UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
One)


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


For the quarterly period ended March
31, 2009


or





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


For the transition period from
_____________ to _____________





Commission
file number:  0-31641





SCI
ENGINEERED MATERIALS, INC.


(Exact
name of small business issuer 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) (Zip Code)





(614)
486-0261


(Registrant’s
telephone number, including area code)





Not
Applicable


(Former
name, former address and former fiscal year, if changed since last
report)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.  Yes x   No  ̈





Indicate by check mark 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 x





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





3,562,259
shares of Common Stock, without par value, were outstanding at April 30,
2009.





FORM
10-Q





SCI
ENGINEERED MATERIALS, INC.





Table of
Contents





Page No.PART
      I.        FINANCIAL
      INFORMATIONItem
      1.
                          Financial
      Statements.
                          
                          3Balance
      Sheets as of March 31, 2009 (unaudited)and
      December 31, 2008
                          
                          3Statements
      of Operations for the Three MonthsEnded
      March 31, 2009 and 2008 (unaudited)
                          
                          5Statements
      of Cash Flows for the Three MonthsEnded
      March 31, 2009 and 2008 (unaudited)
                          
                          6Notes
      to Financial Statements (unaudited)
                          
                          8Item
      2.
                          Management's
      Discussion and Analysis of Financial Condition andResults
      of Operations.
                          
                          14Item
      3.
                          Quantitative
      and Qualitative Disclosures About Market Risk.
                          
                          N/AItem
      4.
                          Controls
      and Procedures.
                          
                          19PART
      II.         OTHER
      INFORMATIONItem
      1.
                          Legal
      Proceedings.
                          
                          N/AItem
      1A.
                          Risk
      Factors
                          
                          N/AItem
      2.
                          Unregistered
      Sales of Equity Securities and Use of Proceeds.
                          
                          N/AItem
      3.
                          Defaults
      Upon Senior Securities.
                          
                          N/AItem
      4.
                          Submission
      of Matters to a Vote of Security Holders.
                          
                          N/AItem
      5.
                          Other
      Information.
                          
                          N/AItem
      6.
                          Exhibits.
                          
                          21Signatures.
                          
                          21




2





PART
I.  FINANCIAL INFORMATION





ITEM
1. FINANCIAL STATEMENTS





SCI
ENGINEERED MATERIALS, INC.





BALANCE
SHEETS





ASSETS





March 31,
                
                
                December 31,2009
                
                
                2008(UNAUDITED)CURRENT
      ASSETSCash
                
                $
                1,443,231
                
                
                $
                1,399,050Accounts
      receivableTrade,
      less allowance for doubtful accounts of $ 15,753 and
    $24,700
                
                
                248,168
                
                
                
                464,016Contract
                
                
                84,634
                
                
                
                109,717Other
                
                
                7,891
                
                
                
                3,423Inventories
                
                
                881,588
                
                
                
                1,264,433Prepaid
      expenses
                
                
                355,512
                
                
                
                42,562Total
      current assets
                
                
                3,021,024
                
                
                
                3,283,201PROPERTY
      AND EQUIPMENT, AT COSTMachinery
      and equipment
                
                
                4,865,664
                
                
                
                4,192,516Furniture
      and fixtures
                
                
                107,998
                
                
                
                107,998Leasehold
      improvements
                
                
                313,951
                
                
                
                313,951Construction
      in progress
                
                
                -
                
                
                
                144,6825,287,613
                
                
                
                4,759,147Less
      accumulated depreciation
                
                
                (2,583,429
                )
                
                
                (2,469,030
                )2,704,184
                
                
                
                2,290,117OTHER
      ASSETSDeposits
                
                
                24,953
                
                
                
                29,002Intangibles
                
                
                34,273
                
                
                
                34,254Total
      other assets
                
                
                59,226
                
                
                
                63,256TOTAL
      ASSETS
                
                $
                5,784,434
                
                
                $
                5,636,574





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


3





SCI
ENGINEERED MATERIALS, INC.





