference to Exhibit
      10(g) to the Company’s Form 10-SB Amendment No. 1, filed on January 3,
      2001)10(f)
              
              Nonexclusive
      License with The University of Chicago (as Operator of Argonne National
      Laboratory) dated October 12, 1995 (Incorporated by reference to Exhibit
      10(h) to the Company’s Form 10-SB Amendment No. 1, filed on January 3,
      2001)10(g)
              
              Ohio
      Department of Development Third Frontier Action Fund Award dated February
      20, 2004 (Incorporated by reference to Exhibit 10(o) to the Company’s
      Annual Report on Form 10-KSB, filed on March 30, 2004)10(h)
              
              Description
      of the Material Terms of the Superconductive Components, Inc. 2005
      Executive Bonus Plan (Incorporated by reference to Exhibit 10 to the
      Company’s Current Report on Form 8-K, filed on April 20,
    2005)10(i)
              
              Form
      of Non-Statutory Stock Option Agreement Under the Superconductive
      Components, Inc. Fourth Amended and Restated 1995 Stock Option Plan
      (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report
      on Form 8-K, filed on December 22, 2005)10(j)
              
              Department
      of Energy Award dated July 21, 2005 (Incorporated by reference to Exhibit
      10(k) to the Company’s Registration Statement on Form SB-2 (Registration
      No. 333-131605), filed on February 6, 2006, and amended by Pre-effective
      Amendment No. 1 filed March 23, 2006)10(k)
              
              Subscription
      Agreement between the Company and the Estate of Edward R. Funk, dated
      October 14, 2005 (Incorporated by reference to Exhibit 10(o) to the
      Company’s Registration Statement on Form SB-2 (Registration No.
      333-131605), filed on February 6, 2006, and amended by Pre-effective
      Amendment No. 1 filed March 23, 2006)10(l)
              
              Subscription
      Agreement between the Company and the Estate of Ingeborg V. Funk, dated
      October 14, 2005 (Incorporated by reference to Exhibit 10(p) to the
      Company’s Registration Statement on Form SB-2 (Registration No.
      333-131605), filed on February 6, 2006, and amended by Pre-effective
      Amendment No. 1 filed March 23, 2006)10(m)
              
              Subscription
      Agreement between the Company and Robert H. Peitz, dated October 14, 2005
      (Incorporated by reference to Exhibit 10(q) to the Company’s Registration
      Statement on Form SB-2 (Registration No. 333-131605), filed on February 6,
      2006, and amended by Pre-effective Amendment No. 1 filed March 23,
      2006)10(n)
              
              Warrant
      to purchase common stock of Superconductive Components, Inc. issued to the
      Estate of Edward R. Funk, dated October 19, 2005 (Incorporated by
      reference to Exhibit 10(r) to the Company’s Registration Statement Form on
      SB-2 (Registration No. 333-131605), filed on February 6, 2006, and amended
      by Pre-effective Amendment No. 1 filed March 23,
  2006)




23




10(o)
              
              Warrant
      to purchase common stock of Superconductive Components, Inc. issued to the
      Estate of Ingeborg V. Funk, dated October 19, 2005 (Incorporated by
      reference to Exhibit 10(s) to the Company’s Registration Statement on Form
      SB-2 (Registration No. 333-131605), filed on February 6, 2006, and amended
      by Pre-effective Amendment No. 1 filed March 23, 2006)10(p)
              
              Warrant
      to purchase common stock of Superconductive Components, Inc. issued to
      Robert H. Peitz, effective October 19, 2005 (Incorporated by reference to
      Exhibit 10(t) to the Company’s Registration Statement on Form SB-2
      (Registration No. 333-131605), filed on February 6, 2006, and amended by
      Pre-effective Amendment No. 1 filed March 23, 2006)10(q)
              
              Conversion
      Agreement between the Company and the Estate of Edward R. Funk, dated
      October 14, 2005 (Incorporated by reference to Exhibit 10(u) to the
      Company’s Registration Statement on Form SB-2 (Registration No.
      333-131605), filed on February 6, 2006, and amended by Pre-effective
      Amendment No. 1 filed March 23, 2006)10(r)
              
              Conversion
      Agreement between the Company and the Estate of Ingeborg V. Funk, dated
      October 14, 2005 (Incorporated by reference to Exhibit 10(v) to the
      Company’s Registration Statement on Form SB-2 (Registration No.
      333-131605), filed on February 6, 2006, and amended by Pre-effective
      Amendment No. 1 filed March 23, 2006)10(s)
              
              Description
      of purchase order received from an existing customer (Incorporated by
      reference to the Company’s Current Report on Form 8-K, filed January 24,
      2007).10(t)
              
              Ohio
      Department of Development Third Frontier Advanced Energy Program Award
      (Incorporated by reference to the Company’s Current Report on Form 8-K,
      filed December 16, 2008).10(u)
              
              Description
      of material terms of Stock Option Agreements with the Company’s Executive
      Officers and Board of Directors (Incorporated by reference to the
      Company’s Current Report on Form 8-K, filed January 6,
    2009).10(v)
              
              Business
      Loan Agreement between the Company and The Huntington National Bank, dated
      as of January 13, 2009 (Incorporated by reference to the Company’s Current
      Report on Form 8-K, filed January 23, 2009).10(w)
              
              Description
      of material modification to rights of security holders of common stock
      purchase warrants set to expire in 2009 (Incorporated by reference to the
      Company’s Current Report on Form 8-K, filed May 7,
  2009).10(x)
              
              Description
      of Purchase Order received from a new customer (Incorporated by reference
      to the Company’s Current Report on Form 8-K, filed June 22,
      2009).10(y)
              
              Description
      of information received from a customer regarding customer’s intent to
      purchase material (Incorporated by reference to the Company’s Current
      Report on Form 8-K, filed September 17, 2009).10(z)
              
              Notification
      from the Ohio Department of Development Third Frontier Photovoltaic
      Program of grant to be awarded dated December 17, 2009 (Incorporated by
      reference to the Company’s Current Report on Form 8-K, filed December 22,
      2009).




24




99.1
              
              Press
      Release dated February 17, 2010, entitled “SCI Engineered Materials, Inc.,
      Reports Fourth Quarter and Full-Year 2009 Results.”23
              *
              Consent
      of Independent Registered Accounting Firm24
              *
              Powers
      of Attorney.31.1
              *
              Rule
      13a-14(a) Certification of Principal Executive Officer.31.2
              *
              Rule
      13a-14(a) Certification of Principal Financial Officer.32.1
              *
              Section
      1350 Certification of Principal Executive Officer.32.2
              *
              Section
      1350 Certification of Principal Financial
  Officer.





*  Filed
herewith





SIGNATURES





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.





SCI
      ENGINEERED MATERIALS, INC.Date:  February
      17, 2010
                
                By:
                /s/ Daniel RooneyDaniel
      Rooney, Chairman of the Board of
                  Directors,
      President and Chief Executive
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 on
the 17th day of
February 2010.





