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,
2009


or





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


For the transition period
from ____________ to _________________





Commission
file number:  0-31641





SCI
ENGINEERED MATERIALS, INC.


(Exact
name of small business issuer as specified in its charter)





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





2839
Charter Street, Columbus, Ohio 43228


(Address
of principal executive offices) (Zip Code)





(614)
486-0261


(Registrant’s
telephone number, including area code)





Not
Applicable


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





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.  Yesx  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
companyx





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





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





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, 2009 (unaudited)and
      December 31, 2008
                                3Statements
      of Operations for the Three Months and Nine MonthsEnded
      September 30, 2009 and 2008 (unaudited)
                                5Statements
      of Cash Flows for the Nine MonthsEnded
      September 30, 2009 and 2008 (unaudited)
                                6Notes
      to Financial Statements (unaudited)
                                8Item
      2.
                                Management's
      Discussion and Analysis of Financial Condition andResults
      of Operations.
                                14Item
      3.
                                Quantitative
      and Qualitative Disclosures About Market Risk.
                                N/AItem
      4.
                                Controls
      and Procedures.
                                22PART
      II.     OTHER
      INFORMATIONItem
      1.
                                Legal
      Proceedings.
                                N/AItem 1A.
                                Risk
      Factors
                                N/AItem
      2.
                                Unregistered
      Sales of Equity Securities and Use of Proceeds.
                                N/AItem
      3.
                                Defaults
      Upon Senior Securities.
                                N/AItem
      4.
                                Submission
      of Matters to a Vote of Security Holders.
                                N/AItem
      5.
                                Other
      Information.
                                N/AItem
      6.
                                Exhibits.
                                23Signatures.
                                23




2


PART
I.  FINANCIAL INFORMATION





ITEM
1. FINANCIAL STATEMENTS





SCI
ENGINEERED MATERIALS, INC.





BALANCE
SHEETS





September
      30,
                  
                  
                  December
      31,2009
                  
                  
                  2008(UNAUDITED)ASSETSCURRENT
      ASSETSCash
                  
                  $
                  827,694
                  
                  
                  $
                  1,399,050Accounts
      receivableTrade,
      less allowance for doubtful accounts of $15,753 and
$24,700
                  
                  
                  620,213
                  
                  
                  
                  464,016Contract
                  
                  
                  77,789
                  
                  
                  
                  109,717Other
                  
                  
                  16,496
                  
                  
                  
                  3,423Inventories
                  
                  
                  928,711
                  
                  
                  
                  1,264,433Prepaid
      expenses
                  
                  
                  427,764
                  
                  
                  
                  42,562Total
      current assets
                  
                  
                  2,898,667
                  
                  
                  
                  3,283,201PROPERTY
      AND EQUIPMENT, AT COSTMachinery
      and equipment
                  
                  
                  5,011,703
                  
                  
                  
                  4,192,516Furniture
      and fixtures
                  
                  
                  107,998
                  
                  
                  
                  107,998Leasehold
      improvements
                  
                  
                  315,054
                  
                  
                  
                  313,951Construction
      in progress
                  
                  
                  19,453
                  
                  
                  
                  144,6825,454,208
                  
                  
                  
                  4,759,147Less
      accumulated depreciation
                  
                  
                  (2,799,841
                  )
                  
                  
                  (2,469,030
                  )2,654,367
                  
                  
                  
                  2,290,117OTHER
      ASSETSDeposits
                  
                  
                  22,164
                  
                  
                  
                  29,002Intangibles
                  
                  
                  42,071
                  
                  
                  
                  34,254Total
      other assets
                  
                  
                  64,235
                  
                  
                  
                  63,256TOTAL
      ASSETS
                  
                  $
                  5,617,269
                  
                  
                  $
                  5,636,574





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


3





SCI
ENGINEERED MATERIALS, INC.





BALANCE
SHEETS





LIABILITIES AND
SHAREHOLDERS' EQUITY





September
      30,
                
                
                December
      31,2009
                
                
                2008(UNAUDITED)CURRENT
      LIABILITIESCapital
      lease obligation, current portion
                
                $
                368,843
                
                
                $
                285,408Note
      payable, current portion
                
                
                62,697
                
                
                
                20,386Accounts
      payable
                
                
                412,667
                
                
                
                249,309Accrued
      contract expenses
                
                
                -
                
                
                
                52,525Customer
      deposits
                
                
                537,646
                
                
                
                700,118Accrued
      compensation
                
                
                86,322
                
                
                
                94,167Accrued
      expenses and other
                
                
                127,459
                
                
                
                94,928Total
      current liabilities
                
                
                1,595,634
                
                
                
                1,496,841Capital
      lease obligation, net current portion
                
                
                827,776
                
                
                
                622,769Note
      payable, net current portion
                
                
                332,226
                
                
                
                379,614Total
      liabilities
                
                
                2,755,636
                
                
                
                2,499,224COMMITMENTS
      AND CONTINGENCIES
                
                
                -
                
                
                
                -SHAREHOLDERS'
      EQUITYConvertible
      preferred stock, Series B, 10% cumulative, nonvoting, no par value, $10
      stated value, optional redemption at 103%;   24,430 issued
      and outstanding
                
                
                367,539
                
                
                
                373,647Common
      stock, no par value, authorized 15,000,000 shares; 3,562,259 and 3,560,259
      shares issued and outstanding respectively
                
                
                9,187,733
                
                
                
                9,180,183Additional
      paid-in capital
                
                
                1,368,577
                
                
                
                985,396Accumulated
      deficit
                
                
                (8,062,216
                )
                
                
                (7,401,876
                )2,861,633
                
                
                
                3,137,350TOTAL
      LIABILITIES AND SHAREHOLDERS' EQUITY
                
                $
                5,617,269
                
                
                $
                5,636,574





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


4





SCI
ENGINEERED MATERIALS, INC.