BALANCE
SHEETS





LIABILITIES AND
SHAREHOLDERS' EQUITY





March 31,
                
                
                December 31,2009
                
                
                2008(UNAUDITED)CURRENT
      LIABILITIESCapital
      lease obligation, current portion
                
                $
                358,047
                
                
                $
                285,408Note
      payable, current portion
                
                
                35,810
                
                
                
                20,386Accounts
      payable
                
                
                256,316
                
                
                
                249,309Accrued
      contract expenses
                
                
                110,548
                
                
                
                52,525Customer
      deposits
                
                
                497,584
                
                
                
                700,118Accrued
      compensation
                
                
                83,763
                
                
                
                94,167Accrued
      expenses and other
                
                
                81,294
                
                
                
                94,928Total
      current liabilities
                
                
                1,423,362
                
                
                
                1,496,841Capital
      lease obligation, net of current portion
                
                
                934,013
                
                
                
                622,769Note
      payable, net of current portion
                
                
                364,190
                
                
                
                379,614Total
      liabilities
                
                
                2,721,565
                
                
                
                2,499,224COMMITMENTS
      AND CONTINGENCIES
                
                
                -
                
                
                
                -SHAREHOLDERS'
      EQUITYConvertible
      preferred stock, Series B, 10% cumulative, nonvoting, no par value, $10
      stated value, optional redemption at 103%; 24,430 issued and
      outstanding
                
                
                379,754
                
                
                
                373,647Common
      stock, no par value, authorized 15,000,000 shares; 3,562,259 and 3,560,259
      shares issued and outstanding respectively
                
                
                9,187,733
                
                
                
                9,180,183Additional
      paid-in capital
                
                
                1,204,578
                
                
                
                985,396Accumulated
      deficit
                
                
                (7,709,196
                )
                
                
                (7,401,876
                )3,062,869
                
                
                
                3,137,350TOTAL
      LIABILITIES AND SHAREHOLDERS' EQUITY
                
                $
                5,784,434
                
                
                $
                5,636,574





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


4





SCI
ENGINEERED MATERIALS, INC.





STATEMENTS
OF OPERATIONS





THREE
MONTHS ENDED MARCH 31, 2009 AND 2008


(UNAUDITED)





2009
                  
                  
                  2008SALES
      REVENUE
                  
                  $
                  1,655,110
                  
                  
                  $
                  1,673,819CONTRACT
      RESEARCH REVENUE
                  
                  
                  246,425
                  
                  
                  
                  40,1211,901,535
                  
                  
                  
                  1,713,940COST
      OF SALES REVENUE
                  
                  
                  1,287,143
                  
                  
                  
                  1,253,971COST
      OF CONTRACT RESEARCH
                  
                  
                  186,872
                  
                  
                  
                  30,9441,474,015
                  
                  
                  
                  1,284,915GROSS
      PROFIT
                  
                  
                  427,520
                  
                  
                  
                  429,025MARKETING
      AND SALES EXPENSE
                  
                  
                  168,092
                  
                  
                  
                  127,386GENERAL
      AND ADMINISTRATIVE EXPENSE
                  
                  
                  415,324
                  
                  
                  
                  258,330RESEARCH
      AND DEVELOPMENT EXPENSE
                  
                  
                  125,330
                  
                  
                  
                  97,763LOSS
      FROM OPERATIONS
                  
                  
                  (281,226
                  )
                  
                  
                  (54,454
                  )OTHER
      INCOME (EXPENSE)Interest
      income
                  
                  
                  2,494
                  
                  
                  
                  8,830Interest
      expense
                  
                  
                  (28,588
                  )
                  
                  
                  (26,602
                  )(26,094
                  )
                  
                  
                  (17,772
                  )LOSS
      BEFORE PROVISION FOR INCOME TAX
                  
                  
                  (307,320
                  )
                  
                  
                  (72,226
                  )INCOME
      TAX EXPENSE
                  
                  
                  -
                  
                  
                  
                  -NET
      LOSS
                  
                  
                  (307,320
                  )
                  
                  
                  (72,226
                  )DIVIDENDS
      ON PREFERRED STOCK
                  
                  
                  (6,107
                  )
                  