Signature
                                    
                                    Title/s/ Daniel Rooney
                                    
                                    Chairman
      of the Board of Directors, President, andChief
      Executive Officer(principal
      executive officer)/s/ Gerald S. Blaskie
                                    
                                    Vice
      President and Chief Financial OfficerGerald
      S. Blaskie
                                    
                                    (principal
      financial officer and principal accounting
                                      officer)Robert J. Baker*
                                    
                                    DirectorRobert
      J. BakerEdward W. Ungar*
                                    
                                    DirectorEdward
      W. UngarRobert H. Peitz*
                                    
                                    DirectorRobert
      H. PeitzWalter J. Doyle*
                                    
                                    DirectorWalter
      J. Doyle


*By:
                    /s/ Daniel
      RooneyDaniel
      Rooney,
Attorney-in-Fact




25




INDEX
TO FINANCIAL STATEMENTS





PageReport
      of Independent Registered Public Accounting Firm
                    F-1Balance
      Sheets
                    F-2Statements
      of Operations
                    F-4Statements
      of Shareholders’ Equity
                    F-5Statements
      of Cash Flows
                    F-6Notes
      to Financial Statements
                    F-8









Report of Independent
Registered Public Accounting Firm





To the
Board of Directors and Shareholders


SCI
Engineered Materials, Inc.


Columbus,
Ohio





We have audited the accompanying
balance sheets of SCI Engineered Materials, Inc. as of December 31, 2009 and
2008, and the related statements of operations, shareholders' equity and cash
flows for each of the two years in the period ended December 31,
2009.  These financial statements are the responsibility of the
Company's management.  Our responsibility is to express an opinion on
these financial statements based on our audits.





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 perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement.  The Company is not required to have, nor
were we engaged to perform, an audit of its internal control over financial
reporting.  Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting.  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 provide a reasonable basis for our opinion.





In our opinion, the financial
statements referred to above present fairly, in all material respects, the
financial position of SCI Engineered Materials, Inc. as of December 31, 2009 and
2008, and the results of its operations and its cash flows for each of the two
years in the period ended December 31, 2009 in conformity with accounting
principles generally accepted in the United States of America.





/s/
      MALONEY + NOVOTNY LLC


Canton,
Ohio


February
17, 2010




F-1




PART
I.  FINANCIAL INFORMATION





ITEM
1. FINANCIAL STATEMENTS





SCI
ENGINEERED MATERIALS, INC.





BALANCE
SHEETS





DECEMBER
31, 2009 AND 2008





ASSETS





2009
                
                
                2008Current
      AssetsCash
                
                $
                1,107,216
                
                
                $
                1,399,050Accounts
      receivableTrade,
      less allowance for doubtful accounts of $15,753 and
$24,700
                
                
                539,398
                
                
                
                464,016Contract
                
                
                19,714
                
                
                
                109,717Other
                
                
                11,000
                
                
                
                3,423Inventories
                
                
                1,031,777
                
                
                
                1,264,433Deferred
      taxes
                
                
                156,000
                
                
                
                -Prepaid
      expenses
                
                
                977,536
                
                
                
                42,562Total
      current assets
                
                
                3,842,641
                
                
                
                3,283,201Property
      and Equipment, at costMachinery
      and equipment
                
                
                4,933,855
                
                
                
                4,192,516Furniture
      and fixtures
                
                
                127,451
                
                
                
                107,998Leasehold
      improvements
                
                
                315,054
                
                
                
                313,951Construction
      in progress
                
                
                22,966
                
                
                
                144,6825,399,326
                
                
                
                4,759,147Less
      accumulated depreciation
                
                
                (2,868,198
                )
                
                
                (2,469,030
                )2,531,128
                
                
                
                2,290,117Other
      AssetsDeposits
                
                
                21,909
                
                
                
                29,002Intangibles
                
                
                41,358
                
                
                
                34,254Total
      other assets
                
                
                63,267
                
                
                
                63,256TOTAL
      ASSETS
                
                $
                6,437,036
                
                
                $
                5,636,574





The
accompanying notes are an integral part of these financial
statements.





F-2





SCI
ENGINEERED MATERIALS, INC.





BALANCE
SHEETS





DECEMBER
31, 2009 AND 2008





LIABILITIES AND
SHAREHOLDERS' EQUITY





2009
                    
                    
                    2008Current
      LiabilitiesCapital
      lease obligation, current portion
                    
                    $
                    363,270
                    
                    
                    $
                    285,408Note
      payable, current portion
                    
                    
                    62,394
                    
                    
                    
                    20,386Accounts
      payable
                    
                    
                    263,468
                    
                    
                    
                    249,309Accrued
      contract expenses
                    
                    
                    -
                    
                    
                    
                    52,525Customer
      deposits
                    
                    
                    1,319,455
                    
                    
                    
                    700,118Accrued
      compensation
                    
                    
                    67,863
                    
                    
                    
                    94,167Accrued
      expenses and other
                    
                    
                    210,294
                    
                    
                    
                    94,928Total
      current liabilities
                    
                    
                    2,286,744
                    
                    
                    
                    1,496,841Capital
      lease obligation, net of current portion
                    
                    
                    738,750
                    
                    
                    
                    622,769Note
      payable, net of current portion
                    
                    
                    317,219
                    
                    
                    
                    379,614Total
      liabilities
                    
                    
                    3,342,713
                    
                    
                    
                    2,499,224Commitments
      and contingencies
                    
                    
                    -
                    
                    
                    
                    -Shareholders'
      EquityConvertible
      preferred stock, Series B, 10% cumulative, nonvoting
                      no
      par value, $10 stated value, optional redemption at 103%;
                      24,297
      and 24,430 issued and outstanding respectively
                    
                    
                    371,612
                    
                    
                    
                    373,647Common
      stock, no par value, authorized 15,000,000 shares;
                      3,571,775
      and 3,560,259 shares issued and outstanding respectively
                    
                    
                    9,209,424
                    
                    
                    
                    9,180,183Additional
      paid-in capital
                    
                    
                    1,412,382
                    
                    
                    
                    985,396Accumulated
      deficit
                    
                    
                    (7,899,095
                    )
                    
                    
                    (7,401,876
                    )3,094,323
                    
                    
                    
                    3,137,350TOTAL
      LIABILITIES AND SHAREHOLDERS' EQUITY
                    
                    $
                    6,437,036
                    
                    
                    $
                    5,636,574





The
accompanying notes are an integral part of these financial
statements.





F-3





SCI
ENGINEERED MATERIALS, INC.





STATEMENTS
OF OPERATIONS





YEARS
ENDED DECEMBER 31, 2009 AND 2008





2009
                      
                      
                      2008SALES
      REVENUE
                      
                      $
                      7,004,527
                      
                      
                      $
                      9,462,863CONTRACT
      RESEARCH
                      
                      
                      1,005,708
                      
                      
                      
                      157,032TOTAL
      REVENUE
                      
                      
                      8,010,235
                      
                      
                      
                      9,619,895COST
      OF SALES REVENUE
                      
                      
                      5,311,459
                      
                      
                      
                      7,335,860COST
      OF CONTRACT RESEARCH
                      
                      
                      828,897
                      
                      
                      
                      72,558TOTAL
      COST OF REVENUE
                      
                      
                      6,140,356
                      
                      
                      
                      7,408,418GROSS
      PROFIT
                      
                      
                      1,869,879
                      
                      
                      
                      2,211,477GENERAL
      AND ADMINISTRATIVE EXPENSE
                      
                      
                      1,237,672
                      
                      
                      
                      966,979RESEARCH
      AND DEVELOPMENT EXPENSE
                      
                      
                      314,386
                      
                      
                      
                      454,424MARKETING
      AND SALES EXPENSE
                      
                      
                      647,859
                      
                      
                      
                      587,202(LOSS)
      INCOME FROM OPERATIONS
                      
                      
                      (330,038
                      )
                      
                      
                      202,872OTHER
      INCOME (EXPENSE)Interest
      income
                      
                      
                      6,394
                      
                      
                      