STATEMENTS
OF OPERATIONS





THREE
MONTHS ENDED SEPTEMBER 30, 2009 AND 2008


AND
NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008


(UNAUDITED)





THREE
      MONTHS ENDED SEPT. 30,
                              
                              
                              NINE
      MONTHS ENDED SEPT. 30,2009
                              
                              
                              2008
                              
                              
                              2009
                              
                              
                              2008SALES
      REVENUE
                              
                              $
                              2,028,355
                              
                              
                              $
                              3,959,286
                              
                              
                              $
                              4,738,869
                              
                              
                              $
                              7,150,618CONTRACT
      RESEARCH REVENUE
                              
                              
                              196,401
                              
                              
                              
                              49,349
                              
                              
                              
                              697,475
                              
                              
                              
                              89,4702,224,756
                              
                              
                              
                              4,008,635
                              
                              
                              
                              5,436,344
                              
                              
                              
                              7,240,088COST
      OF SALES REVENUE
                              
                              
                              1,481,956
                              
                              
                              
                              3,218,620
                              
                              
                              
                              3,651,003
                              
                              
                              
                              5,552,257COST
      OF CONTRACT RESEARCH REVENUE
                              
                              
                              190,501
                              
                              
                              
                              20,449
                              
                              
                              
                              556,532
                              
                              
                              
                              51,3931,672,457
                              
                              
                              
                              3,239,069
                              
                              
                              
                              4,207,535
                              
                              
                              
                              5,603,650GROSS
      PROFIT
                              
                              
                              552,299
                              
                              
                              
                              769,566
                              
                              
                              
                              1,228,809
                              
                              
                              
                              1,636,438MARKETING
      AND SALES EXPENSE
                              
                              
                              178,107
                              
                              
                              
                              169,524
                              
                              
                              
                              492,557
                              
                              
                              
                              441,556GENERAL
      AND ADMINISTRATIVE EXPENSE
                              
                              
                              273,472
                              
                              
                              
                              241,101
                              
                              
                              
                              977,430
                              
                              
                              
                              751,562RESEARCH
      AND DEVELOPMENT EXPENSE
                              
                              
                              59,829
                              
                              
                              
                              133,066
                              
                              
                              
                              264,406
                              
                              
                              
                              355,785INCOME
      (LOSS) FROM OPERATIONS
                              
                              
                              40,891
                              
                              
                              
                              225,875
                              
                              
                              
                              (505,584
                              )
                              
                              
                              87,535OTHER
      INCOME (EXPENSE)Interest
      income
                              
                              
                              842
                              
                              
                              
                              5,569
                              
                              
                              
                              5,688
                              
                              
                              
                              19,744Interest
      expense
                              
                              
                              (26,834
                              )
                              
                              
                              (27,490
                              )
                              
                              
                              (84,057
                              )
                              
                              
                              (79,487
                              )Financing
      expense
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              (76,387
                              )
                              
                              
                              -Gain
      on disposal of equipment
                              
                              
                              -
                              
                              
                              
                              800
                              
                              
                              
                              -
                              
                              
                              
                              2,000(25,992
                              )
                              
                              
                              (21,121
                              )
                              
                              
                              (154,756
                              )
                              
                              
                              (57,743
                              )INCOME
      (LOSS) BEFORE PROVISION FOR INCOME TAX
                              
                              
                              14,899
                              
                              
                              
                              204,754
                              
                              
                              
                              (660,340
                              )
                              
                              
                              29,792INCOME
      TAX EXPENSE
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -NET
      INCOME (LOSS)
                              
                              
                              14,899
                              
                              
                              
                              204,754
                              
                              
                              
                              (660,340
                              )
                              
                              
                              29,792DIVIDENDS
      ON PREFERRED STOCK
                              
                              
                              (6,107
                              )
                              
                              
                              (6,119
                              )
                              
                              
                              (18,322
                              )
                              
                              
                              (18,402
                              )INCOME
      (LOSS) APPLICABLE TO COMMON SHARES
                              
                              $
                              8,792
                              
                              
                              $
                              198,635
                              
                              
                              $
                              (678,662
                              )
                              
                              $
                              11,390EARNINGS
      PER SHARE - BASIC AND DILUTED(Note
      7)NET
      INCOME (LOSS) PER COMMON SHARE BEFORE DIVIDENDS ON PREFERRED
      STOCKBasic
                              
                              $
                              0.00
                              
                              
                              $
                              0.06
                              
                              
                              $
                              (0.19
                              )
                              
                              $
                              0.01Diluted
                              
                              $
                              0.00
                              
                              
                              $
                              0.05
                              
                              
                              $
                              (0.19
                              )
                              
                              $
                              0.01INCOME
      (LOSS) PER COMMON SHARE AFTER DIVIDENDS ON PREFERRED
      STOCKBasic
                              
                              $
                              0.00
                              
                              
                              $
                              0.06
                              
                              
                              $
                              (0.19
                              )
                              
                              $
                              0.00Diluted
                              
                              $
                              0.00
                              
                              
                              $
                              0.05
                              
                              
                              $
                              (0.19
                              )
                              
                              $
                              0.00WEIGHTED
      AVERAGE SHARES OUTSTANDINGBasic
                              
                              
                              3,562,259
                              
                              
                              
                              3,560,196
                              
                              
                              
                              3,562,186
                              
                              
                              
                              3,520,490Diluted
                              
                              
                              3,896,530
                              
                              
                              
                              4,086,906
                              
                              
                              
                              3,562,186
                              
                              
                              