                  
                  (6,142
                  )LOSS
      APPLICABLE TO COMMON SHARES
                  
                  $
                  (313,427
                  )
                  
                  $
                  (78,368
                  )EARNINGS
      PER SHARE - BASIC AND DILUTED(Note
      6)NET
      LOSS PER COMMON SHARE BEFORE DIVIDENDS ON PREFERRED STOCKBasic
                  
                  $
                  (0.09
                  )
                  
                  $
                  (0.02
                  )Diluted
                  
                  $
                  (0.09
                  )
                  
                  $
                  (0.02
                  )LOSS
      PER COMMON SHARE AFTER DIVIDENDS ON PREFERRED STOCKBasic
                  
                  $
                  (0.09
                  )
                  
                  $
                  (0.02
                  )Diluted
                  
                  $
                  (0.09
                  )
                  
                  $
                  (0.02
                  )WEIGHTED
      AVERAGE SHARES OUTSTANDINGBasic
                  
                  
                  3,562,037
                  
                  
                  
                  3,489,874Diluted
                  
                  
                  3,562,037
                  
                  
                  
                  3,489,874





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


5





SCI
ENGINEERED MATERIALS, INC.





STATEMENTS
OF CASH FLOWS





THREE
MONTHS ENDED MARCH 31, 2009 AND 2008





(UNAUDITED)





2009
                      
                      
                      2008CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      loss
                      
                      $
                      (307,320
                      )
                      
                      $
                      (72,226
                      )Adjustments
      to reconcile net loss to net cash provided (used) by operating
      activities:Depreciation
      and accretion
                      
                      
                      116,054
                      
                      
                      
                      92,302Amortization
                      
                      
                      772
                      
                      
                      
                      772Stock
      based compensation
                      
                      
                      231,290
                      
                      
                      
                      14,313Inventory
      reserve
                      
                      
                      6,000
                      
                      
                      
                      3,000Provision
      for doubtful accounts
                      
                      
                      (8,947
                      )
                      
                      
                      -Changes
      in operating assets and liabilities:(Increase)
      decrease in assets:Accounts
      receivable
                      
                      
                      245,410
                      
                      
                      
                      (268,407
                      )Inventories
                      
                      
                      376,845
                      
                      
                      
                      (115,550
                      )Prepaid
      expenses
                      
                      
                      (312,950
                      )
                      
                      
                      (26,880
                      )Other
      assets
                      
                      
                      3,258
                      
                      
                      
                      (2,838
                      )Increase
      (decrease) in liabilities:Accounts
      payable
                      
                      
                      7,007
                      
                      
                      
                      158,989Accrued
      expenses and cutomer deposits
                      
                      
                      (170,205
                      )
                      
                      
                      (14,881
                      )Total
      adjustments
                      
                      
                      494,534
                      
                      
                      
                      (159,180
                      )Net
      cash provided (used) by operating activities
                      
                      
                      187,214
                      
                      
                      
                      (231,406
                      )CASH
      FLOWS FROM INVESTING ACTIVITIESPurchases
      of property and equipment
                      
                      
                      (60,116
                      )
                      
                      
                      (48,513
                      )Net
      cash used in investing activities
                      
                      
                      (60,116
                      )
                      
                      
                      (48,513
                      )CASH
      FLOWS FROM FINANCING ACTIVITIESProceeds
      from exercise of common stock options
                      
                      
                      1,550
                      
                      
                      
                      10,250Proceeds
      from exercise of common stock warrants
                      
                      
                      -
                      
                      
                      
                      10,000Principal
      payments on capital lease obligations
                      
                      
                      (84,467
                      )
                      
                      
                      (68,917
                      )Net
      cash used in financing activities
                      
                      
                      (82,917
                      )
                      
                      
                      (48,667
                      )





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


6





SCI
ENGINEERED MATERIALS, INC.