                      24,271Interest
      expense
                      
                      
                      (108,712
                      )
                      
                      
                      (102,763
                      )(Loss)
      gain on disposal of equipment
                      
                      
                      (45,646
                      )
                      
                      
                      2,000Financing
      expense
                      
                      
                      (76,387
                      )
                      
                      
                      -Miscellaneous,
      net
                      
                      
                      (1,830
                      )
                      
                      
                      (1,830
                      )(226,181
                      )
                      
                      
                      (78,322
                      )(LOSS)
      INCOME BEFORE PROVISION FOR INCOME TAX
                      
                      
                      (556,219
                      )
                      
                      
                      124,550INCOME
      TAX BENEFIT
                      
                      
                      (59,000
                      )
                      
                      
                      -NET
      (LOSS) INCOME
                      
                      
                      (497,219
                      )
                      
                      
                      124,550DIVIDENDS
      ON PREFERRED STOCK
                      
                      
                      (24,430
                      )
                      
                      
                      (24,373
                      )(LOSS)
      INCOME APPLICABLE TO COMMON SHARES
                      
                      $
                      (521,649
                      )
                      
                      $
                      100,177EARNINGS
      PER SHARE - BASIC AND DILUTED(Note
      2)NET
      (LOSS) INCOME PER COMMON SHARE BEFOREDIVIDENDS
      ON PREFERRED STOCKBasic
                      
                      $
                      ($0.14
                      )
                      
                      $
                      0.04Diluted
                      
                      $
                      ($0.14
                      )
                      
                      $
                      0.03NET
      (LOSS) INCOME PER COMMON SHARE AFTERDIVIDENDS
      ON PREFERRED STOCKBasic
                      
                      $
                      ($0.15
                      )
                      
                      $
                      0.03Diluted
                      
                      $
                      ($0.15
                      )
                      
                      $
                      0.02WEIGHTED
      AVERAGE SHARES OUTSTANDINGBasic
                      
                      
                      3,562,960
                      
                      
                      
                      3,530,486Diluted
                      
                      
                      3,562,960
                      
                      
                      
                      4,035,065





The
accompanying notes are an integral part of these financial
statements.





F-4





SCI
ENGINEERED MATERIALS, INC.





STATEMENTS
OF SHAREHOLDERS' EQUITY





YEARS ENDED DECEMBER 31,
2009 AND 2008





Convertible
                  
                  
                  
                  
                  
                  AdditionalPreferred
      Stock,
                  
                  
                  Common
                  
                  
                  Paid-In
                  
                  
                  AccumulatedSeries
      B
                  
                  
                  Stock
                  
                  
                  Capital
                  
                  
                  Deficit
                  
                  
                  TotalBalance
      12/31/07
                  
                  $
                  375,861
                  
                  
                  $
                  9,061,378
                  
                  
                  $
                  987,840
                  
                  
                  $
                  (7,526,426
                  )
                  
                  $
                  2,898,653Accretion
      of cumulative dividends
                  
                  
                  24,373
                  
                  
                  
                  -
                  
                  
                  
                  (24,373
                  )
                  
                  
                  -
                  
                  
                  
                  -Common
      stock conversion from preferred stock (Note 8)
                  
                  
                  (2,021
                  )
                  
                  
                  2,021
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Stock
      based compensation expense (Note 2H)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  21,929
                  
                  
                  
                  -
                  
                  
                  
                  21,929Proceeds
      from exercise of stock warrants (Note 8)
                  
                  
                  -
                  
                  
                  
                  68,021
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  68,021Proceeds
      from exercise of stock options (Note 8)
                  
                  
                  -
                  
                  
                  
                  10,250
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  10,250Private
      placement and SB-2 registration
                  
                  
                  -
                  
                  
                  
                  (16,906
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (16,906
                  )Common
      stock issued
                  
                  
                  -
                  
                  
                  
                  55,419
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  55,419Payment
      of cumulative dividends
                  
                  
                  (24,566
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (24,566
                  )Net
      income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  124,550
                  
                  
                  
                  124,550Balance
      12/31/08
                  
                  $
                  373,647
                  
                  
                  $
                  9,180,183
                  
                  
                  $
                  985,396
                  
                  
                  $
                  (7,401,876
                  )
                  
                  $
                  3,137,350Accretion
      of cumulative dividends
                  
                  
                  24,430
                  
                  
                  
                  -
                  
                  
                  
                  (24,430
                  )
                  
                  
                  -
                  
                  
                  
                  -Common
      stock conversion from preferred stock (Note 8)
                  
                  
                  (2,035
                  )
                  
                  
                  2,035
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Stock
      based compensation expense (Note 2H)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  451,416
                  
                  
                  
                  -
                  
                  
                  
                  451,416Proceeds
      from exercise of stock options (Note 8)
                  
                  
                  -
                  
                  
                  
                  21,206
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  21,206Common
      stock issued
                  
                  
                  -
                  
                  
                  
                  6,000
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  6,000Payment
      of cumulative dividends
                  
                  
                  (24,430
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (24,430
                  )Net
      loss
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (497,219
                  )
                  
                  
                  (497,219
                  )Balance
      12/31/09
                  
                  $
                  371,612
                  
                  
                  $
                  9,209,424
                  
                  
                  $
                  1,412,382
                  
                  
                  $
                  (7,899,095
                  )
                  
                  $
                  3,094,323





The
accompanying notes are an integral part of these financial
statements.





F-5





SCI ENGINEERED MATERIALS, INC.





STATEMENTS
OF CASH FLOWS





YEARS
ENDED DECEMBER 31, 2009 AND 2008





2009
                    
                    
                    2008CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      (loss) income
                    
                    $
                    (497,219
                    )
                    
                    $
                    124,550Adjustments
      to reconcile net (loss) income to net cash provided by operating
      activities:Depreciation
      and accretion
                    
                    
                    443,800
                    
                    
                    
                    371,125Amortization
                    
                    
                    3,088
                    
                    
                    
                    3,088Stock
      based compensation
                    
                    
                    381,030
                    
                    
                    
                    77,348Financing
      expense related to warrant extension
                    
                    
                    76,387
                    
                    
                    
                    -Increase
      in deferred tax asset
                    
                    
                    (156,000
                    )
                    
                    
                    -Loss
      (gain) on sale of equipment
                    
                    
                    45,646
                    
                    
                    
                    (2,000
                    )Increase
      (decrease) in inventory reserve
                    
                    
                    554
                    
                    
                    
                    (33,116
                    )Changes
      in allowance for doubtful accounts
                    
                    
                    (8,947
                    )
                    
                    
                    -Changes
      in operating assets and liabilities:(Increase)
      decrease in assets:Accounts
      receivable
                    
                    
                    15,991
                    
                    
                    
                    (291,430
                    )Inventories
                    
                    
                    232,102
                    
                    
                    
                    (474,318
                    )Prepaid
      expenses
                    
                    
                    (934,973
                    )
                    
                    
                    (21,414
                    )Other
      assets
                    
                    
                    (3,099
                    )
                    
                    
                    (18,503
                    )Increase
      in liabilities:Accounts
      payable
                    
                    
                    14,159
                    
                    
                    
                    88,841Accrued
      expenses and customer deposits
                    
                    
                    649,246
                    
                    
                    
                    632,867Total
      adjustments
                    
                    
                    758,984
                    
                    
                    
                    332,488Net
      cash provided by operating activities
                    
                    
                    261,765
                    
                    
                    
                    457,038CASH
      FLOWS FROM INVESTING ACTIVITIESProceeds
      on sale of equipment
                    