                              4,122,439





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, 2009 AND 2008





(UNAUDITED)





2009
                          
                          
                          2008CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      (loss) income
                          
                          $
                          (660,340
                          )
                          
                          $
                          29,792Adjustments
      to reconcile net (loss) income to net cash used in operating
      activities:Depreciation
      and accretion
                          
                          
                          339,401
                          
                          
                          
                          281,446Amortization
                          
                          
                          2,316
                          
                          
                          
                          2,316Stock
      based compensation
                          
                          
                          331,117
                          
                          
                          
                          45,873Financing
      expense related to warrant expiration date extension
                          
                          
                          76,387
                          
                          
                          
                          -Gain
      on sale of equipment
                          
                          
                          -
                          
                          
                          
                          (2,000
                          )Inventory
      reserve
                          
                          
                          12,868
                          
                          
                          
                          7,930Provision
      for doubtful accounts
                          
                          
                          (8,947
                          )
                          
                          
                          -Changes
      in operating assets and liabilities:(Increase)
      decrease in assets:Accounts
      receivable
                          
                          
                          (128,395
                          )
                          
                          
                          (397,472
                          )Inventories
                          
                          
                          322,855
                          
                          
                          
                          (764,389
                          )Prepaid
      expenses
                          
                          
                          (385,202
                          )
                          
                          
                          (149,089
                          )Other
      assets
                          
                          
                          (3,295
                          )
                          
                          
                          (16,855
                          )Increase
      (decrease) in liabilities:Accounts
      payable
                          
                          
                          163,358
                          
                          
                          
                          71,007Accrued
      expenses and customer deposits
                          
                          
                          (195,281
                          )
                          
                          
                          738,670Total
      adjustments
                          
                          
                          527,182
                          
                          
                          
                          (182,563
                          )Net
      cash used in operating activities
                          
                          
                          (133,158
                          )
                          
                          
                          (152,771
                          )CASH
      FLOWS FROM INVESTING ACTIVITIESProceeds
      on sale of equipment
                          
                          
                          -
                          
                          
                          
                          2,000Purchases
      of property and equipment
                          
                          
                          (142,983
                          )
                          
                          
                          (93,836
                          )Net
      cash used in investing activities
                          
                          
                          (142,983
                          )
                          
                          
                          (91,836
                          )CASH
      FLOWS FROM FINANCING ACTIVITIESProceeds
      from exercise of common stock options
                          
                          
                          1,550
                          
                          
                          
                          10,250Proceeds
      from exercise of common stock warrants
                          
                          
                          -
                          
                          
                          
                          68,021Payments
      related to registration of common stock
                          
                          
                          -
                          
                          
                          
                          (16,906
                          )Payments
      related to Preferred Series B dividend
                          
                          
                          (24,430
                          )
                          
                          
                          (24,566
                          )Proceeds
      from note payable
                          
                          
                          -
                          
                          
                          
                          400,000Principal
      payments on capital lease obligations and note payable
                          
                          
                          (272,335
                          )
                          
                          
                          (467,869
                          )Net
      cash used in financing activities
                          
                          
                          (295,215
                          )
                          
                          
                          (31,070
                          )





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


6





SCI
ENGINEERED MATERIALS, INC.





STATEMENTS
OF CASH FLOWS (CONTINUED)





NINE
MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





(UNAUDITED)





2009
                  
                  
                  2008NET
      DECREASE IN CASH
                  
                  $
                  (571,356
                  )
                  
                  $
                  (275,677
                  )CASH - Beginning of
      period
                  
                  
                  1,399,050
                  
                  
                  
                  1,182,086CASH - End of
      period
                  
                  $
                  827,694
                  
                  
                  $
                  906,409SUPPLEMENTAL
      DISCLOSURES OF CASHFLOW
      INFORMATIONCash
      paid during the years for:Interest,
      net
                  
                  $
                  84,057
                  
                  
                  $
                  79,487Income
      taxes
                  
                  $
                  -
                  
                  
                  $
                  -SUPPLEMENTAL
      DISCLOSURES OF NONCASH FINANCING ACTIVITIESProperty
      and equipment purchased by capital lease
                  
                  $
                  555,700
                  
                  
                  $
                  262,900Machinery
      & equipment accrued asset retirement obligation
    increase
                  
                  $
                  4,968
                  
                  
                  $
                  2,484Financing
      expense related to warrant expiration date extension
                  
                  $
                  76,387
                  
                  
                  $
                  -SUPPLEMENTAL
      DISCLOSURES OF NONCASH OPERATING ACTIVITIESStock
      based compensation expense
                  
                  $
                  331,117
                  
                  
                  $
                  45,873





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


7


SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
1.                  Business
Organization and Purpose





SCI
Engineered Materials, Inc. (“SCI” or the “Company”), formerly Superconductive
Components, Inc., an Ohio corporation, was incorporated in 1987.  The
Company manufactures ceramic and metal sputtering targets for a variety of
industrial applications including: Photonics, Thin Film Solar, Thin Film
Battery, Semiconductor, and, to a lesser extent High Temperature Superconductive
(HTS) materials.  Photonics currently represents the Company’s largest
market for its targets.  Thin Film Solar is an industry that is
exhibiting rapid growth.  Thin Film Battery is a developing market
where manufacturers of batteries use the Company’s targets to produce very small
power supplies with small quantities of stored energy.  Semiconductor
is a developing market 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, 2008.  Interim results are not
      necessarily indicative of results for the full
  year.





