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
September 30,
2010


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 has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such
files).    Yes  ̈  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





3,773,298
shares of Common Stock, without par value, were outstanding at October 20,
2010.





FORM
10-Q





SCI
ENGINEERED MATERIALS, INC.





Table of
Contents





Page No.PART
      I.              
       FINANCIAL INFORMATIONItem
      1.
                            Financial
      Statements.Balance
      Sheets as of September 30, 2010 (unaudited)and
      December 31, 2009
                            
                            3Statements
      of Operations for the Three and Nine MonthsEnded
      September 30, 2010 and 2009 (unaudited)
                            
                            5Statements
      of Cash Flows for the Nine MonthsEnded
      September 30, 2010 and 2009 (unaudited)
                            
                            6Statement
      of Shareholders’ Equity for the Nine MonthsEnded
      September 30, 2010 (unaudited)
                            
                            7Notes
      to Financial Statements (unaudited)
                            
                            8Item
      2.
                            Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations.
                            
                            13Item
      3.
                            Quantitative
      and Qualitative Disclosures About Market Risk.
                            
                            N/AItem
      4.
                            Controls
      and Procedures.
                            
                            20PART
      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.
                            (Removed
      and Reserved).
                            
                            N/AItem
      5.
                            Other
      Information.
                            
                            N/AItem
      6.
                            Exhibits.
                            
                            22Signatures.
                            
                            22


2


PART
I.  FINANCIAL INFORMATION
 
 ITEM
1. FINANCIAL STATEMENTS
 
 SCI
ENGINEERED MATERIALS, INC.
 
 BALANCE
SHEETS
  ASSETS
 
 September 30,
                                                      
                                                      
                                                      December 31,2010
                                                      
                                                      
                                                      2009(UNAUDITED)CURRENT
      ASSETSCash
                                                      
                                                      $
                                                      1,536,513
                                                      
                                                      
                                                      $
                                                      1,107,216Accounts
      receivableTrade,
      less allowance for doubtful accounts of $16,000
                                                      
                                                      
                                                      561,377
                                                      
                                                      
                                                      
                                                      539,398Contract
                                                      
                                                      
                                                      115,820
                                                      
                                                      
                                                      
                                                      19,714Other
                                                      
                                                      
                                                      7,394
                                                      
                                                      
                                                      
                                                      11,000Inventories
                                                      
                                                      
                                                      965,773
                                                      
                                                      
                                                      
                                                      1,031,777Deferred
      income taxes
                                                      
                                                      
                                                      112,000
                                                      
                                                      
                                                      
                                                      156,000Prepaid
      expenses
                                                      
                                                      
                                                      45,551
                                                      
                                                      
                                                      
                                                      977,536Total
      current assets
                                                      
                                                      
                                                      3,344,428
                                                      
                                                      
                                                      
                                                      3,842,641PROPERTY
      AND EQUIPMENT, AT COSTMachinery
      and equipment
                                                      
                                                      
                                                      5,188,665
                                                      
                                                      
                                                      
                                                      4,933,855Furniture
      and fixtures
                                                      
                                                      
                                                      134,666
                                                      
                                                      
                                                      
                                                      127,451Leasehold
      improvements
                                                      
                                                      
                                                      315,054
                                                      
                                                      
                                                      
                                                      315,054Construction
      in progress
                                                      
                                                      
                                                      75,128
                                                      
                                                      
                                                      
                                                      22,9665,713,513
                                                      
                                                      
                                                      
                                                      5,399,326Less
      accumulated depreciation
                                                      
                                                      
                                                      (3,127,325
                                                      )
                                                      
                                                      
                                                      (2,868,198
                                                      )2,586,188
                                                      
                                                      
                                                      
                                                      2,531,128OTHER
      ASSETSDeposits
                                                      
                                                      
                                                      15,394
                                                      
                                                      
                                                      
                                                      21,909Intangibles
                                                      
                                                      
                                                      39,041
                                                      
                                                      
                                                      
                                                      41,358Total
      other assets
                                                      
                                                      
                                                      54,435
                                                      
                                                      
                                                      
                                                      63,267TOTAL
      ASSETS
                                                      
                                                      $
                                                      5,985,051
                                                      
                                                      
                                                      $
                                                      6,437,036
 
 The
accompanying notes are an integral part of these financial
statements.
  3
 
 SCI
ENGINEERED MATERIALS, INC.
 
 BALANCE
SHEETS
  LIABILITIES
AND SHAREHOLDERS' EQUITY
 
 September
      30,
                                                    
                                                    
                                                    December
      31,2010
                                                    
                                                    
                                                    2009(UNAUDITED)CURRENT
      LIABILITIESCapital
      lease obligation, current portion
                                                    
                                                    $
                                                    395,936
                                                    
                                                    
                                                    $
                                                    363,270Note
      payable, current portion
                                                    
                                                    
                                                    63,813
                                                    
                                                    
                                                    
                                                    62,394Accounts
      payable
                                                    
                                                    
                                                    423,342
                                                    
                                                    
                                                    
                                                    263,468Customer
      deposits
                                                    
                                                    
                                                    80,264
                                                    
                                                    
                                                    
                                                    1,319,455Accrued
      compensation
                                                    
                                                    
                                                    112,326
                                                    
                                                    
                                                    
                                                    67,863Accrued
      expenses and other
                                                    
                                                    
                                                    208,222
                                                    
                                                    
                                                    
                                                    210,294Total
      current liabilities
                                                    
                                                    
                                                    1,283,903
                                                    
                                                    
                                                    
                                                    2,286,744Capital
      lease obligation, net of current portion
                                                    
                                                    
                                                    608,380
                                                    
                                                    
                                                    