                    
                    -
                    
                    
                    
                    2,000Purchases
      of property and equipment
                    
                    
                    (168,132
                    )
                    
                    
                    (142,332
                    )Net
      cash used in investing activities
                    
                    
                    (168,132
                    )
                    
                    
                    (140,332
                    )CASH
      FLOWS FROM FINANCING ACTIVITIESProceeds
      from exercise of common stock options
                    
                    
                    21,206
                    
                    
                    
                    10,250Proceeds
      from exercise of common stock warrants
                    
                    
                    -
                    
                    
                    
                    68,021Proceeds
      from note payable
                    
                    
                    -
                    
                    
                    
                    400,000Payment
      for accumulated dividends on preferred stock
                    
                    
                    (24,430
                    )
                    
                    
                    (24,566
                    )Payments
      related to registration of common stock
                    
                    
                    -
                    
                    
                    
                    (16,906
                    )Principal
      payments on capital lease obligations and note payable
                    
                    
                    (382,243
                    )
                    
                    
                    (536,541
                    )Net
      cash used in financing activities
                    
                    
                    (385,467
                    )
                    
                    
                    (99,742
                    )





The
accompanying notes are an integral part of these financial
statements.





F-6





SCI ENGINEERED MATERIALS, INC.





STATEMENTS
OF CASH FLOWS (CONTINUED)





YEARS
ENDED DECEMBER 31, 2009 AND 2008





2009
                
                
                2008NET
      (DECREASE) INCREASE IN CASH
                
                $
                (291,834
                )
                
                $
                216,964CASH - Beginning of
      period
                
                
                1,399,050
                
                
                
                1,182,086CASH - End of
      period
                
                $
                1,107,216
                
                
                $
                1,399,050SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATIONCash
      paid during the years for:Interest,
      net
                
                $
                108,712
                
                
                $
                102,763Income
      taxes
                
                $
                -
                
                
                $
                -SUPPLEMENTAL
      DISCLOSURES OF NONCASH FINANCING ACTIVITIESProperty
      and equipment purchased by capital lease
                
                $
                555,700
                
                
                $
                338,571Property
      and equipment accrued asset retirement obligation increase
                
                $
                6,624
                
                
                $
                3,312Financing
      expense related to warrant expiration date extension
                
                $
                76,387
                
                
                $
                -SUPPLEMENTAL
      DISCLOSURES OF NONCASH OPERATING ACTIVITIESStock
      based compensation expense
                
                $
                381,030
                
                
                $
                77,348





The
accompanying notes are an integral part of these financial
statements.





F-7




SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note 1.
            Business
      Organization and Purpose





SCI
Engineered Materials, Inc. (“SCI” or the “Company”), formerly Superconductive
Components, Inc., an Ohio corporation, was incorporated in 1987.  The
Company manufactures ceramic and metal sputtering targets for a variety of
industrial applications including: Photonics, Thin Film Solar, Thin Film
Battery, Semiconductor, and, to a lesser extent High Temperature Superconductive
(HTS) materials.  Photonics currently represents the Company’s largest
market for its targets.  Thin Film Solar is an industry that is
exhibiting rapid growth.  Thin Film Battery is a developing market
where manufacturers of batteries use the Company’s targets to produce very small
power supplies with small quantities of stored energy.  Semiconductor
is a developing market.





Note 2.
            Summary
      of Significant Accounting Policies





A.
            Inventories
      - Inventories are stated at the lower of cost or market on an acquired or
      internally produced lot basis, and consist of raw materials,
      work-in-process and finished goods.  Cost includes material,
      labor, freight and applied overhead.  Inventory reserves are
      established for obsolete inventory and excess inventory quantities based
      on management’s estimate of net realizable value.  The inventory
      reserve increased $554 during 2009 and decreased $33,116 during
      2008.





The
Company enters into cancelable purchase commitment arrangements with some
suppliers.  Estimated purchase commitments to these suppliers
approximate $769,000 and $237,000 at December 31, 2009 and 2008,
respectively.  The Company can cancel these commitments at the
Company’s discretion without penalty.





B.
            Property
      and Equipment - Property and equipment are carried at
      cost.  Depreciation is provided on the straight-line method
      based on the estimated useful lives of the assets for financial reporting
      purposes and allowable accelerated methods for tax
      purposes.  Useful lives range from ten years on certain
      furniture and fixtures and leasehold improvements to three years on
      computer equipment.  Depreciation and accretion expense totaled
      $443,800 and $371,125 for the years ended December 31, 2009 and 2008,
      respectively.  Expenditures for renewals and betterments are
      capitalized and expenditures for repairs and maintenance are charged to
      operations as incurred.  Construction in process at December 31,
      2009, consists primarily of two pieces of equipment that are expected to
      be placed in service in the first quarter of 2010 at a total cost of
      approximately $23,000.  Construction in process at December 31,
      2008, consists primarily of two pieces of equipment that was placed in
      service in January 2009 at a total cost of approximately
      $150,000.





Long-lived
      assets are reviewed for impairment whenever events or changes in
      circumstances indicate that the carrying amount may not be
      recoverable.  If the fair value is less than the carrying amount
      of the asset, a loss is recognized for the
      difference.  Equipment with a net book value of approximately
      $44,000 was considered impaired, and a loss was recognized in the fourth
      quarter of 2009.





C.
            Research
      and Development - Research and development costs are expensed as
      incurred.  Research and development expenses for the years ended
      December 31, 2009 and 2008 were $314,386 and $454,424,
      respectively.  The decrease was due to continued contractual
      research related to Small Business Innovation Research projects and Third
      Frontier Programs.  These costs were recognized as Cost of
      Contract Research.




F-8




SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note 2.
            Summary
      of Significant Accounting Policies
(Continued)





D.
            Equipment
      - In 2004, the Company received funds of $517,935 from the Ohio Department
      of Development’s Third Frontier Action Fund (TFAF) for the purchase of
      equipment related to the grant’s purpose.  In a separate
      contract with the Department of Energy the Company received $27,500 for
      the purchase of equipment related to the contract’s
      purpose.  The Company has elected to record the funds disbursed
      as a contra asset; therefore, the assets are not reflected in the
      Company’s financial statements.  As assets were purchased, the
      liability initially created when the cash was received was reduced with no
      revenue recognized or fixed asset recorded on the balance
      sheet.  As of December 31, 2009, the Company had disbursed the
      entire amount received.  The grant and contract both provide
      that as long as the Company performs in compliance with the
      grant/contract, the Company retains the rights to the
      equipment.  The grant was completed in January
      2009.  The Company was in compliance with the requirements and
      retained the equipment.





E.
            Licenses
      - The Company has secured licenses to produce various superconductive
      materials for periods up to the expiration of the applicable
      patents.  The license fees, included in “Other Assets” on the
      balance sheet, are being amortized over the expected life of the agreement
      or applicable patent, which is seventeen years.  Cost and
      accumulated amortization of licenses at December 31, 2009 were $21,000 and
      $17,748, respectively.  Cost and accumulated amortization of
      licenses at December 31, 2008 were $21,000 and $16,489,
      respectively.  Amortization expense was $1,259 for the years
      ended December 31, 2009, and 2008.  Amortization expense is
      estimated to be $1,259 for each of the next two years and $734 in
      2012.