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





Equipment
purchased with grant funding





In
      2004, the Company received funds of $517,935 from the Ohio Department of
      Development’s Third Frontier Action Fund (TFAF) for the purchase of
      equipment related to the grant’s purpose.  In a separate
      contract with the Department of Energy the Company received $27,500 for
      the purchase of equipment related to the contract’s
      purpose.  The Company elected to record the funds disbursed as a
      contra asset; therefore, the assets are not reflected in the Company’s
      financial statements.  As assets were purchased, the liability
      initially created when the cash was received was reduced with no revenue
      recognized or fixed asset recorded on the balance sheet.  As of
      September 30, 2009, the Company had disbursed the entire amount
      received.  The grant and contract both provide that as long as
      the Company performed in compliance with the grant/contract, the Company
      retained the rights to the equipment.  The grant was completed
      in January 2009.  The Company was in compliance with the
      requirements and retained the
equipment.


8


SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
2.                  Summary
of Significant Accounting Policies (continued)





Stock
Based Compensation





Compensation
cost recognized in 2009 and 2008 includes compensation cost for all stock-based
awards granted on or subsequent to January 1, 2006, based on the grant date fair
value estimated in accordance with the Stock Compensation Topic of the FASB
Accounting Standards Codification.  Non cash stock based compensation
costs were $331,117 and $45,873 for the nine months ended September 30, 2009 and
2008, respectively.   On January 2, 2009, the Stock Option and
Compensation Committee (the “Committee”) of the Board of Directors of the
Company approved the grant of options to purchase a total of 450,000 shares of
the Company’s common stock, effective January 2, 2009, to the Company’s Chief
Executive Officer and three other executive officers.  The Committee
also approved the grant of options to purchase 90,000 shares to the four
non-employee board members.  Pursuant to the terms of the agreements,
the options have an exercise price of $6.00 per share, the closing price of the
Company’s common stock as reported on the OTC Bulletin Board regulated quotation
service on January 2, 2009.  The four non-employee board members each
received compensation of 1,819 shares of the Company’s common stock and $5,000
in 2008.





Reclassification





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


9


SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
3. Common
Stock and Stock Options





The
cumulative status of options granted and outstanding at September 30, 2009, and
December 31, 2008, as well as options which became exercisable in connection
with the Stock Option Plans is summarized as follows:





Employee Stock
Options


AverageStock Options
                  
                  
                  Exercise PriceOutstanding
      at December 31, 2007
                  
                  
                  343,250
                  
                  
                  $
                  2.08Granted
                  
                  
                  21,000
                  
                  
                  
                  3.10Exercised
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  (1,500
                  )
                  
                  
                  3.10Outstanding
      at December 31, 2008
                  
                  
                  362,750
                  
                  
                  $
                  2.14Granted
                  
                  
                  450,000
                  
                  
                  
                  6.00Exercised
                  
                  
                  (1,000
                  )
                  
                  
                  1.55Forfeited
                  
                  
                  (10,000
                  )
                  
                  
                  3.10Outstanding
      at September 30, 2009
                  
                  
                  801,750
                  
                  
                  $
                  4.29Shares
      exercisable at December 31, 2008
                  
                  
                  321,050
                  
                  
                  $
                  2.00Shares
      exercisable at September 30, 2009
                  
                  
                  372,450
                  
                  
                  $
                  2.51





Non-Employee Director Stock
Options


WeightedAverageStock Options
                  
                  
                  Exercise PriceOutstanding
      at December 31, 2007
                  
                  
                  241,000
                  
                  
                  $
                  2.51Granted
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  (7,500
                  )
                  
                  
                  1.37Expired
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      at December 31, 2008
                  
                  
                  233,500
                  
                  
                  $
                  2.54Granted
                  
                  
                  90,000
                  
                  
                  
                  6.00Exercised
                  
                  
                  -
                  
                  
                  
                  -Expired
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      at September 30, 2009
                  
                  
                  323,500
                  
                  
                  $
                  3.50Shares
      exercisable at December 31, 2008
                  
                  
                  233,500
                  
                  
                  $
                  2.54Shares
      exercisable at September 30, 2009
                  
                  
                  263,500
                  
                  
                  $
                  2.94




10


SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
3. Common
Stock and Stock Options (continued)





Exercise
prices for options range from $1.00 to $6.00 at September 30,
2009.  The weighted average option price for all options outstanding
is $4.07 with a weighted average remaining contractual life of 6.0
years.





Note
4. Common
Stock Warrants





On
      May 1, 2009 the Board of Directors authorized the extension of the
      expiration date of the common stock purchase warrants that were due to
      expire in May 2009 and November 2009.  The expiration dates were
      extended to May 2010 and November 2010, respectively.  In total,
      this extension of the expiration date applied to an aggregate of 160,418
      warrants.  The non-cash financing expense associated with this
      extension was approximately
$76,000.





Note
5. Preferred
Stock





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





Note
6. Inventory





Inventory
is comprised of the following:


September
      30,
                  
                  
                  December 31,2009
                  
                  
                  2008(unaudited)Raw
      materials
                  
                  $
                  322,755
                  
                  
                  $
                  299,750Work-in-progress
                  
                  
                  415,530
                  
                  
                  
                  754,097Finished
      goods
                  
                  
                  252,336
                  
                  
                  
                  259,629Inventory
      reserve
                  
                  
                  (61,910
                  )
                  
                  
                  (49,043
                  )$
                  928,711
                  
                  
                  $
                  1,264,433




11


SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS




Note
7.                  Earnings
Per Share




Basic
      income (loss) per share is calculated as income (loss) available to common
      stockholders divided by the weighted average of common shares
      outstanding.  Diluted earnings per share is calculated as
      diluted income available to common stockholders divided by the diluted
      weighted average number of common shares.  Diluted weighted
      average number of common shares has been calculated using the treasury
      stock method for Common Stock equivalents, which includes Common Stock
      issuable pursuant to stock options and Common Stock
      warrants.  For the nine months ended September 30, 2009, all
      common stock options and warrants are anti-dilutive due to the net
      loss.  The following is provided to reconcile the earnings per
      share calculations:





Three
      months ended Sept 30,
                  
                  
                  Nine
      months ended Sept 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Income
      (loss) applicable to common shares
                  
                  $
                  8,792
                  
                  
                  $
                  198,635
                  
                  
                  $
                  (678,662
                  )
                  
                  $
                  11,390Weighted
      average common shares outstanding – basic
                  
                  
                  3,562,259
                  
                  
                  
                  3,560,196
                  
                  
                  
                  3,562,186
                  
                  
                  
                  3,520,490Effect
      of dilutions
                  
                  
                  334,271
                  
                  
                  
                  526,710
                  
                  
                  
                  -
                  
                  
                  
                  601,949Weighted
      average shares outstanding – diluted
                  
                  
                  3,896,530
                  
                  
                  
                  4,086,906
                  
                  
                  
                  3,562,186
                  
                  
                  
                  4,122,439





Note
8.                  Capital
Requirements





The
Company’s accumulated deficit since inception was $8,062,216 (unaudited) at
September 30, 2009.  While the Company has been profitable in recent
years, the historical losses have been financed primarily from additional
investments and loans by major shareholders and private offerings of common
stock and warrants to purchase common stock.  The Company cannot
assure that it will continue to operate at a profit or it will be able to raise
additional capital in the future to fund its operations.





As of
September 30, 2009, cash on-hand was $827,694.  Management believes,
based on forecasted sales and expenses, that funding will be adequate to sustain
operations at least through September 30, 2010.





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


12


SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
9. Note
Payable





On
January 22, 2009, the Company issued a Promissory Note dated as of January 13,
2009, to The Huntington National Bank, as Lender, pursuant to a Business Loan
Agreement dated as of January 13, 2009.  The Note is secured by a
Commercial Security Agreement granting the Lender a security interest in the
Company’s inventory, equipment and accounts.  The balance owed on the
Note at September 30, 2009 was $0.





Among
other items, the Note provides for the following:





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





Interest
on the note is subject to change from time to time based on changes in an
independent index which is the LIBO rate.  The index at the inception
of the note was 0.386% per annum.  The interest rate to be applied to
the unpaid principal balance during this note will be at a rate of 3.500
percentage points over the index.





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





Note
10.                Concentrations





At
September 30, 2009 the Company had a prepaid expense of approximately $379,000
to a supplier for the purchase of raw material.  The Company is confident
the supplier, with revenues of several billion dollars, will continue to deliver
the raw material as agreed upon.





Note
11.                Subsequent
Event.





The
Securities and Exchange Commission announced on October 2, 2009 that starting
for fiscal years on or after June 15, 2010, it will require non-accelerated
filers provide an attestation report of their independent auditor on internal
control over financial reporting as required by Section 404 of the
Sarbanes-Oxley Act of 2002.  It was previously announced that
non-accelerated filers would be required to provide an attestation report of
their independent auditor on internal control beginning for fiscal years ending
on or after December 15, 2009.  The Company did not anticipate an
extension at this late date and incurred expenses of approximately $42,000
through September 30, 2009 as it prepared to comply with Section 404 of the
Act.  Under Section 404, public companies and their independent
auditors are each required to report on the effectiveness of the companies'
internal control over financial reporting.


13


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





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




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




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




Overview




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


14


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





Executive
Summary





For the
nine months ended September 30, 2009, we had $407,504 in non-cash expenses,
which included $383,296 in non-cash expenses for the following items: stock
based compensation for stock options issued in January of 2009 and charges
related to the extension of the expiration date of common stock warrants in May
of 2009.  These non-cash stock based compensation expense included a
one time charge of $175,376 for options that vested immediately and ongoing
charges of $131,533.  These ongoing non-cash charges will continue
through 2010 and then decline beginning in the first quarter of
2011.  The non-cash financing expense related to the extension of the
expiration date of common stock warrants was a one time charge of
$76,387.  For the nine months ended September 30, 2008, we had $45,873
in non-cash stock based compensation expense.  The increase in these
non-cash charges of $361,631 had a material effect on our Statement of
Operations in 2009.





For the
nine months ended September 30, 2009, we had revenues of
$5,436,344.  This was a decrease of $1,803,744, or 24.9% when compared
to the nine months ended September 30, 2008.  Contract research
revenue increased to $697,475 for the first nine months of 2009 from $89,470 for
the same period in 2008, an increase of $608,005, reflecting the position of our
company in key technologies.  This increase in contract research
revenue combined with revenue from new markets helped offset the decrease in our
automotive market revenue.  The decline in total revenue can be
attributed to the current economic downturn as customers have decreased spending
and reduced inventory levels.   However, during the third quarter
of 2009 some of our automotive customers placed orders with us for delivery
during the third and fourth quarters of 2009.





Gross
profit was $1,228,809 for the nine months ended September 30, 2009 compared to
$1,636,438 for the same nine months in 2008.  This decrease was due to
the lower product revenue mentioned earlier.  Gross margin was 22.6%
of total revenues for the first nine months of 2009 and 2008.





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





Benefits
from these investments have been trial and qualification orders that were
shipped to customers in the Thin Film Solar industry.  The revenue
from these shipments totaled approximately $100,000 in the first quarter,
$312,000 in the second quarter, and $153,000 in the third quarter of 2009,
respectively.  Some of these trials and qualifications have resulted
in orders of approximately $1.3 million that are scheduled to ship during the
second half of 2009.  Additionally, late in the second quarter we
received some orders from our traditional markets that had been slow during the
first six months of 2009. This led to increased revenue in the third quarter of
2009 of $2,224,756 which was an increase of 69.7% over the second quarter of
2009 and 17.0% better than the first three months of 2009.   This
could be an indication that restocking inventories or increased business levels
is occurring.