                                                    738,750Note
      payable, net of current portion
                                                    
                                                    
                                                    269,181
                                                    
                                                    
                                                    
                                                    317,219Total
      liabilities
                                                    
                                                    
                                                    2,161,464
                                                    
                                                    
                                                    
                                                    3,342,713COMMITMENTS
      AND CONTINGENCIES
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -SHAREHOLDERS'
      EQUITYConvertible
      preferred stock, Series B, 10% cumulative,nonvoting,
      no par value, $10 stated value, optionalredemption
      at 103%;   optional shareholder conversion 2 shares for
      1;24,152
      and 24,297 shares issued and outstanding,
respectively
                                                    
                                                    
                                                    387,592
                                                    
                                                    
                                                    
                                                    371,612Common
      stock, no par value, authorized 15,000,000 shares;3,773,298
      and 3,571,755 shares issued and outstanding, respectively
                                                    
                                                    
                                                    9,721,360
                                                    
                                                    
                                                    
                                                    9,209,424Additional
      paid-in capital
                                                    
                                                    
                                                    1,543,900
                                                    
                                                    
                                                    
                                                    1,412,382Accumulated
      deficit
                                                    
                                                    
                                                    (7,829,265
                                                    )
                                                    
                                                    
                                                    (7,899,095
                                                    )3,823,587
                                                    
                                                    
                                                    
                                                    3,094,323TOTAL
      LIABILITIES AND SHAREHOLDERS' EQUITY
                                                    
                                                    $
                                                    5,985,051
                                                    
                                                    
                                                    $
                                                    6,437,036
 
 The
accompanying notes are an integral part of these financial
statements.
  4
 
 SCI
ENGINEERED MATERIALS, INC.
 
 STATEMENTS
OF OPERATIONS
 
 THREE
MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009
 
 (UNAUDITED)
 
 THREE MONTHS ENDED SEPT. 30,
                                                            
                                                            
                                                            NINE MONTHS ENDED SEPT. 30,2010
                                                            
                                                            
                                                            2009
                                                            
                                                            
                                                            2010
                                                            
                                                            
                                                            2009PRODUCT
      REVENUE
                                                            
                                                            $
                                                            2,191,843
                                                            
                                                            
                                                            $
                                                            2,028,355
                                                            
                                                            
                                                            $
                                                            6,548,847
                                                            
                                                            
                                                            $
                                                            4,738,869CONTRACT
      RESEARCH REVENUE
                                                            
                                                            
                                                            241,538
                                                            
                                                            
                                                            
                                                            196,401
                                                            
                                                            
                                                            
                                                            686,311
                                                            
                                                            
                                                            
                                                            697,4752,433,381
                                                            
                                                            
                                                            
                                                            2,224,756
                                                            
                                                            
                                                            
                                                            7,235,158
                                                            
                                                            
                                                            
                                                            5,436,344COST
      OF PRODUCT REVENUE
                                                            
                                                            
                                                            1,746,844
                                                            
                                                            
                                                            
                                                            1,481,956
                                                            
                                                            
                                                            
                                                            4,871,252
                                                            
                                                            
                                                            
                                                            3,651,003COST
      OF CONTRACT RESEARCH
                                                            
                                                            
                                                            170,592
                                                            
                                                            
                                                            
                                                            190,501
                                                            
                                                            
                                                            
                                                            504,111
                                                            
                                                            
                                                            
                                                            556,5321,917,436
                                                            
                                                            
                                                            
                                                            1,672,457
                                                            
                                                            
                                                            
                                                            5,375,363
                                                            
                                                            
                                                            
                                                            4,207,535GROSS
      PROFIT
                                                            
                                                            
                                                            515,945
                                                            
                                                            
                                                            
                                                            552,299
                                                            
                                                            
                                                            
                                                            1,859,795
                                                            
                                                            
                                                            
                                                            1,228,809MARKETING
      AND SALES EXPENSE
                                                            
                                                            
                                                            185,767
                                                            
                                                            
                                                            
                                                            178,107
                                                            
                                                            
                                                            
                                                            495,997
                                                            
                                                            
                                                            
                                                            492,557GENERAL
      AND ADMINISTRATIVE EXPENSE
                                                            
                                                            
                                                            265,843
                                                            
                                                            
                                                            
                                                            273,185
                                                            
                                                            
                                                            
                                                            862,054
                                                            
                                                            
                                                            
                                                            976,568RESEARCH
      AND DEVELOPMENT EXPENSE
                                                            
                                                            
                                                            119,979
                                                            
                                                            
                                                            
                                                            59,829
                                                            
                                                            
                                                            
                                                            320,740
                                                            
                                                            
                                                            
                                                            264,406INCOME
      (LOSS) FROM OPERATIONS
                                                            
                                                            
                                                            (55,644
                                                            )
                                                            
                                                            
                                                            41,178
                                                            
                                                            
                                                            
                                                            181,004
                                                            
                                                            
                                                            
                                                            (504,722
                                                            )OTHER
      INCOME (EXPENSE)Interest
      income
                                                            
                                                            
                                                            1,531
                                                            
                                                            
                                                            
                                                            842
                                                            
                                                            
                                                            
                                                            4,194
                                                            
                                                            
                                                            
                                                            5,688Interest
      expense
                                                            
                                                            
                                                            (21,623
                                                            )
                                                            
                                                            
                                                            (26,834
                                                            )
                                                            
                                                            
                                                            (66,555
                                                            )
                                                            
                                                            
                                                            (84,057
                                                            )Financing
      expense
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            (76,387
                                                            )Gain
      on disposal of equipment
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            10,251
                                                            