STATEMENTS
OF CASH FLOWS (CONTINUED)





THREE
MONTHS ENDED MARCH 31, 2009 AND 2008





2009
                
                
                2008NET
      INCREASE (DECREASE) IN CASH
                
                $
                44,181
                
                
                $
                (328,586
                )CASH - Beginning of
      period
                
                
                1,399,050
                
                
                
                1,182,086CASH - End of
      period
                
                $
                1,443,231
                
                
                $
                853,500SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATIONCash
      paid during the years for:Interest,
      net
                
                $
                28,588
                
                
                $
                26,602Income
      taxes
                
                $
                -
                
                
                $
                -SUPPLEMENTAL
      DISCLOSURES OF NONCASH FINANCING ACTIVITIESProperty
      and equipment purchased by capital lease
                
                $
                468,350
                
                
                $
                159,104Property
      & equipment accrued asset retirement obligation
    increase
                
                $
                1,656
                
                
                $
                828SUPPLEMENTAL
      DISCLOSURES OF NONCASH OPERATING ACTIVITIESStock
      based compensation expense
                
                $
                231,290
                
                
                $
                14,313





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


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





The
accompanying unaudited financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
for interim financial information and with instructions to Form 10-Q and Article
10 of Regulation S-X.  Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements.  In
the opinion of management, all adjustments considered necessary for fair
presentation of the results of operations for the periods presented have been
included.  The financial statements should be read in conjunction with
the audited financial statements and the notes thereto for the year ended
December 31, 2008.  Interim results are not necessarily indicative of
results for the full year.





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 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.





Equipment
purchased with grant funding





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 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 March
31, 2009, the Company had disbursed the entire amount received.  The
grant and contract both provide that as long as the Company performed in
compliance with the grant/contract, the Company retained the rights to the
equipment.  The grant was completed in January 2009.  The
Company was in compliance with the requirements and retained the
equipment.


8





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      2.
            Summary
      of Significant Accounting Policies
(continued)





Stock
Based Compensation





In
December 2004, the FASB issued SFAS No. 123 (Revised), “Shared Based Payment”
(SFAS No. 123R).  SFAS No. 123R replaced SFAS No. 123, and superseded
APB Opinion No. 25.  Effective January 1, 2006, the Company adopted
the fair value recognition provisions of SFAS No. 123R and related
interpretations using the modified-prospective transition
method.  Under this method, 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 provisions of SFAS No. 123R.  Non cash stock based
compensation costs were $231,290 and $14,313 for the three months ended March
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.





Reclassification





Certain
amounts in the prior year financial statements have been reclassified to conform
to the current year presentation.


9





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      3.
              Common
      Stock and Stock Options





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





Employee Stock
Options





StockOptions
                        
                        
                        Average
                          ExercisePriceOutstanding
      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
                        
                        
                        (1,000
                        )
                        
                        
                        1.55Forfeited
                        
                        
                        (10,000
                        )
                        
                        
                        3.10Outstanding
      at March 31, 2009
                        
                        
                        801,750
                        
                        
                        $
                        4.29Shares
      exercisable at December 31, 2008
                        
                        
                        321,050
                        
                        
                        $
                        2.00Shares
      exercisable at March 31, 2009
                        
                        
                        365,050
                        
                        
                        $
                        2.50





Non-Employee Director Stock
Options





WeightedStockOptions
                  
                  
                  Average
                    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
                  
                  
                  -
                  
                  
                  
                  -Expired
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      at March 31, 2009
                  
                  
                  323,500
                  
                  
                  $
                  3.50Shares
      exercisable at December 31, 2008
                  
                  
                  233,500
                  
                  
                  $
                  2.54Shares
      exercisable at March 31, 2009
                  
                  
                  263,500
                  
                  
                  $
                  2.94





10





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      3.
              Common
      Stock and Stock Options
(continued)





Exercise
prices for options range from $1.00 to $6.00 at March 31, 2009.  The
weighted average option price for all options outstanding is $4.07 with a
weighted average remaining contractual life of 6.5 years.





Note
      4.
              Preferred
      Stock





On
January 15, 2009 the Board of Directors approved the payment of one year of
accrued dividends on convertible preferred stock, Series B, to shareholders of
record as of December 31, 2008.  Payment is expected to be made June
30, 2009.