For the
nine months ended September 30, 2009, we had net loss applicable to common
shares of $678,662 compared to net income of $11,390 for the same period in
2008.  The decrease can be attributed to additional operating expenses
of approximately $185,000 along with the decline in product revenue and gross
profit mentioned above.  Non-cash stock based compensation expense
increased approximately $285,000 in the first nine months of 2009 versus the
first nine months of 2008.  A non-cash financing expense related to
the extension of the expiration date for warrants was approximately $76,000 and
$0 for the nine months ended September 30, 2009 and 2008,
respectively.


15


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





It is
possible that the revenues for the entire year of 2009 could be less than 2008
due to the significant reduction in a high priced raw material.  After
two years of unusually high prices above the long term average price of this raw
material, the price has returned to its long term average.  On
September 17, 2009 we filed a Form 8-K announcing a major customer informed us
that it intended to purchase this high value raw material directly and ship it
to us for processing.  However, since the September 17, 2009 filing
the customer has asked us, at times, to purchase this raw material for
them.  Should the customer purchase this raw material on a consistent
basis and ship it to us for processing it is anticipated that it would not
materially impact net income but it would result in lower revenue than previous
periods.  In addition, the global economic condition has weakened our
traditional markets.





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





During
the third quarter of 2009 we received notification from the Department of Energy
of an Assistance Agreement in the amount of approximately
$750,000.   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 began during the third quarter of 2009 and is expected to continue
through August 2011.





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





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





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


16


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





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





RESULTS
OF OPERATIONS





Nine
and three months ended September 30, 2009 (unaudited) compared to nine and three
months ended September 30, 2008 (unaudited):





Revenues





For the
nine months ended September 30, 2009, we had revenues of
$5,436,344.  This was a decrease of $1,803,744, or 24.9%, compared to
the nine months ended September 30, 2008.  Contract research revenue
increased to $697,475 for the first nine months of 2009 from $89,470 for the
same period in 2008, an increase of $608,005, reflecting our position in key
technologies.  This increase in contract research revenue combined
with revenue from new markets helped offset the decrease in our automotive
market revenue.  The decline in total revenue can be attributed to the
current economic downturn as customers have decreased spending and reduced
inventory levels.





For the
three months ended September 30, 2009 we had revenues of $2,224,756 compared to
$4,008,635 for the same period in 2008.  Contract research revenue was
$196,401 for the three months ended September 30, 2009 versus $49,349 for the
three months ended September 30, 2008.  Product revenue was $2,028,355
for the third quarter of 2009 compared to $3,959,286 for the third quarter of
2008, a decrease of $1,930,931.  This decrease can be attributable to
the automotive market.  As mentioned above, this decline in product
revenue can also be attributed to the current economic downturn as customers
have decreased spending and reduced inventory levels.





Late in
the second quarter of 2009, we received a $1 million order from a solar customer
and commenced shipping against this order in the third quarter.  In
addition we began receiving orders from our traditional markets.  This
led to revenue in the third quarter of 2009 of $2,224,756, which was an increase
of 69.7% over the second quarter of 2009 and 17.0% better than the first three
months of 2009.   This could be an indication of a need to
restock inventories or an increase in business levels.





Gross
Profit





Gross
profit for the nine months ended September 30, 2009 was $1,228,809 which
represented a gross margin of 22.6% of total revenue compared to $1,636,438 and
22.6% of total revenue for the nine months ended September 30,
2008.  Gross profit for the three months ended September 30, 2009 was
$552,299 which represented a gross margin of 24.8% of total revenue compared to
$769,566 and 19.2% of total revenue for the three months ended September 30,
2008.   The gross profit decline can be attributed primarily to
the decrease in product revenue previously mentioned.


17


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





Marketing
and Sales Expense





Marketing
and Sales expense for the nine months ended September 30, 2009 increased 11.6%
to $492,557 from $441,556 for the same period in 2008.  The increase
was due to increased non-cash stock based compensation expense of approximately
$38,000, higher expenses related to trade shows of approximately $12,000 as well
as increased commissions to our outside manufacturing sales representatives of
approximately $33,000.  A portion of this increase was offset by a
reduction in compensation to our inside personnel of approximately
$30,000.  Marketing and Sales expense for the three months ended
September 30, 2009 increased 5.1% to $178,107 from $169,524 for the same period
in 2008.





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





General
and Administrative Expense





General
and administrative expense for the nine months ended September 30, 2009
increased to $977,430 from $751,562 for the nine months ended September 30,
2008, or 30.1%.  The increase was primarily the result of non-cash
stock based compensation expense of approximately $243,000 compared to
approximately $36,000 for the same period in 2008, as well expenses related to
Sarbanes Oxley which were approximately $42,000 for the nine months ended
September 30, 2009 versus approximately $5,000 for the same period in
2008.  General and administrative expense for the three months ended
September 30, 2009 increased to $273,472 from $241,101 for the three months
ended September 30, 2008, or 13.4%.  The increase was primarily the
result of expenses related to Sarbanes Oxley which were $37,580 for the three
months ended September 30, 2009 versus $227 for the same period in 2008, an
increase of $37,353.   A portion of this increase was offset by a
reduction in compensation.