                                                            
                                                            
                                                            -(20,092
                                                            )
                                                            
                                                            
                                                            (25,992
                                                            )
                                                            
                                                            
                                                            (52,110
                                                            )
                                                            
                                                            
                                                            (154,756
                                                            )INCOME
      (LOSS) BEFORE PROVISION FOR INCOME TAX
                                                            
                                                            
                                                            (75,736
                                                            )
                                                            
                                                            
                                                            15,186
                                                            
                                                            
                                                            
                                                            128,894
                                                            
                                                            
                                                            
                                                            (659,478
                                                            )INCOME
      TAX BENEFIT (EXPENSE)
                                                            
                                                            
                                                            24,304
                                                            
                                                            
                                                            
                                                            (287
                                                            )
                                                            
                                                            
                                                            (59,064
                                                            )
                                                            
                                                            
                                                            (862
                                                            )NET
      INCOME (LOSS)
                                                            
                                                            
                                                            (51,432
                                                            )
                                                            
                                                            
                                                            14,899
                                                            
                                                            
                                                            
                                                            69,830
                                                            
                                                            
                                                            
                                                            (660,340
                                                            )DIVIDENDS
      ON PREFERRED STOCK
                                                            
                                                            
                                                            (6,072
                                                            )
                                                            
                                                            
                                                            (6,107
                                                            )
                                                            
                                                            
                                                            (18,222
                                                            )
                                                            
                                                            
                                                            (18,322
                                                            )INCOME
      (LOSS) APPLICABLE TO COMMON SHARES
                                                            
                                                            $
                                                            (57,504
                                                            )
                                                            
                                                            $
                                                            8,792
                                                            
                                                            
                                                            $
                                                            51,608
                                                            
                                                            
                                                            $
                                                            (678,662
                                                            )EARNINGS
      PER SHARE - BASIC AND DILUTED(Note
      6)INCOME
      (LOSS) APPLICABLE TO COMMON SHARESPER
      COMMON SHAREBasic
                                                            
                                                            $
                                                            (0.02
                                                            )
                                                            
                                                            $
                                                            0.00
                                                            
                                                            
                                                            $
                                                            0.01
                                                            
                                                            
                                                            $
                                                            (0.19
                                                            )Diluted
                                                            
                                                            $
                                                            (0.02
                                                            )
                                                            
                                                            $
                                                            0.00
                                                            
                                                            
                                                            $
                                                            0.01
                                                            
                                                            
                                                            $
                                                            (0.19
                                                            )WEIGHTED
      AVERAGE SHARES OUTSTANDINGBasic
                                                            
                                                            
                                                            3,773,017
                                                            
                                                            
                                                            
                                                            3,562,259
                                                            
                                                            
                                                            
                                                            3,742,553
                                                            
                                                            
                                                            
                                                            3,562,186Diluted
                                                            
                                                            
                                                            3,773,017
                                                            
                                                            
                                                            
                                                            3,896,530
                                                            
                                                            
                                                            
                                                            3,899,852
                                                            
                                                            
                                                            
                                                            3,562,186
 
 The
accompanying notes are an integral part of these financial
statements.
  5
 
 SCI
ENGINEERED MATERIALS, INC.
 
 STATEMENTS
OF CASH FLOWS
 
 NINE
MONTHS ENDED SEPTEMBER 30, 2010 AND 2009
 
 (UNAUDITED)
 
 2010
                              
                              
                              2009CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      income (loss)
                              
                              $
                              69,830
                              
                              
                              $
                              (660,340
                              )Adjustments
      to reconcile net income (loss) to net cashfrom
      operating activities:Depreciation
      and accretion
                              
                              
                              363,436
                              
                              
                              
                              339,401Amortization
                              
                              
                              2,316
                              
                              
                              
                              2,316Stock
      based compensation
                              
                              
                              153,490
                              
                              
                              
                              331,117Financing
      expense related to warrant expiration date extension
                              
                              
                              -
                              
                              
                              
                              76,387Gain
      on sale of equipment
                              
                              
                              (10,251
                              )
                              
                              
                              -Deferred
      income taxes
                              
                              
                              44,000
                              
                              
                              
                              -Inventory
      reserve
                              
                              
                              20,591
                              
                              
                              
                              12,868Credit
      for doubtful accounts
                              
                              
                              -
                              
                              
                              
                              (8,947
                              )Changes
      in operating assets and liabilities:Accounts
      receivable
                              
                              
                              (114,479
                              )
                              
                              
                              (128,395
                              )Inventories
                              
                              
                              45,413
                              
                              
                              
                              322,855Prepaid
      expenses
                              
                              
                              931,985
                              
                              
                              
                              (385,202
                              )Other
      assets
                              
                              
                              6,516
                              
                              
                              
                              (3,295
                              )Accounts
      payable
                              
                              
                              159,873
                              
                              
                              
                              163,358Accrued
      expenses and customer deposits
                              
                              
                              (1,201,767
                              )
                              
                              
                              (195,281
                              )Net
      cash provided by (used in) operating activities
                              
                              
                              470,953
                              
                              
                              
                              (133,158
                              )CASH
      FLOWS FROM INVESTING ACTIVITIESProceeds
      on sale of equipment
                              
                              
                              10,500
                              
                              
                              
                              -Purchases
      of property and equipment
                              
                              
                              (221,111
                              )
                              
                              
                              (142,983
                              )Net
      cash used in investing activities
                              
                              
                              (210,611
                              )
                              
                              
                              (142,983
                              )CASH
      FLOWS FROM FINANCING ACTIVITIESProceeds
      from exercise of common stock options
                              