Note
      5.
            Inventory





Inventory
is comprised of the following:





March 31,
                  
                  
                  December31,2009
                  
                  
                  2008(unaudited)Raw
      materials
                  
                  $
                  314,788
                  
                  
                  $
                  299,750Work-in-progress
                  
                  
                  273,496
                  
                  
                  
                  754,097Finished
      goods
                  
                  
                  348,347
                  
                  
                  
                  259,629Inventory
      reserve
                  
                  
                  (55,043
                  )
                  
                  
                  (49,043
                  )$
                  881,588
                  
                  
                  $
                  1,264,433




11





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      6.
              Earnings
      Per Share





Basic
income (loss) per share is calculated as income (loss) 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.  At March 31, 2009 and 2008 all common stock
options and warrants are anti-dilutive due to the net loss.  The
following is provided to reconcile the earnings per share
calculations:





Three
      months ended March 31,2009
                  
                  
                  2008Loss
      applicable to common shares
                  
                  $
                  (313,427
                  )
                  
                  $
                  (78,368
                  )Weighted
      average common shares outstanding – basic
                  
                  
                  3,562,037
                  
                  
                  
                  3,489,874Effect
      of dilutions - stock options
                  
                  
                  -
                  
                  
                  
                  -Weighted
      average shares outstanding – diluted
                  
                  
                  3,562,037
                  
                  
                  
                  3,489,874





Note
      7.
            Capital
      Requirements





The
Company’s accumulated deficit since inception was $7,709,196 (unaudited) at
March 31, 2009.  While the Company has been profitable in recent
years, the historical losses have been financed primarily from additional
investments and loans by major shareholders and private offerings of common
stock and warrants to purchase common stock.  The Company cannot
assure that it will continue to operate at a profit or it will be able to raise
additional capital in the future to fund its operations.





As of
March 31, 2009, cash on-hand was $1,443,231.  Management believes,
based on forecasted sales and expenses, that funding will be adequate to sustain
operations at least through March 31, 2010.





Numerous
factors may make it necessary for the Company to seek additional
capital.  In order to support the initiatives included in its business
plan, the Company may need to raise additional funds through public or private
financing, collaborative relationships or other arrangements.  Its
ability to raise additional financing depends on many factors beyond its
control, including the state of capital markets, the market price of its common
stock and the development or prospects for development of competitive products
by others.  Because the common stock is not listed on a major stock
exchange, many investors may not be willing or allowed to purchase it or may
demand steep discounts.  The additional financing may not be available
or may be available only on terms that would result in further dilution to the
current owners of the common stock.


12




SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      8.
            Note
      Payable





On
January 22, 2009, the Company issued a Promissory Note dated as of January 13,
2009, to The Huntington National Bank, as Lender, pursuant to a Business Loan
Agreement dated as of January 13, 2009.  The Note is secured by a
Commercial Security Agreement granting the Lender a security interest in the
Company’s inventory, equipment and accounts.   The Company did
not draw on the note in the first three months of 2009.





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) $1,000,000 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 0.386% per annum.  The interest rate to be applied to
the unpaid principal balance during this note will be at a rate of 3.500
percentage points over the index.





All
accrued interest is payable monthly.  The outstanding principal and
accrued interest owed on the Note matures on January 1, 2010.


13




Item
      2.
            Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations





The
following discussion should be read in conjunction with the Financial Statements
and Notes contained herein and with those in our Form 10-K for the year ended
December 31, 2008.




Except
for the historical information contained herein, the matters discussed in this
Quarterly Report on Form 10-Q include certain forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, which are
intended to be covered by the safe harbors created thereby.  Those
statements include, but may not be limited to, all statements regarding our
intent, belief, and expectations, such as statements concerning our future
profitability and operating and growth strategy.  Words such as
“believe,” “anticipate,” “expect,” “will,” “may,” “should,” “intend,” “plan,”
“estimate,” “predict,” “potential,” “continue,” “likely” and similar expressions
are intended to identify forward-looking statements.  Investors are
cautioned that all forward-looking statements contained in this Quarterly Report
on Form 10-Q and in other statements we make involve risks and uncertainties
including, without limitation, the factors set forth under the caption “Risk
Factors” included in our Annual Report on Form 10-K for the year ended December
31, 2008, and other factors detailed from time to time in our other filings with
the Securities and Exchange Commission.  One or more of these factors
have affected, and in the future could affect our business and financial
condition and could cause actual results to differ materially from plans and
projections.  Although we believe the assumptions underlying the
forward-looking statements contained herein are reasonable, there can be no
assurance that any of the forward-looking statements included in this Quarterly
Report on Form 10-Q will prove to be accurate.  In light of the
significant uncertainties inherent in the forward-looking statements included
herein, the inclusion of such information should not be regarded as a
representation by us or any other person that our objectives and plans will be
achieved.