Research
and Development Expense





Research
and development expense for the first nine months of 2009 was $264,406 compared
to $355,785 for the same period in 2008, a decrease of
25.7%.  Research and development expense for the three months ended
September 30, 2009 was $59,829 compared to $133,066 for the same period in 2008,
a decrease of 55.0%.  We continue to incur expenses associated with
the continued development efforts in the Photonic, Thin Film Solar, Thin Film
Battery and Semiconductor markets, as well as research related to the SBIRs and
TFAEP.   The decrease in expense was a result of compensation
that was assigned to Cost of Contract Research
Revenue of approximately $59,000 for the third quarter of 2009 and $162,000 for
the nine months ended September 30, 2009.





Other
Income and Expense





Interest
income was $5,688 and $19,744 for the nine months ended September 30, 2009 and
2008, respectively.   Interest income was $842 and $5,569 for the
three months ended September 30, 2009 and 2008,
respectively.   The decrease in interest rates reduced the amount
of interest earned.


18


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





Interest
      expense was $84,057 and $79,487 for the nine months ended September 30,
      2009 and 2008, respectively and $26,834 and $27,490 for the three months
      ended September 30, 2009 and 2008, respectively.  The increase
      was due to additional capital lease obligations incurred for the purchase
      of production equipment for increased production capacity.  We
      received loan proceeds in the amount of $400,000 from the Ohio Department
      of Development in 2008.  These proceeds were used to reduce the
      balance on outstanding capital lease obligations.  The favorable
      interest rate on this loan (3%) helped offset the interest expense related
      to new capital lease obligations.





The
      non-cash financing expense associated with the extension of the warrant
      expiration date previously mentioned was approximately $76,000 for the
      nine months ended September 30, 2009 versus $0 in
  2008.





INCOME
      (LOSS) APPLICABLE TO COMMON SHARES





Loss
applicable to common shares was $678,662, or $(0.19) per common share compared
to net income of $11,390, or $0.00 per common share for the nine months ended
September 30, 2009 and 2008, respectively.  The loss or income
applicable to common shares includes net loss or net income from operations and
the accretion of Series B preferred stock dividends.  Dividends on the
Series B preferred stock accrue at 10% annually on the outstanding
shares.  Accrued dividends on the Series B preferred stock was $18,322
and $18,402 for the nine months ended September 30, 2009 and 2008,
respectively.  Basic net loss per common share before dividends on
preferred stock and based on (loss) income applicable to common shares was
($0.19) and $0.01 for the nine months ended September 30, 2009 and 2008,
respectively.




The
weighted averaged shares outstanding were 3,562,186 at September 30,
2009.  All outstanding common stock equivalents were anti-dilutive for
the nine months ended September 30, 2009 due to the net loss.  Basic
and diluted net income for the nine months ended September 30, 2008 was $0.00
per common share based on 3,520,490 and 4,122,439 weighted average shares
outstanding, respectively.




Basic net
income applicable to common shares for the three months ended September 30, 2009
was $0.00 per common share based on 3,562,259 weighted average shares
outstanding compared to $0.06 per common share based on 3,560,196 weighted
average shares outstanding for the three months ended September 30,
2008.




Diluted
net income applicable to common shares for the three months ended September 30,
2009 was $0.00 per common share based on 3,896,530 weighted average shares
outstanding compared to $0.05 per common share based on 4,086,906 weighted
average shares outstanding for the three months ended September 30,
2008.




The
income applicable to common shares includes net income from operations and the
accretion of Series B preferred stock dividends.  Dividends on the
Series B preferred stock accrue at 10% annually on the outstanding
shares.  Accrued dividends on the Series B preferred stock was $6,107
and $6,119 for the three months ended September 30, 2009 and 2008,
respectively.


19


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





The
following schedule represents our outstanding common shares during the period of
2009 through 2019 assuming all outstanding stock options and stock warrants are
exercised during the year of expiration.  If each shareholder
exercises his or her options or warrants, it could increase our common shares by
1,682,307 to 5,244,566 by December 31, 2019.  Exercise prices for
options and warrants range from $1.00 to $6.00 at September 30,
2009.  Assuming all such options and warrants are exercised in the
year of expiration, the effect on shares outstanding is illustrated as
follows:





Options and Warrants due to
      expire
                      
                      
                      Potential Shares
Outstanding2009
                      
                      
                      -
                      
                      
                      
                      3,562,2592010
                      
                      
                      603,807
                      
                      
                      
                      4,166,0662011
                      
                      
                      62,500
                      
                      
                      
                      4,228,5662012
                      
                      
                      169,000
                      
                      
                      
                      4,397,5662013
                      
                      
                      30,500
                      
                      
                      
                      4,428,0662014
                      
                      
                      180,000
                      
                      
                      
                      4,608,0662015
                      
                      
                      140,000
                      
                      
                      
                      4,748,0662016
                      
                      
                      37,000
                      
                      
                      
                      4,785,0662017
                      
                      
                      -
                      
                      
                      
                      4,785,0662018
                      
                      
                      9,500
                      
                      
                      
                      4,794,5662019
                      
                      
                      450,000
                      
                      
                      
                      5,244,566





LIQUIDITY
AND WORKING CAPITAL





At
September 30, 2009, working capital was $1,303,033 compared to $1,742,912 at
September 30, 2008.  We used cash in operations of approximately
$133,000 for the nine months ended September 30, 2009 and approximately $153,000
for the nine months ended September 30, 2008.   Significant
non-cash items including depreciation, accretion and amortization, stock based
compensation expense, financing expense of warrant extension, inventory reserve
on excess and obsolete inventory, and provision for doubtful accounts were
approximately $753,000 and $338,000 respectively, for the nine months ended
September 30, 2009 and 2008.  Accounts receivable, inventory, prepaid
expenses and other assets increased approximately $194,000 for the nine months
ended September 30, 2009.  Accounts receivable, inventory, prepaid
expenses and other assets increased approximately $1,327,800 for the nine months
ended September 30, 2008.  Accounts payable, accrued expenses and
customer deposits decreased approximately $32,000 for the nine months ended
September 30, 2009 and increased approximately $810,000 for the same period in
2008.  Cash of approximately $143,000 and $92,000 was used for
investing activities for the nine months ended September 30, 2009 and 2008,
respectively.  The amounts invested were used to purchase machinery
and equipment for increased production capacity and new product
lines.