                              
                              15,145
                              
                              
                              
                              1,550Net
      proceeds from exercise of common stock warrants
                              
                              
                              490,799
                              
                              
                              
                              -Payments
      related to Preferred Series B dividend
                              
                              
                              -
                              
                              
                              
                              (24,430
                              )Principal
      payments on capital lease obligations and note payable
                              
                              
                              (336,989
                              )
                              
                              
                              (272,335
                              )Net
      cash provided by (used in) financing activities
                              
                              
                              168,955
                              
                              
                              
                              (295,215
                              )NET
      INCREASE (DECREASE) IN CASH
                              
                              
                              429,297
                              
                              
                              
                              (571,356
                              )CASH - Beginning of
      period
                              
                              
                              1,107,216
                              
                              
                              
                              1,399,050CASH - End of
      period
                              
                              $
                              1,536,513
                              
                              
                              $
                              827,694SUPPLEMENTAL
      DISCLOSURES OF CASHFLOW
      INFORMATIONCash
      paid during the periods for:Interest,
      net
                              
                              $
                              66,555
                              
                              
                              $
                              84,057Income
      taxes
                              
                              
                              2,400
                              
                              
                              
                              2,450SUPPLEMENTAL
      DISCLOSURES OF NONCASHFINANCING
      ACTIVITIESProperty
      and equipment purchased by capital lease
                              
                              
                              192,665
                              
                              
                              
                              555,700Increase
      in asset retirement obligation
                              
                              
                              4,968
                              
                              
                              
                              4,968Financing
      expense related to warrant extension
                              
                              
                              -
                              
                              
                              
                              76,387
 
 The
accompanying notes are an integral part of these financial
statements.
  6
 
 SCI
ENGINEERED MATERIALS, INC.
 
 STATEMENT
OF SHAREHOLDERS' EQUITY
 
 NINE
MONTHS ENDED SEPTEMBER 30, 2010
 
 Convertible
                      
                      
                      
                      
                      
                      AdditionalPreferredStock,
                      
                      
                      Common
                      
                      
                      Paid-In
                      
                      
                      AccumulatedSeries
      B
                      
                      
                      Stock
                      
                      
                      Capital
                      
                      
                      Deficit
                      
                      
                      TotalBalance
      at December 31, 2009
                      
                      $
                      371,612
                      
                      
                      $
                      9,209,424
                      
                      
                      $
                      1,412,382
                      
                      
                      $
                      (7,899,095
                      )
                      
                      $
                      3,094,323Accretion
      of cumulative dividends
                      
                      
                      18,222
                      
                      
                      
                      -
                      
                      
                      
                      (18,222
                      )
                      
                      
                      -
                      
                      
                      
                      -Common
      stock conversion from preferred stock (Note 4)
                      
                      
                      (2,242
                      )
                      
                      
                      2,242
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Common
      stock issued (Note 2)
                      
                      
                      -
                      
                      
                      
                      3,750
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      3,750Stock
      based compensation expense (Note 2)
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      149,740
                      
                      
                      
                      -
                      
                      
                      
                      149,740Proceeds
      from exercise of stock warrants (Note 3)
                      
                      
                      -
                      
                      
                      
                      490,799
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      490,799Proceeds
      from exercise of stock options (Note 3)
                      
                      
                      -
                      
                      
                      
                      15,145
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      15,145Net
      income
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      69,830
                      
                      
                      
                      69,830Balance
      at September 30, 2010
                      
                      $
                      387,592
                      
                      
                      $
                      9,721,360
                      
                      
                      $
                      1,543,900
                      
                      
                      $
                      (7,829,265
                      )
                      
                      $
                      3,823,587
 
 The
accompanying notes are an intergral 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 develops, commercializes technologies and manufactures ceramics and
metals for advanced applications in the physical vapor deposition industry
including: Photonics, Solar, Thin Film Battery, Semiconductor, and, to a lesser
extent High Temperature Superconductor (HTS) materials.  Photonics
currently represents the Company’s largest market.  Solar is an
industry that is exhibiting rapid growth.  Thin Film Battery is a
developing market where manufacturers of batteries use the Company’s products to
produce very small power supplies with small quantities of stored
energy.    Semiconductor is a developing market for the
Company.





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, 2009.  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.





Stock
Based Compensation





Stock
Based Compensation - Compensation cost recognized in 2010 and 2009 includes
compensation cost for 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 $153,490 and $331,117 for the nine
months ended September 30, 2010 and 2009, 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.  Unrecognized compensation expense as of September
30, 2010 was approximately $776,000 which will be recognized through
2017.


8


SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      2.
            Summary
      of Significant Accounting Policies
(continued)





Reclassification





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





Note
      3.
            Common
      Stock and Stock Options





On May
31, 2010 a total of 40,833 common stock warrants were exercised at a price of
$2.88 per common share.  The cash proceeds were
$117,599.  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.





During
the first nine months of 2010, 9,400 stock options were exercised at a weighted
average price of $1.61.  The total cash proceeds were
$15,145.





A total
of 99,585 common stock warrants at a price of $2.88 expired on May 31,
2010.  Subsequent to September 30, 2010, a total of 246,639 common
stock warrants and 35,000 stock options at a price of $3.00
expired.  The Company also has 20,000 common stock warrants at a price
of $2.50 due to expire in November 2010.