Any
forward-looking statement speaks only as of the date on which such statement is
made, and we undertake no obligation to update any forward-looking statement or
statements to reflect events or circumstances after the date on which such
statements are made or reflect the occurrence of unanticipated events, unless
necessary to prevent such statements from becoming misleading.  New
factors emerge from time to time and it is not possible for us to predict all
factors, nor can it assess the impact of each such factor on the business or the
extent to which any factor, or combination of factors, may cause actual results
to differ materially from those contained in any forward-looking
statements.




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.


14


Item
      2.
            Management's
      Discussion and Analysis of Financial Condition and Results of Operations
      (continued)





Executive
Summary





For the
three months ended March 31, 2009, we had revenues of
$1,901,535.  This was an increase of $187,595, or 10.9%, compared to
the three months ended March 31, 2008.  The increase in revenues can
be attributed to an increase in contract research revenue.  Contract
research revenue increased 514.2% to $246,425 for the first quarter of 2009 from
$40,121 for the first quarter of 2008.  Product revenue decreased
$18,709 for the three months ended March 31, 2009 from the same time period in
2008, or 1.1%.   This decline can be attributed to the current
economic downturn as customers have decreased spending and maintained reduced
inventory levels.





Gross
profit was almost identical for the three months ended March 31, 2009 compared
to the same three months in 2008.  The slight decline of $1,505 can be
attributed to higher depreciation expense related to investments made to develop
new markets.  Gross margin was 22.5% of total revenues for the first
three months of 2009 compared to 25.0% for the same period in 2008.





For the
three months ended March 31, 2009, we had net loss applicable to common shares
of $313,427 compared to a net loss of $78,368 for the same period in
2008.  This decrease can be largely attributed to additional operating
expenses of approximately $225,000 along with the depreciation expense increase
mentioned above. Included in the additional operating expenses is approximately
$217,000 in non-cash stock based compensation.  Given current market
opportunities, we continued to invest in expanding production, R&D,
marketing, and sales to take advantage of these opportunities.  This
has resulted in trial and qualification orders that were shipped to customers in
the thin film solar industry during the first quarter of 2009 which totaled
approximately $100,000 in revenues.  We anticipate revenues for the
first half of 2009 to be comparable to the first six months of
2008.   It is possible that the revenues for the entire year of
2009 could be less than 2008 due to the significant reduction in a high priced
raw material.  After two years of unusually high prices above the long
term average price of this raw material, the price has returned to its long term
average.  In addition, the global economic condition has weakened our
traditional markets.  All of our employees are committed to fighting
through this economic downturn.  Late in the first quarter of 2009 we
reduced hours in most departments and members of executive management have
agreed to salary reductions to help reduce costs in the coming
months.





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 $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.





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.


15


Item
      2.
            Management's
      Discussion and Analysis of Financial Condition and Results of Operations
      (continued)





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 first quarter of 2009.





RESULTS
OF OPERATIONS





Three
months ended March 31, 2009 (unaudited) compared to three months ended March 31,
2008 (unaudited):





Revenues





Revenues
for the three months ended March 31, 2009 were $1,901,535 compared to
$1,713,940, for the same period last year, an increase of $187,595 or
10.9%.  The increase in revenues can be attributed to an increase in
contract research revenue.  Contract research revenue increased 514.2%
to $246,425 for the first quarter of 2009 from $40,121 for the first quarter of
2008.  Product revenue decreased $18,709, or 1.1% for the three months
ended March 31, 2009 from the same time period in
2008.    This decline can be attributed to the current
economic uncertainty as some customers have reduced spending.