F.
            Patent
      - The Company has secured patents for manufacturing processes used in its
      operations.  Costs incurred to secure the patents have been
      capitalized, included in “Other Assets” on the balance sheet, and are
      being amortized over the life of the patents.  Cost and
      accumulated amortization of the patents at December 31, 2009 were $56,201
      and $18,096 respectively.  Cost and accumulated amortization of
      the patents at December 31, 2008 were $46,009 and $16,266
      respectively.  Amortization expense was $1,830 for the years
      ended December 31, 2009 and 2008.  Amortization expense is
      estimated to be at least $2,300 for each of the next five years due to the
      amortization of an additional patent which had cost at December 31, 2009
      of $19,728 and was applied for in January
2009.





G.
            Income
      Taxes - Income taxes are provided for by utilizing the asset and liability
      method which requires the recognition of deferred tax assets and
      liabilities for the expected future tax consequences of temporary
      differences between the carrying amounts and the tax bases of assets and
      liabilities using presently enacted tax rates.  Deferred tax
      assets are recognized for net operating loss carryforwards, reduced by a
      valuation allowance which   is established when “it is more
      likely than not” that some portion or all of the deferred tax assets will
      not be recognized.




F-9




SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note 2.
            Summary
      of Significant Accounting Policies
(Continued)





H.
              Stock
      Based Compensation - Compensation cost recognized in 2009 and 2008
      includes compensation cost for all stock-based awards granted on or
      subsequent to January 1, 2006, based on the grant date fair value
      estimated in accordance with the Stock Compensation Topic of the FASB
      Accounting Standards Codification.  Non cash stock based
      compensation costs were $381,030 and $77,348 for the year ended December
      31, 2009 and 2008, respectively.   On January 2, 2009, the
      Stock Option and Compensation Committee (the “Committee”) of the Board of
      Directors of the Company approved the grant of options to purchase a total
      of 450,000 shares of the Company’s common stock, effective January 2,
      2009, to the Company’s Chief Executive Officer and three other executive
      officers.  The Committee also approved the grant of options to
      purchase 90,000 shares to the four non-employee board
      members.  Pursuant to the terms of the agreements, the options
      have an exercise price of $6.00 per share, the closing price of the
      Company’s common stock as reported on the OTC Bulletin Board regulated
      quotation service on January 2, 2009.  The four non-employee
      board members each received compensation of 1,819 shares of the Company’s
      common stock and $5,000 in
2008.





I.
            Net
      Income Per Common Share - Net income per common share amounts are based on
      the weighted average number of shares
  outstanding.





J 
      .
              Statements
      of Cash Flows - For purposes of the statements of cash flows, the Company
      considers all highly liquid investments purchased with maturity of three
      months or less to be cash.  No such investments were purchased
      in 2008 and 2009.





K.
            Concentrations
      of Credit Risk - The Company’s cash balances, which are at times in excess
      of federally insured levels, are maintained at a large regional bank and a
      global investment banking group, and are continually monitored to minimize
      the risk of loss.  The Company grants credit to most customers,
      who are varied in terms of size, geographic location and financial
      strength. Customer balances are continually monitored to minimize the risk
      of loss.





The
      Company had four major customers in 2009 and 2008, which accounted for
      revenue of approximately $4,200,000 and $7,000,000, respectively. These
      customers totaled approximately $372,000 and $210,000 of the trade
      accounts receivable at December 31, 2009 and 2008, respectively. The
      largest customer represented approximately 25% of total revenues in 2009
      and over 47% of total revenues in
2008.





L 
      .
              Use
      of Estimates - The preparation of financial statements in conformity with
      accounting principles generally accepted in the United States of America
      requires management to make estimates and assumptions that affect the
      reported amounts of assets and liabilities and disclosure of contingent
      assets and liabilities at the date of the financial statements and the
      reported amounts of revenues and expenses during the reporting
      period.  Actual results could differ from those
      estimates.





M.
            Fair
      Value - The estimated fair value of amounts reported in the financial
      statements have been determined using available market information and
      valuation methodologies, as applicable (see Note
  12).





F-10





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS








Note 2.
              Summary of Significant
      Accounting Policies (Continued)N.
              Revenue
      Recognition - Revenue from product sales is recognized upon shipment to
      customers.  Provisions for discounts and rework costs for
      returns are established when products are shipped based on historical
      experience.  Customer deposits represent cash received in
      advance of revenue earned.  Revenue from contract research
      provided for third parties is recognized on the percentage of completion
      method.





O.
              Accounts
      Receivable - The Company extends unsecured credit to customers under
      normal trade agreements, which require payment within 30
      days.  Accounts greater than 90 days past due, which amounted to
      $0 as of December 31, 2009 and 2008, are considered
      delinquent.  The Company does not charge interest on delinquent
      trade accounts receivable.  Accounts greater than one year past
      due are placed on non-accrual status.  Unless specified by the
      customer, payments are applied to the oldest unpaid
      invoice.  Accounts receivable are presented at the amount
      billed.





Management
estimates an allowance for doubtful accounts, which was $15,753 and $24,700 as
of December 31, 2009 and 2008, respectively.  The estimate is based
upon management’s review of delinquent accounts and an assessment of the
Company’s historical evidence of collections.  Bad debt expense was $0
for the years ended December 31, 2009 and 2008. Specific accounts are charged
directly to the reserve when management obtains evidence of a customer’s
insolvency or otherwise determines that the account is
uncollectible.  Charge-offs of specific accounts for the years ended
December 31, 2009 and 2008 totaled $8,947 and $0, respectively.





P.
              Intangible
      Assets - The Company accounts for Intangible Assets in accordance with the
      Intangible Assets Topic of the FASB Standards
      Codification.  This topic requires certain intangible assets to
      be tested for impairment under certain circumstances, and written off when
      impaired, rather than being amortized as previous standards
      required.  There were no impairment adjustments for the years
      ended December 31, 2009 and
2008.





Q.
            Recently
      Issued Accounting Standards
      -





In June
2009, the Financial Accounting Standards Board (FASB) issued Statement No. 168,
The FASB Accounting Standards Codification and the Hierarchy of Generally
Accepted Accounting Principles (SFAS 168).  SFAS 168 became the single
source of authoritative nongovernmental U.S. generally accepted accounting
principles (GAAP), superseding existing FASB, American Institute of Certified
Public Accountants (AICPA), Emerging Issues Task Force (EITF), and related
accounting literature.  SFAS 168 reorganized the thousands of GAAP
pronouncements into roughly 90 accounting topics and displays them using a
consistent structure.  Also included is relevant Securities and
Exchange Commission guidance organized using the same topical structure in
separate sections.  SFAS 168 was effective for financial statements
issued for reporting periods that ended after September 15,
2009.  This had an impact on the Company’s financial statements since
all references to authoritative accounting literature is now referenced in
accordance with SFAS 168.


F-11





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      2.
            Summary
      of Significant Accounting Policies
(Continued)




The
Subsequent Events Topic of the FASB Accounting Standards Codification was issued
in May 2009 and is intended to establish general standards of accounting for and
disclosures of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. This topic
requires the disclosure of the date through which an entity has evaluated
subsequent events and the basis for that date. The Company has evaluated
subsequent events through the date of this report and there are none except
those listed in Note 14.





The Fair
Value Measurements Topic of the FASB Accounting Standards Codification became
effective for the Company beginning on January 1, 2008. This topic defines fair
value, establishes a framework for measuring fair value, and expands disclosures
about fair value measurements. This topic establishes a fair value hierarchy
that distinguishes between valuations obtained from sources independent of the
entity and those from the entity’s own unobservable inputs that are not
corroborated by observable market data. It expands disclosures about the use of
fair value to measure assets and liabilities in interim and annual periods
subsequent to initial recognition. The disclosures focus on the inputs used to
measure fair value and for recurring fair value measurements using significant
unobservable inputs, the effect of the measurements on earnings or changes in
net assets for the period. The Company adopted this topic on January 1, 2008 and
it did not have a material impact on the financial statements.  The
Company has deferred the application of this topic related to non-financial
assets and liabilities.