The
cumulative status of options granted and outstanding at September 30, 2010, and
December 31, 2009, as well as options which became exercisable in connection
with the Stock Option Plans are summarized as follows:





Employee Stock
Options





WeightedAverageStock Options
                  
                  
                  Exercise PriceOutstanding
      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
                  
                  
                  $
                  4.31Granted
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  (8,400
                  )
                  
                  
                  1.55Forfeited
                  
                  
                  (500
                  )
                  
                  
                  2.13Outstanding
      at September 30, 2010
                  
                  
                  787,350
                  
                  
                  $
                  4.34Shares
      exercisable at December 31, 2009
                  
                  
                  369,325
                  
                  
                  $
                  2.52Shares
      exercisable at September 30, 2010
                  
                  
                  415,200
                  
                  
                  $
                  2.94


9


SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      3.
            Common
      Stock and Stock Options (continued)





Non-Employee Director Stock
Options




WeightedAverageStock Options
                  
                  
                  Exercise PriceOutstanding
      at December 31, 2008
                  
                  
                  233,500
                  
                  
                  $
                  2.54Granted
                  
                  
                  90,000
                  
                  
                  
                  6.00Exercised
                  
                  
                  (4,000
                  )
                  
                  
                  2.13Expired
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      at December 31, 2009
                  
                  
                  319,500
                  
                  
                  $
                  3.52Granted
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  (1,000
                  )
                  
                  
                  2.13Expired
                  
                  
                  (1,000
                  )
                  
                  
                  2.13Forfeited
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      at September 30, 2010
                  
                  
                  317,500
                  
                  
                  $
                  3.53Shares
      exercisable at December 31, 2009
                  
                  
                  259,500
                  
                  
                  $
                  2.95Shares
      exercisable at September 30, 2010
                  
                  
                  287,500
                  
                  
                  $
                  3.27





Exercise
prices for options range from $1.00 to $6.00 at September 30,
2010.  The weighted average option price for all options outstanding
is $4.11 with a weighted average remaining contractual life of 5.1
years.





Note
      4.
            Preferred
      Stock





On
February 15, 2010 the Board of Directors voted not to authorize the payment of a
cash dividend on convertible preferred stock, Series B, to shareholders of
record as of December 31, 2009.  Dividends on the Series B preferred
stock accrue at 10% annually on the outstanding shares.  Accrued
dividends on the Series B preferred stock were $18,222 and $18,322 for the nine
months ended September 30, 2010 and 2009, respectively.  During the
third quarter of 2010 a shareholder converted 145 shares of Series B preferred
stock into 290 shares of common stock.





Note
      5.
            Inventories





Inventories
      are comprised of the following:





September
      30,
                  
                  
                  December
      31,2010
                  
                  
                  2009(unaudited)Raw
      materials
                  
                  $
                  398,554
                  
                  
                  $
                  371,060Work-in-progress
                  
                  
                  423,217
                  
                  
                  
                  506,288Finished
      goods
                  
                  
                  213,635
                  
                  
                  
                  204,026Inventory
      reserve
                  
                  
                  (69,633
                  )
                  
                  
                  (49,597
                  )$
                  965,773
                  
                  
                  $
                  1,031,777


10


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 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. For the three months ended
      September 30, 2010, all (188,421) common stock options and warrants were
      anti-dilutive due to the Company’s net loss.  For the nine
      months ended September 30, 2009, all (294,021) common stock options and
      warrants were anti-dilutive due to the net loss.  The following
      is provided to reconcile the earnings per share
    calculations:





For
      three months ended Sept. 30,
                  
                  
                  For
      nine months ended Sept. 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Income
      (loss) applicable to common shares
                  
                  $
                  (57,504
                  )
                  
                  $
                  8,792
                  
                  
                  $
                  51,608
                  
                  
                  $
                  (678,662
                  )Weighted
      average common shares outstanding – basic
                  
                  
                  3,773,017
                  
                  
                  
                  3,562,259
                  
                  
                  
                  3,742,553
                  
                  
                  
                  3,562,186Effect
      of dilutions
                  
                  
                  -
                  
                  
                  
                  334,271
                  
                  
                  
                  157,299
                  
                  
                  
                  -Weighted
      average shares outstanding – diluted
                  
                  
                  3,773,017
                  
                  
                  
                  3,896,530
                  
                  
                  
                  3,899,852
                  
                  
                  
                  3,562,186





Note
      7.
            Notes
      Payable





In
December 2009, the Company issued a Promissory Note to The Huntington National
Bank, as Lender, pursuant to a Business Loan Agreement dated as of December 14,
2009.  The Note is collateralized by a Commercial Security Agreement
granting the Lender a security interest in the Company’s inventory, equipment
and accounts receivable.  As of September 30, 2010 there was no
outstanding balance on the Revolving Note.





Among
other items, the Revolving Note provides for the following:





·
            At
      no time shall the outstanding balance of the principal sum of the
      Revolving Note 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 Revolving Note is subject to change from time to time based on
      changes in an independent index (LIBOR).  The index at the
      inception of the Note was 0.235% per annum.  The interest rate
      to be applied to the unpaid principal balance will be at a rate of 2.75
      percentage points over the index.





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


11





SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
      7.
            Notes
      Payable (continued)





During
2006, the Company was approved for a 166 Direct Loan from the Ohio Department of
Development in the amount of $400,000.  These funds were received in
July of 2008.  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.  The Company is making
monthly servicing fee, interest and principal payments of approximately
$6,000.  The loan principal balance will be fully amortized at the end
of the term in August of 2015.  The Note is secured by a Security
Agreement granting the Lender a security interest in the project
equipment.  As of September 30, 2010 the note had a balance of
$332,994.





Note
      8.
            Concentration
      Risk





At
September 30, 2010 the Company had a receivable of approximately $200,000 from a
customer.  This balance was consistent with month end balances for the
past year.  None of the outstanding balance was past due as of
September 30, 2010 and was expected to be collected.