Gross
Profit





Gross
profit for the three months ended March 31, 2009 was $427,520 which represents a
gross margin of 22.5% of total revenue compared to $429,025 and 25.0% of total
revenue for the three months ended March 31, 2008.  The slight
decrease was almost entirely attributable to higher depreciation expense related
to investments made to develop new markets.





Marketing
and Sales Expense





Marketing
and Sales expense for the three months ended March 31, 2009 increased 32.0% to
$168,092 from $127,386 for the same period in 2008.  The increase was
due to increased non-cash stock based compensation expense of approximately
$28,000, additional travel and higher sales representative
expenses.





General
and Administrative Expense





General
and administrative expense for the three months ended March 31, 2009 increased
to $415,324 from $258,330 for the three months ended March 31, 2008, or
60.8%.  The increase was the result of non-cash stock based
compensation expense of approximately $173,000.





Research
and Development Expense





Research
and development expense for the first three months of 2009 was $125,330 compared
to $97,763 for the same period in 2008, an increase of 28.2%.  The increase was due to expense
associated within the continued development efforts in the Photonic, Thin Film
Solar, Thin Film Battery and Semiconductor markets, as well as research related
to the SBIRs.   Also, higher non-cash stock based
compensation expense (approximately $25,000) increased research and development
expense from the same time period in 2008.


16


Item
      2.
            Management's
      Discussion and Analysis of Financial Condition and Results of Operations
      (continued)





Interest
Income and Expense





Interest
income was $2,494 and $8,830 for the three months ended March 31, 2009 and 2008,
respectively.   While our cash position increased over the past
12 months the decrease in interest rates reduced the amount of interest
earned.





Interest
expense was $28,588 and $26,602 for the three months ended March 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.





LOSS
APPLICABLE TO COMMON SHARES





Loss
applicable to common shares was $313,427 compared to $78,368 for the three
months ended March 31, 2009 and 2008, respectively.  Basic net loss
per common share after dividends on preferred stock and based on income
applicable to common shares was $0.09 and $0.02 for the three months ended March
31, 2009 and 2008, respectively.  The income applicable to common
shares includes 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 $6,107 and $6,142 for the three months ended
March 31, 2009 and 2008, respectively.  The weighted averaged shares
outstanding were 3,562,037 at March 31, 2009 and 3,489,874 at March 31,
2008.  All outstanding common stock equivalents were anti-dilutive for
the three months ended March 31, 2009 and 2008 due to the net loss.




The
following schedule represents our outstanding common shares during the period of
2009 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
1,682,307 to 5,244,566 by December 31, 2019.  Exercise prices for
options and warrants range from $1.00 to $6.00 at March 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 Warrants due to expire
            
            
            Potential Shares Outstanding2009
            
            
            160,418
            
            
            
            3,722,6772010
            
            
            443,389
            
            
            
            4,166,0662011
            
            
            62,500
            
            
            
            4,228,5662012
            
            
            169,000
            
            
            
            4,397,5662013
            
            
            30,500
            
            
            
            4,428,0662014
            
            
            180,000
            
            
            
            4,608,0662015
            
            
            140,000
            
            
            
            4,748,0662016
            
            
            37,000
            
            
            
            4,785,0662017
            
            
            -
            
            
            
            4,785,0662018
            
            
            9,500
            
            
            
            4,794,5662019
            
            
            450,000
            
            
            
            5,244,566





17


Item
      2.
            Management's
      Discussion and Analysis of Financial Condition and Results of Operations
      (continued)