The Fair
Value Option for Financial Assets and Financial LiabilitiesTopic of the FASB
Accounting Standards Codification became effective for the Company beginning on
January 1, 2008. This topic provides entities with an option to report selected
financial assets and liabilities at fair value, with the objective to reduce
both the complexity in accounting for financial instruments and the volatility
in earnings caused by measuring related assets and liabilities
differently.  Adoption on January 1, 2008 did not have a material
effect on the Company since the Company did not elect to measure any financial
assets or liabilities at fair value.




Note
      3.
            Inventories





Inventories consist of the following at
December 31:





2009
                  
                  
                  2008Raw
      materials
                  
                  $
                  371,060
                  
                  
                  $
                  299,750Work-in-process
                  
                  
                  506,288
                  
                  
                  
                  754,097Finished
      goods
                  
                  
                  204,026
                  
                  
                  
                  259,6291,081,374
                  
                  
                  
                  1,313,476Less
      reserve for obsolete inventory
                  
                  
                  49,597
                  
                  
                  
                  49,043$
                  1,031,777
                  
                  
                  $
                  1,264,433


F-12





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      4.
            Note
      Payable





During
the third quarter of 2006, the Company met with the Development Financing
Advisory Council (DFAC) of the Ohio Department of Development (ODOD) and applied
for a loan from the Innovation Ohio Loan Fund.   The Company was
subsequently approved for a 166 Direct Loan from the ODOD in the amount of
$400,000.  These funds were received in July of 2008.  The
proceeds were used to reduce the balance on outstanding capital lease
obligations.  The term of the loan is 84 months at an interest rate of
3%. There is also a one-quarter percent annual servicing fee to be charged
monthly on the outstanding principal balance.  During each of the
first 12 months the Company made only monthly servicing fee and interest
payments per the loan agreement.  During months 13 through 84, the
Company will make monthly servicing fee, interest and principal
payments.  The loan principal balance will be fully amortized over the
last 72 months.  The Note is secured by a Security Agreement granting
the Lender a security interest in the project equipment.  The future
minimum payment, year by year, with the present value of such payments, as of
December 31, 2009, is as follows:





2010
                  
                  $
                  73,8082011
                  
                  
                  73,6492012
                  
                  
                  73,4862013
                  
                  
                  73,3192014
                  
                  
                  73,1462015
                  
                  
                  48,665Total
      minimum note payments
                  
                  
                  416,073Less
      amount representing interest
                  
                  
                  36,460Present
      value of minimum note payments
                  
                  
                  379,613Less
      current portion
                  
                  
                  62,394Long-term
      note payable obligation
                  
                  $
                  317,219





On
December 14, 2009, the Company issued a Promissory Note dated as of December 14,
2009, to The Huntington National Bank, as Lender, pursuant to a Business Loan
Agreement dated as of December 14, 2009.  The Note is secured by a
Commercial Security Agreement granting the Lender a security interest in the
Company’s inventory, equipment and accounts.  This Note replaces the
Note previously signed on January 13, 2009 which matured on January 1,
2010.  As of December 31, 2009 there was no outstanding
balance.





Among
other items, the Note provides for the following:





·
            At
      no time shall the outstanding balance of the principal sum of the
      Revolving Loan exceed the lesser of (1) $500,000 or (2) an amount equal to
      the sum of 80% of Eligible Accounts plus the lesser of (A) 50% of Eligible
      inventory or (B) $200,000.





·
            Interest
      on the Note is subject to change from time to time based on changes in an
      independent index, which is the LIBO rate.  The index at the
      inception of the Note was 0.235% per annum.  The interest rate
      to be applied to the unpaid principal balance during this Note will be at
      a rate of 2.75 percentage points over the
index.





·
            All
      accrued interest is payable monthly.  The outstanding principal
      and accrued interest owed on the Note matures on January 15,
      2011.


F-13


SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      5.
            Lease
      Obligations





Operating





The
      Company leases its facilities and certain office equipment under
      agreements classified as operating leases expiring at various dates
      through 2015.  Rent expense which includes various monthly
      rentals for the years ended December 31, 2009 and 2008, totaled $149,230
      and $141,798, respectively.  Future minimum lease payments at
      December 31, 2009 are as follows:





2010
                      
                      $
                      112,6662011
                      
                      
                      112,3912012
                      
                      
                      112,0042013
                      
                      
                      112,0042014
                      
                      
                      71,4692015
                      
                      
                      1,600$
                      522,134





Capital





The
      Company also leases certain equipment under capital leases.  The
      future minimum lease payment, by year, with the present value of such
      payments, as of December 31, 2009 is as
follows:





2010
                  
                  $
                  430,0642011
                  
                  
                  406,0022012
                  
                  
                  237,9482013
                  
                  
                  151,0382014
                  
                  
                  6,844Total
      minimum lease payments
                  
                  
                  1,231,896Less
      amount representing interest
                  
                  
                  129,876Present
      value of minimum lease payments
                  
                  
                  1,102,020Less
      current portion
                  
                  
                  363,270Long-term
      capital lease obligations
                  
                  $
                  738,750


F-14





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      5.
            Lease
      Obligations (continued)





The
equipment under capital lease at December 31 is included in the accompanying
balance sheet under the following captions:





2009
                  
                  
                  2008Machinery
      and equipment
                  
                  $
                  1,985,901
                  
                  
                  $
                  1,544,263Less
      accumulated depreciation
                  
                  
                  217,589
                  
                  
                  
                  328,182Net
      book value
                  
                  $
                  1,768,312
                  
                  
                  $
                  1,216,081





These
assets are amortized over three to ten years using the straight-line method and
amortization is included in depreciation expense.





Note 6.
            Purchase
      Commitments





Equipment
      purchases commitments approximated $140,000 at December 31, 2009 and
      $468,000 at December 31, 2008.





In
      addition, estimated purchase commitments for inventories approximated
      $769,000 and $237,000 (see Note 2A) at December 31, 2009 and
      2008.





Note
      7.
            Concentrations
      - Supplier





At
December 31, 2009 the Company had a prepaid expense of approximately $949,000 to
a supplier for the purchase of raw material.  The Company is confident the
supplier, with revenues of several billion dollars, will continue to deliver the
raw material as agreed upon.





Note
      8.
            Common
      and Preferred Stock





Common
Stock





10,250
stock options were exercised during 2009 resulting in proceeds of
$21,206.  The exercise price for these options ranged from $1.55 to
$2.125.





In 2008,
proceeds of $10,250 were received from the exercising of 7,500
options.  The exercise price for these options ranged from $1.00 to
$1.50.  Proceeds from 68,021 warrants exercised were
$68,021.


F-15





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      8.
            Common
      and Preferred Stock (continued)





Preferred
Stock





Shares of
preferred stock authorized at December 31, 2009 and 2008 and outstanding at
December 31, 2009 were as follows:


Shares
                    
                    
                    SharesAuthorized
                    
                    
                    OutstandingCumulative
      Preferred Stock
                    
                    
                    10,000
                    
                    
                    
                    -Voting
      Preferred Stock
                    
                    
                    125,000
                    
                    
                    
                    -Non-Voting
      Preferred Stock
                    
                    
                    125,000
                    (a)
                    
                    
                    24,297
                    (b)





(a)
            Includes
      700 shares of Series A Preferred Stock and 100,000 shares of Series B
      Preferred Stock authorized for
issuance.