Note
      9.
            Income
      Taxes





Income
tax expense consists of the following for the nine months ended September 30,
2010 and 2009, respectively:





2010
                          
                          
                          2009Federal
      - deferred
                          
                          $
                          44,000
                          
                          
                          $
                          -State
      and local
                          
                          
                          15,064
                          
                          
                          
                          862$
                          59,064
                          
                          
                          $
                          862


12


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, 2009.




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, 2009, 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 we 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.




We desire
to take advantage of the “safe harbor” provisions of the Private Securities
Litigation Reform Act of 1995.  The factors listed under the caption
“Risk Factors” in our Form 10-K filed with the Securities and Exchange
Commission on February 17, 2010, 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.




Overview




SCI
Engineered Materials, Inc. (“SCI” or the “Company”), formerly Superconductive
Components, Inc., an Ohio corporation, was incorporated in 1987.  We
develop, commercialize technologies and manufacture ceramics and metals for
advanced applications in the physical vapor deposition industry including:
Photonics, Solar, Thin Film Battery, Semiconductor, and, to a lesser extent HTS
materials.  Photonics currently represents the largest market for our
targets.  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 products to produce very small
power supplies with small quantities of stored
energy.    Semiconductor is a developing market for
us.  In recent years we added to our sales staff for the purpose of
focusing on opportunities for our products in the Solar industry.  We
also added staff to our Technology group for the development of innovative
products.  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 of this order shipped before December 31, 2009.  Late in
the fourth quarter of 2009 this same customer placed another order greater than
$1 million.  Nearly the entire order shipped during the first half of
2010.  We continue to receive ongoing orders from this
customer.


13


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





Executive
Summary





For the
nine months ended September 30, 2010, we had revenue of
$7,235,158.  This was an increase of $1,798,814, or 33.1%, compared to
the nine months ended September 30, 2009.  The increase in revenue can
be attributed to an increase in product volume.  Product revenue
increased $1,809,978 or 38.2%, for the nine months ended September 30, 2010 from
the same period in 2009.   We anticipate the cost associated with
a high priced raw material will be significantly lower in the upcoming
months.  This is expected to lead to significantly lower revenue
during the quarter ended December 31, 2010, compared to previous periods in
2010.  The effect of this reduced cost is expected to have less of an
impact on gross profit.  Contract research revenue decreased slightly
to $686,311 from $697,475 for the first nine months of 2010 compared to the
first nine months of 2009.





Gross
profit increased $630,986 to $1,859,795, or 51.3%, for the nine months ended
September 30, 2010 compared to the same nine months in 2009.  The
increase in gross profit can be attributed to the increase in product revenue as
mentioned above.  Gross margin was 25.7% of total revenues for the
first nine months of 2010 compared to 22.6% for the same period in 2009,
reflecting higher product volume and improved product mix.





For the
nine months ended September 30, 2010, we had income before provision for income
tax of $128,894 compared to a loss of $659,478 for the nine months ended
September 30, 2009.  We had income applicable to common shares of
$51,608 for the nine months ended September 30, 2010 compared to a loss of
$678,662 for the same period in 2009.  This increase can be attributed
to the increase in revenue previously mentioned and a reduction of operating
expenses of approximately $55,000. Non-cash stock based compensation expenses
decreased to approximately $150,000 in the first nine months of 2010 from
approximately $331,000 in the same period of 2009.  In addition, the
first nine months of 2009 included a one time non-cash charge of $76,387 related
to the extension of expiration dates for common stock purchase
warrants.





Given
current market opportunities, we continue to invest in expanding production,
research and development, marketing, and sales.  This has resulted in
trial and qualification orders that were shipped to customers in the solar
industry throughout 2009 and 2010.  This should allow us to gain
market share and to be poised to receive large orders in targeted
applications.





In April
of 2010, we received ISO 9001:2008 registration, an internationally recognized
quality standard.  Prior to April 2010 we were ISO 9001:2000
registered.





During
the first quarter of 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.  During
the second quarter of 2010 a total of 40,833 common stock warrants were
exercised at a price of $2.88 per common share.  The related cash
proceeds were $117,599.


14


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





The
Company’s growth strategy, especially for the  Solar market, involves
substantial investments to develop innovative transparent conductive oxide
material systems and also scale production capabilities.  Research
also continues on High Temperature Superconductor
applications.  During the past three years the Company has received
several grants and awards from Federal and State agencies to advance these
efforts.  Additional detail concerning these grants and awards is
presented in Government Grants and Awards on page 19 of this
document.





RESULTS
OF OPERATIONS





Nine
and three months ended September 30, 2010 (unaudited) compared to nine and three
months ended September 30, 2009 (unaudited):





Revenue





Revenue
for the nine months ended September 30, 2010 were $7,235,158 compared to
$5,436,344, for the same period last year, an increase of $1,798,814 or
33.1%.  Product revenue increased $1,809,978 or 38.2%, for the nine
months ended September 30, 2010 from the same period in 2009.  The
increase in revenue can be attributed to an increase in product
volume.  Contract research revenue decreased slightly to $686,311 from
$697,475 for the first nine months of 2010 compared to the same period in
2009.





Revenue
for the three months ended September 30, 2010 was $2,433,381 compared to
$2,224,756, for the same period last year, an increase of $208,625 or
9.4%.  As previously mentioned this increase can be attributed to an
increase in product volume.  Product revenue increased $163,488 or
8.1%, for the three months ended September 30, 2010 from the same period in
2009. Contract research revenue increased to $241,538 from $196,401, an increase
of 23.0%, for the third quarter of 2010 compared to the third quarter of 2009,
due to the commencement of the TFPVP project in 2010.