Cash of
approximately $295,000 was used for financing activities during the nine months
ended September 30, 2009.  Cash payments to third parties for capital
lease obligations and a note payable 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.





Cash of
approximately $31,000 was used for financing activities during the nine months
ended September 30, 2008.  Cash payments to third parties for capital
lease obligations approximated $468,000.  Proceeds received from a
note payable were $400,000.  Proceeds received from the exercise of
common stock warrants were approximately $68,000.  Proceeds received
from the exercise of common stock options were $10,250.  Payments
related to Series B Preferred stock dividends were $24,566.  Payments
related to the registration of common stock were approximately
$17,000.  We incurred new capital lease obligations of approximately
$263,000 for new production equipment.


20


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





RISK
FACTORS





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





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





While we
have had profitable operations in recent years, profits have not been consistent
and we financed the historical losses primarily from additional investments and
loans by our major shareholders and private offerings of common stock and
warrants to purchase common stock. We cannot assure you that we will be able to
raise additional capital in the future to fund our operations.  While
certain of our major shareholders have advanced funds in the form of secured
debt, subordinated debt, accounts payable and guaranteeing bank debt in the
past, there is no commitment by these individuals to continue funding us or
guaranteeing bank debt in the future.  We will continue to seek new
financing or equity financing arrangements.  However, we cannot be
certain that we will be successful in efforts to raise additional
funds.




Off
Balance Sheet Arrangements





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





Critical Accounting
Policies





The
preparation of financial statements and related disclosures in conformity with
accounting principles generally accepted in the United States requires
management to make judgments, assumptions and estimates that affect the amounts
reported in the Financial Statements and accompanying notes.Note
2 to the Financial Statements in our Annual Report on Form 10-K for the year
ended December 31, 2008 describes the significant accounting policies and
methods used in the preparation of the Financial
Statements.  Estimates are used for, but not limited to, accounting
for the allowance for doubtful accounts, inventory allowances, property and
equipment depreciable lives, patents and licenses useful lives, and assessing
changes in which impairment of certain long-lived assets may
occur.   Actual results could differ from these
estimates.  The following critical accounting policies are impacted
significantly by judgments, assumptions and estimates used in the preparation of
the Financial Statements.  The allowance for doubtful accounts is
based on our assessment of the collectability of specific customer accounts and
the aging of the accounts receivable.  If there is a deterioration of
a major customer’s credit worthiness or actual defaults are higher than our
historical experience, our estimates of the recoverability of amounts due us
could be adversely affected.  Inventory purchases and commitments are
based upon future demand forecasts. If there is a sudden and significant
decrease in demand for our products or there is a higher risk of inventory
obsolescence because of rapidly changing technology and customer requirements,
we may be required to increase our inventory allowances and our gross margin
could be adversely affected.


21


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





Depreciable
and useful lives estimated for property and equipment, licenses and patents are
based on initial expectations of the period of time these assets and intangibles
will benefit us.  Changes in circumstances related to a change in our
business, change in technology or other factors could result in these assets
becoming impaired, which could adversely affect the value of these
assets.





Item
4.                   Controls
and Procedures





Evaluation of Disclosure Controls and
Procedures





Based on
an evaluation under the supervision and with the participation of our
management, our principal executive officer and principal financial officer have
concluded that the our disclosure controls and procedures as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934,
as  amended ("Exchange Act") were effective as of September 30, 2009
to ensure that information required to be disclosed in reports that are filed or
submitted under the Exchange Act is (i) recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission rules and forms and (ii) accumulated and communicated to our
management, including our principal executive officer and principal financial
officer, as appropriate to allow timely decisions regarding required
disclosure.




Inherent Limitations over Internal
Controls





Our
internal control over financial reporting is designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles. Our internal control over financial reporting
includes those policies and procedures that: (i) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of our assets;  (ii) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted  accounting
principles, and that receipts and expenditures are being made only in accordance
with authorizations of management and directors; and (iii) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of assets that could have a material effect on the financial
statements.





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





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


22


Part
II.   Other Information





Item
6.                   Exhibits.





10.1
              Description
      of information received from a customer regarding customer’s intent to
      purchase material directly and ship it to the Company (Incorporated by
      reference to the Company’s Current Report on Form 8-K, dated September 17,
      2009).31.1
              Rule
      13a-14(a) Certification of Principal Executive
Officer.*31.2
              Rule
      13a-14(a) Certification of Principal Financial
Officer.*32.1
              Section
      1350 Certification of Principal Executive Officer.*32.2
              Section
      1350 Certification of Principal Financial Officer and Principal Accounting
      Officer.*99.1
              Press
      Release dated November 3, 2009, entitled “SCI Engineered Materials, Inc.
      Reports Third Quarter 2009 Results.”*
      Filed with this report





Signatures





Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.





SCI
      ENGINEERED MATERIALS, INC.Date:  November
      3, 2009
              /s/ Daniel RooneyDaniel
      Rooney, Chairman of the Board of
                Directors,
      President and Chief Executive Officer(Principal
      Executive Officer)/s/ Gerald S. BlaskieGerald
      S. Blaskie, Vice President and Chief
                Financial
      Officer(Principal
      Financial Officer and Principal
                Accounting
      Officer)




23