LIQUIDITY
AND WORKING CAPITAL





At March
31, 2009, working capital was $1,597,662 compared to $1,458,241 at March 31,
2008. We provided cash from operations of approximately $187,000 for the three
months ended March 31, 2009.  We used cash from operations of
approximately $231,000 for the three months ended March 31,
2008.   Significant non-cash items including depreciation,
accretion and amortization, stock based compensation expense, inventory reserve
on excess and obsolete inventory, and provision for doubtful accounts were
approximately $345,000 and $110,000, respectively, for the three months ended
March 31, 2009 and 2008.  Accounts receivable, inventory, prepaid
expenses and other assets decreased approximately $313,000 for the three months
ended March 31, 2009.  Accounts receivable, inventory, prepaid
expenses and other assets increased approximately $414,000 for the three months
ended March 31, 2008.  Accounts payable, accrued expenses and customer
deposits decreased approximately $163,000 for the three months ended March 31,
2009 and increased approximately $144,000 for the same period in
2008.  Cash of approximately $60,000 and $49,000 was used for
investing activities for the three months ended March 31, 2009 and 2008,
respectively.  The amounts invested were used to purchase machinery
and equipment for increased production capacity and new product
lines.





Cash of
approximately $83,000 was used for financing activities during the three months
ended March 31, 2009.  Cash payments to third parties for capital
lease obligations approximated $84,000.  Proceeds received from the
exercise of common stock options were $1,550.  We incurred new capital
lease obligations of approximately $468,000 for new production
equipment.





Cash of
approximately $49,000 was used for financing activities during the three months
ended March 31, 2008.  Cash payments to third parties for capital
lease obligations approximated $69,000.  Proceeds received from the
exercise of common stock warrants were $10,000.  Proceeds received
from the exercise of common stock options were $10,250.  We incurred
new capital lease obligations of approximately $159,000 for new production
equipment.







RISK
FACTORS





We desire
to take advantage of the “safe harbor” provisions of the Private Securities
Litigation Reform Act of 1995.  The following factors, as well as the
factors listed under the caption “Risk Factors” in our Form 10-K filed with the
Securities and Exchange Commission on February 26, 2009, have affected or could
affect our actual results and could cause such results to differ materially from
those expressed in any forward-looking statements made by
us.  Investors should consider carefully these risks and speculative
factors inherent in and affecting our business and an investment in our common
stock.





Historically
we have experienced significant operating losses and may continue to do so in
the future.





While we
have had profitable operations in recent years, profits have not been consistent
and we financed the 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 that we will be able to
raise additional capital in the future to fund our operations.  While
certain of our major shareholders have advanced funds in the form of secured
debt, 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.


18


Item
      2.
            Management's
      Discussion and Analysis of Financial Condition and Results of Operations
      (continued)





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 funds.




Off
Balance Sheet Arrangements





We have
no off balance sheet arrangements including special purpose
entities.





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 our Annual Report on Form 10-K for the year
ended December 31, 2008 describes the significant accounting policies and
methods used in the preparation of the Financial
Statements.  Estimates are used for, but not limited to, 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 orthere 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
benefit 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.





Item
      4.
            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 March 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




Item
      4.
            Controls
      and Procedures (continued)




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 is 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.





Additionally,
there were no changes in our internal controls that could materially affect our
disclosure controls and procedures subsequent to the date of their evaluation,
nor were there any material
deficiencies or material weaknesses in our internal controls.  As a
result, no corrective actions were required.


20


Part
II.   Other Information





Item
      6.
                
                Exhibits.10.1
                Description
      of material terms of Stock Option Grant Agreements with the Company’s
      Executive Officers and Board of Directors (Incorporated by reference to
      the Company’s Current Report on Form 8-K, dated January 6,
      2009).10.2
                Description
      of material terms of a Promissory Note issued to The Huntington National
      Bank (Incorporated by reference to the Company’s Current Report on Form
      8-K, dated January 23, 2009).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 Executive Officer and Principal Financial
      Officer.*99.1
                Press
      Release dated May 5, 2009, entitled “SCI Engineered Materials, Inc.
      Reports First Quarter 2009 Results.”*
      Filed with this report





Signatures





Pursuant
to the requirements 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:  May
      5, 2009
                  /s/
      Daniel RooneyDaniel
      Rooney, Chairman of the Board of Directors, President and Chief Executive
      Officer(Principal
      Executive Officer)/s/
      Gerald S. BlaskieGerald
      S. Blaskie, Vice President and Chief Financial Officer(Principal
      Financial Officer and Principal Accounting
  Officer)




21