Gross
Profit





Gross
profit for the nine months ended September 30, 2010 was $1,859,795, which
represented gross margin of 25.7% of total revenue compared to $1,228,809 and
22.6% of total revenue for the nine months ended September 30,
2009.  The increase in gross profit can be attributed to the increase
in product revenue as previously mentioned.





Gross
profit for the three months ended September 30, 2010 was $515,945, which
represented gross margin of 21.2% of total revenue compared to gross profit of
$552,299 and gross margin of 24.8% of total revenue for the three months ended
September 30, 2009.  This decrease in gross profit and gross margin
can be attributed to the product mix in product
revenue.





Marketing
and Sales Expense





Marketing
and Sales expense for the nine months ended September 30, 2010 increased
slightly to $495,997 from $492,557, an increase of 0.7% over the same period in
2009.  The increase was due to an increase in manufacturer’s sales
representative commissions and travel related expenses.


15


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





Partially
offsetting these increased expenses were a reduction in wages and non-cash stock
based compensation expense.





Marketing
and Sales expense for the three months ended September 30, 2010 increased to
$185,767 from $178,107, an increase of 4.3% for the same period in
2009.  The increase was due to increased marketing efforts which
resulted in higher travel and trade show expenses in the third quarter of 2010
compared to the same period in 2009.





General
and Administrative Expense





General
and administrative expense for the nine months ended September 30, 2010
decreased to $862,054 from $976,568, or 11.7%, for the nine months ended
September 30, 2009.  The decrease was the result of less expense
related to Sarbanes-Oxley compliance and non-cash stock based compensation.
Wages have increased in 2010 as a result of the reinstatement of wage cuts
implemented during the second quarter of 2009.





General
and administrative expense for the three months ended September 30, 2010 was
$265,843 compared to $273,185, a decrease of 2.7%,  for the three
months ended September 30, 2009.  The decrease was the result of less
expense related to Sarbanes-Oxley compliance which was largely offset by the
reinstatement of wage cuts implemented during the second quarter of
2009.





Research
and Development Expense





Research
and development expense for the first nine months of 2010 was $320,740 compared
to $264,406 for the same period in 2009, an increase of
21.3%.  Research and development expense for the three months ended
September 30, 2010 was $119,979 compared to $59,829 for the same period in 2009,
an increase of 100.5%.  We continue to develop innovative transparent
conductive oxide systems to further align our activities with customer needs, as
well as trial materials which resulted in increased research and development
expense.  These new research and development endeavors have moved us beyond
the scope of our current federal and state grants and awards.





Interest
Income and Expense





Interest
income was $4,194 and $5,688 for the nine months ended September 30, 2010 and
2009, respectively.  The decrease in interest rates reduced the amount
of interest earned.  Interest income was $1,531 and $842 for the three
months ended September 30, 2010 and 2009, respectively.  A higher cash
balance during the third quarter of 2010 compared to the third quarter of 2009
resulted in higher interest income.





Interest
expense was $66,555 and $84,057 for the nine months ended September 30, 2010 and
2009, respectively.  Interest expense was $21,623 and $26,834 for the
three months ended September 30, 2010 and 2009, respectively.  The
decrease was due to the maturity of four capital leases plus more principal and
less interest being applied to ongoing capital lease payments.


16


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





Other
Expense





A one
time non-cash financing expense associated with the extension of a warrant
expiration date was approximately $76,000 during the nine months ended September
30, 2009.  There was no such expense in 2010.





Income
Tax Expense





Income
tax expense for the nine months ended September 30, 2010 was $59,064 compared to
$862 for the nine months ended September 30, 2009.  For the three
months ended September 30, 2010 there was an income tax benefit of
$24,304.  Income tax expense for the three months ended September 30,
2009 was $287.  The deferred tax benefit of $156,000 at December 31,
2009 was reduced by $44,000 during the first nine months of 2010 to account for
the expected usage of prior net operating losses against current year
income.





COMMON
SHARES





The
following schedule represents our outstanding common shares during the period of
2010 through 2019 assuming all outstanding stock options and stock warrants at
October 25, 2010 are exercised during the year of expiration.  If each
shareholder exercises his or her options or warrants, it could increase our
common shares by 1,089,850 to 4,863,148 by December 31,
2019.  Exercise prices for options and warrants range from $1.00 to
$6.00 at October 25, 2010.  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
Outstanding2010
                    
                    
                    20,000
                    
                    
                    
                    3,793,2982011
                    
                    
                    62,500
                    
                    
                    
                    3,855,7982012
                    
                    
                    160,600
                    
                    
                    
                    4,016,3982013
                    
                    
                    30,250
                    
                    
                    
                    4,046,6482014
                    
                    
                    180,000
                    
                    
                    
                    4,226,6482015
                    
                    
                    140,000
                    
                    
                    
                    4,366,6482016
                    
                    
                    37,000
                    
                    
                    
                    4,403,6482017
                    
                    
                    -
                    
                    
                    
                    4,403,6482018
                    
                    
                    9,500
                    
                    
                    
                    4,413,1482019
                    
                    
                    450,000
                    
                    
                    