(b)
            Series
      B Preferred Stock outstanding at December 31, 2008 was 24,430
      shares.





A
shareholder converted 133 shares of Series B Preferred Stock into 266 shares of
common stock in 2009.  Shareholders converted 136 shares of Series B
Preferred Stock into 272 shares of common stock during 2008.





In
January 1996, the Company completed an offering of 70,000 shares of $10 stated
value 1995 Series B 10% non-voting convertible preferred stock.  The
shares are convertible to common shares at the rate of $5.00 per
share.  At the Company’s option, the Series B shares are redeemable at
103% of the stated value plus the amount of any accrued and unpaid cash
dividends.





During
2009, a Series B cash dividend of $24,430 was paid to shareholders of record as
of December 31, 2008.  During 2008, a Series B cash dividend of
$24,566 was paid to shareholders of record as of December 31,
2007.  At December 31, 2009 and 2008 the Company had accrued dividends
on Series B preferred stock of $121,793 and $122,018,
respectively.  These amounts are included in convertible preferred
stock, Series B on the balance sheet at December 31, 2009 and 2008.





Earnings Per
Share





Basic
      income per share is calculated as income available to common stockholders
      divided by the weighted average of common shares
      outstanding.  Diluted earnings per share is calculated as
      diluted income available to common stockholders divided by the diluted
      weighted average number of common shares.  Diluted weighted
      average number of common shares has been calculated using the treasury
      stock method for Common Stock equivalents, which includes Common Stock
      issuable pursuant to stock options and Common Stock
    warrants.


F-16





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      8.
            Common
      and Preferred Stock (continued)





Following
      is a summary of preferred stock, Series B, employee and director stock
      options and warrants, at December 31, 2009 and
  2008.





December
      31,
                            
                            
                            December
      31,2009
                            
                            
                            2008Options
                            
                            
                            1,115,750
                            
                            
                            
                            596,250Warrants
                            
                            
                            557,057
                            
                            
                            
                            557,057Preferred
      Series B
                            
                            
                            24,297
                            
                            
                            
                            24,4301,697,104
                            
                            
                            
                            1,177,737





The
following is provided to reconcile the earnings per share
calculations:





2009
                  
                  
                  2008(Loss)
      Income applicable to common shares
                  
                  $
                  (521,649
                  )
                  
                  $
                  100,177Weighted
      average common shares outstanding - basic
                  
                  
                  3,562,960
                  
                  
                  
                  3,530,486Effect
      of dilutions - stock options and warrants
                  
                  
                  -
                  
                  
                  
                  504,579Weighted
      average shares outstanding - diluted
                  
                  
                  3,562,960
                  
                  
                  
                  4,035,065





Note
      9.
            Stock
      Option Plans





On June
9, 2006, shareholders approved the Superconductive Components, Inc. 2006 Stock
Incentive Plan (the “2006 Plan”), which replaced the 1995 Stock Option Plan
(“the 1995 Plan”).  The Company adopted the 2006 Plan as incentive to
key employees, directors and consultants under which options to purchase up to
600,000 shares of the Company’s common stock may be granted, subject to the
execution of stock option agreements.  Incentive stock options may be
granted to key employees of the Company and non-statutory options may be granted
to directors who are not employees and to consultants and advisors who render
services to the Company.  Options may be exercised for periods up to
10 years from the date of grant at prices not less than 100% of fair market
value on the date of grant. As of December 31, 2009 there were 586,500 stock
options outstanding from the 2006 Plan which expire at various dates through
January 2, 2019.  On September 29, 1995, the Company adopted the 1995
Stock Option Plan (the “1995 Plan”) as incentive to key employees, directors and
consultants.  As of December 31, 2009 there were 529,250 stock options
outstanding from the 1995 Plan which expire at various dates through December
16, 2015. The Company adopted the 1995 Plan as incentive to key employees,
directors and consultants under which options to purchase up to 900,000 shares
of the Company’s common stock may be granted, subject to the execution of stock
option agreements.  All outstanding common stock equivalents were
anti-dilutive for the twelve months ended December 31, 2009 due to the net
loss.


F-17





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      9.
            Stock
      Option Plans (continued)





The
cumulative status at December 31, 2009 and 2008 of options granted and
outstanding, as well as options which became exercisable in connection with the
Stock Option Plans is summarized as follows:





Employee Stock
Options


WeightedAverageStock Options
                  
                  
                  Exercise PriceOutstanding
      at December 31, 2007
                  
                  
                  343,250
                  
                  
                  $
                  2.08Granted
                  
                  
                  21,000
                  
                  
                  
                  3.10Exercised
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  (1,500
                  )
                  
                  
                  3.10Outstanding
      at December 31, 2008
                  
                  
                  362,750
                  
                  
                  $
                  2.14Granted
                  
                  
                  450,000
                  
                  
                  
                  6.00Exercised
                  
                  
                  (6,250
                  )
                  
                  
                  2.03Forfeited
                  
                  
                  (10,250
                  )
                  
                  
                  3.05Outstanding
      at December 31, 2009
                  
                  
                  796,250
                  
                  
                  $
                  4.31Shares
      exercisable at December 31, 2008
                  
                  
                  321,050
                  
                  
                  $
                  2.00Shares
      exercisable at December 31, 2009
                  
                  
                  369,325
                  
                  
                  $
                  2.52





Non-Employee Director Stock
Options


WeightedAverageStock Options
                  
                  
                  Exercise PriceOutstanding
      at December 31, 2007
                  
                  
                  241,000
                  
                  
                  $
                  2.51Granted
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  (7,500
                  )
                  
                  
                  1.37Expired
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      at December 31, 2008
                  
                  
                  233,500
                  
                  
                  
                  2.54Granted
                  
                  
                  90,000
                  
                  
                  
                  6.00Exercised
                  
                  
                  (4,000
                  )
                  
                  
                  2.13Expired
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      at December 31, 2009
                  
                  
                  319,500
                  
                  
                  $
                  3.52Shares
      exercisable at December 31, 2008
                  
                  
                  233,500
                  
                  
                  $
                  2.54Shares
      exercisable at December 31, 2009
                  
                  
                  259,500
                  
                  
                  $
                  2.95


F-18





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      9.
            Stock
      Option Plans (continued)





Exercise
prices range from $1.00 to $6.00 for options at December 31,
2009.  The weighted average option price for all options outstanding
was $4.08 with a weighted average remaining contractual life of 5.8 years at
December 31, 2009.  The weighted average option price for all options
outstanding was $2.30 with a weighted average remaining contractual life of 4.6
years at December 31, 2008.




The
weighted average fair values at date of grant for options granted during 2009
and 2008 was $3.84 and $2.83, respectively, and was estimated using the
Black-Scholes option valuation model with the following weighted average
assumptions:





2009
                  
                  
                  2008Expected
      life in years
                  
                  
                  9.2
                  
                  
                  
                  10.0Interest
      rate
                  
                  
                  2.5
                  %
                  
                  
                  5.0
                  %Volatility
                  
                  
                  56.02
                  %
                  
                  
                  100.65
                  %Dividend
      yield
                  
                  
                  0
                  %
                  
                  
                  0
                  %





Note
      10.
            Warrants
      Issued and Vested





The
cumulative status at December 31, 2009 and 2008 of warrants issued and vested is
summarized as follows:





Issue
                  
                  
                  Expiration
                  
                  
                  WarrantIssued
                  
                  Vested
                  
                  Consideration
                  
                  Date
                  
                  
                  Date
                  
                  
                  Price150,000
                  
                  
                  150,000
                  
                  Subordinated
      Notes Payable
                  
                  
                  01/2000
                  
                  
                  
                  01/2010
                  
                  
                  $
                  2.50
                  
                  
                  (a)122,918
                  
                  
                  122,918
                  
                  Private
      Equity Offering
                  
                  
                  05/2004
                  
                  
                  
                  05/2010
                  
                  
                  
                  2.88
                  
                  
                  (b,c)17,500
                  
                  
                  17,500
                  
                  Consulting
      Services
                  
                  
                  05/2004
                  
                  
                  
                  05/2010
                  
                  
                  
                  2.88
                  
                  
                  (b.c)246,639
                  
                  
                  246,639
                  
                  Private
      Equity Offering
                  
                  
                  10/2005
                  
                  
                  
                  10/2010
                  
                  
                  
                  3.00
                  
                  
                  (b)20,000
                  
                  
                  20,000
                  
                  Revolving
      Promissory Note
                  
                  
                  11/2004
                  
                  
                  
                  11/2010
                  
                  
                  
                  2.50
                  
                  
                  (b.c)





(a) –
At fair market value; exercised January 8, 2010





(b) –
Above fair market value.





(c)  – Expiration
date extended from 2009 to 2010 on May 1, 2009 which resulted in non-cash
financing expense of $76,387 as presented on the Statement of
Operations.


F-19





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS




Note
      11.
            Income
      Taxes




Deferred
tax assets and liabilities result from temporary differences in the recognition
of income and expense for tax and financial reporting
purposes.  Significant components of the Company’s deferred tax assets
and liabilities are as follows at December 31.


2009
                  
                  
                  2008Deferred
      tax assetsNOL
      Carryforward
                  
                  $
                  1,553,000
                  
                  
                  $
                  1,898,000Stock
      Based Compensation
                  
                  
                  130,000
                  
                  
                  
                  -UNICAP
                  
                  
                  26,000
                  
                  
                  
                  22,000Allowance
      for doubtful accounts
                  
                  
                  5,000
                  
                  
                  
                  9,000Reserve
      for obsolete inventory
                  
                  
                  17,000
                  
                  
                  
                  19,000Property
      and equipment
                  
                  
                  (72,000
                  )
                  
                  
                  (109,000
                  )1,659,000
                  
                  
                  
                  1,839,000Valuation
      allowance
                  
                  
                  (1,503,000
                  )
                  
                  
                  1,839,000Net
                  
                  $
                  156,000
                  
                  
                  $
                  -





A
valuation allowance has been recorded against the realizability of the net
deferred tax asset resulting in the recording of the asset in the accompanying
financial statements of $156,000 and $0 at December 31, 2009 and 2008,
respectively.  The valuation allowance totaled $1,503,000 and
$1,839,000 at December 31, 2009 and 2008, respectively.





The
Company has net operating loss carryovers available for federal and state tax
purposes of approximately $4,600,000 and $5,000,000, at December 31, 2009 and
2008, respectively, which expire in varying amounts through 2029.





For the
years ended December 31, 2009 and 2008, a reconciliation of the statutory rate
and effective rate for the provisions for income taxes consists of the
following:





Percentage2009
                        
                        
                        2008Federal
      statutory rate
                        
                        
                        34.0
                        
                        
                        
                        34.0State
      tax
                        
                        
                        (11.5
                        )
                        
                        
                        -Non-deductible
      expense
                        
                        
                        (4.7
                        )
                        
                        
                        -Valuation
      allowance
                        
                        
                        (7.2
                        )
                        
                        
                        -Effective
      rate
                        
                        
                        10.6
                        %
                        
                        
                        34.0
                        %





2009
                  
                  
                  2008Current
      expense - state
                  
                  $
                  97,000
                  
                  
                  $
                  -Deferred
      expense:NOL
      utilization/expiration
                  
                  
                  345,000
                  
                  
                  
                  275,000Other
      temporary differences
                  
                  
                  (165,000
                  )
                  
                  
                  49,000Change
      in valuation allowance
                  
                  
                  (336,000
                  )
                  
                  
                  (324,000
                  )Total
                  
                  $
                  (59,000
                  )
                  
                  $
                  -


F-20





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS




Note
      11.
            Income
      Taxes (continued)





The
Company has no unrecognized tax benefits and therefore, there is no anticipated
effect on the Company’s effective tax rate. Any tax penalties or interest
expense will be recognized in income tax expense. No interest and penalties
related to unrecognized tax benefits were accrued at December 31,
2009 and 2008.




The
Company is open to federal and state tax audits until the applicable statute of
limitations expire. There are currently no federal or state income tax
examinations underway for the Company. The tax years 2006through 2009remain open to examination by the
major taxing jurisdictions in which we operate.The Company does, however, have prior
year net operating losses which remain open for
examination.





Note
      12.
            Fair
      Value of Financial Instruments





The fair
value of financial instruments represents the price that would be received to
sell an asset or paid to transfer a liability (an exit price), and not the price
that would be paid to acquire an asset or received to assume a liability (an
entry price).  Significant differences can arise between the fair
value and carrying amount of financial instruments that are recognized at
historical cost amounts.





The
following methods and assumptions were used by the Company in estimating fair
value disclosures for financial instruments:





·
            Cash
      and cash equivalents, short-term debt and current maturities of long-term
      debt:  Amounts reported in the balance sheet approximate fair
      market value due to the short maturity of these
    instruments.





·
            Long-term
      capital lease obligations: Amounts reported in the balance sheet
      approximate fair value as the interest rates on these obligations range
      from 5.9% to 18.5%.





·
            Long-term
      note payable obligation: Amounts reported in the balance sheet approximate
      fair value as the interest rate on the obligation is 3%.  There
      is also a one-quarter percent annual servicing fee to be charged monthly
      on the outstanding principal
balance.


F-21





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      13.
            Asset
      Retirement Obligation





Included
in machinery and equipment is various production equipment, which per the
Company’s building lease, is required to be removed upon termination of the
lease.  Included in accrued expenses in the accompanying balance sheet
is the asset retirement obligation that represents the expected present value of
the liability to remove this equipment.  There are no assets that are
legally restricted for purposes of settling this asset retirement
obligation.





Following
is a reconciliation of the aggregate retirement liability associated with the
Company’s obligation to dismantle and remove the machinery and equipment
associated with its lease.





Balance at December 31, 2007
                                          
                                          $
                                          9,034Increase
      in present value of the obligation(accretion
      expense in the corresponding amount charged against
    earnings)
                                          
                                          
                                          3,312Balance
      at December 31, 2008
                                          
                                          $
                                          12,346Increase
      in present value of the obligation(accretion
      expense in the corresponding amount charged against
    earnings)
                                          
                                          
                                          6,624Balance
      at December 31, 2009
                                          
                                          $
                                          18,970




Note
      14.
            Subsequent
      Events





During
December 2009 the Company entered into a lease agreement for additional
production equipment in the amount of approximately $87,000.  The
equipment is anticipated to be delivered and the lease is expected to commence
in the first quarter of 2010.





On
January 8, 2010 a total of 150,000 common stock warrants, which were originally
in the estates of Dr. Edward R. Funk Sc.D., and Ingeborg V. Funk, founders of
the Company, were exercised at a price of $2.50 per share.  The cash
proceeds received were $375,000.


F-22