                    4,863,148





LIQUIDITY
AND WORKING CAPITAL





At
September 30, 2010, working capital was $2,060,525 compared to $1,303,033 at
September 30, 2009. We provided cash from operations of approximately $471,000
for the nine months ended September 30, 2010.  We used approximately
$133,000 in cash from operations for the nine months ended September 30,
2009.  Non-cash items including depreciation, accretion and
amortization, stock based compensation, financing expense of warrant extension,
change in deferred tax asset, inventory reserve on excess and obsolete
inventory, and provision for doubtful accounts were approximately $574,000 and
$753,000, respectively, for the nine months ended September 30, 2010 and
2009.  Accounts receivable, inventory, prepaid expenses and other
assets decreased approximately $869,000 for the nine months ended September 30,
2010.  This decrease is due to a decrease in prepaid expenses related
to purchases of a high priced raw material whose cost has
declined.  Accounts receivable, inventory, prepaid expenses and other
assets increased approximately $194,000 for the nine months ended September 30,
2009.  Accounts payable, accrued expenses and customer deposits
decreased approximately $1,042,000 for the nine months ended September 30,
2010.  This decrease is related to a reduction in customer deposits
which is due to a decrease in costs associated with a high priced raw material
previously discussed.  Accounts payable, accrued expenses and customer
deposits decreased approximately $32,000 for the nine months ended September 30,
2009.  Cash of approximately $211,000 and $143,000 was used for
investing activities for the nine months ended September 30, 2010 and 2009,
respectively.  The amounts invested were used to purchase machinery
and equipment for increased production capacity and new product
lines.


17


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





Cash of
approximately $169,000 was provided by financing activities during the nine
months ended September 30, 2010.  Principal payments to third parties
for capital lease obligations and a note payable approximated
$337,000.  Proceeds received from the exercise of common stock
warrants were $490,799.  Proceeds received from the exercise of common
stock options were $15,145.  We incurred new capital lease obligations
of approximately $193,000 for new production equipment.





During
the nine months ended September 30, 2009 cash of approximately $295,000 was used
for financing activities.  Principal payments to third parties for
capital lease obligations approximated $272,000.  Proceeds received
from the exercise of common stock options were $1,550. Payments related to
Series B Preferred stock dividends were $24,430.  We incurred new
capital lease obligations of approximately $556,000 for new production
equipment.





As of
September 30, 2010, cash on-hand was $1,536,513.  We believe, based on
forecasted sales and expenses, that funding will be adequate to sustain
operations at least through September 30, 2011.





We have
the ability to draw on a Revolving Note from The Huntington National
Bank.  The principal amount of the Revolving Note is
$500,000.  As of September 30, 2010 there was no outstanding balance
on the Revolving Note.





During
the second quarter of 2010 we applied for a 166 Direct Loan in the amount of
$744,250 with the Ohio Department of Development (ODOD).  Final
approval by the State Controlling Board was granted in September
2010.  ODOD also recommended that the Ohio Tax Credit Authority
approve a tax credit equal to 45 percent of employee income tax withholdings
resulting from the project for five years.   This credit has an
estimated value of $86,000 during the entire term.  ODOD also is
prepared to offer funding from the Rapid Outreach Grant for up to $25,000 for
costs associated with the acquisition and installation of machinery and
equipment.





We also
applied for a 166 Direct Loan through the Advanced Energy Program with The Ohio
Air Quality Development Authority (OAQDA) for approximately $1.4
million.  The 166 Direct Loan from ODOD remains contingent on the
final approval of this 166 Direct Loan from OAQDA.  Together, these
loans can fund approximately 70% of our current capital requirements of
approximately $3 million to support our planned growth.  In October of
2010 the Development Finance Advisory Council recommended the funding of the
loan from OAQDA.  It is anticipated that this loan will reach the
State Controlling Board for final review in the fourth quarter of
2010.


18


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





GOVERNMENT
GRANTS AND CONTRACTS





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 (TFPVP) to commercialize advanced technology for high power
density rotatable ceramic sputtering targets.  These targets are used
in the manufacture of thin film photovoltaics.  This technology will
enable manufacturers to operate rotatable sputtering targets at higher power
densities than current technology.   The approval of the grant
was received during January 2010 and the work on the contract commenced in the
first quarter of 2010.  The work on the contract is expected to
continue through the first quarter of 2012.





During
the third quarter of 2009 we received notification from the Department of Energy
(DOE) of an Assistance Agreement in the amount of approximately
$650,000.  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 (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.  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 the first quarter of 2011.


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, 2009 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.


19





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 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 September 30, 2010
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.





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.


20


Item
      4.
            Controls
      and Procedures (continued)





Internal
Controls over Financial Reporting





Management
previously disclosed a material weakness in internal control over financial
reporting in its annual report on Form 10-K, filed on February 17, 2010 for the
year ended December 31, 2009, relating to 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 shall be
performed by separate individuals.  In order to remediate this
weakness, we will need to hire additional employees.  Although we will
continue to evaluate 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.





Changes
in Internal Controls over Financial Reporting





There
were no changes in our internal controls over financial reporting for the nine
months ended September 30, 2010 that materially affected or were reasonably
likely to materially affect our disclosure controls and
procedures.  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.   As a result, no
corrective actions were required or undertaken.


21





Part
II.   Other Information





Item
      6.
            Exhibits.





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 and Certification of
      Principal Financial Officer and Principal Accounting
    Officer.*





99.1
            Press
      Release dated November 1, 2010, entitled “SCI Engineered Materials, Inc.
      Reports Third Quarter 2010
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:  November
      1, 2010
              /s/ Daniel RooneyDaniel
      Rooney, Chairman of the Board ofDirectors,
      President and Chief Executive Officer(Principal
      Executive Officer)/s/ Gerald S. BlaskieGerald
      S. Blaskie, Vice President and ChiefFinancial
      Officer(Principal
      Financial Officer and PrincipalAccounting
      Officer)


22