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 June 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





3,773,008
shares of Common Stock, without par value, were outstanding at July 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 June 30, 2010 (unaudited) and December 31,
    2009
                3Statements
      of Operations for the Three and Six Months Ended June 30, 2010 and 2009
      (unaudited)
                5Statements
      of Cash Flows for the Six Months Ended June 30, 2010 and 2009
      (unaudited)
                6Notes
      to Financial Statements (unaudited)
                7Item
      2.
                Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations.
                12Item
      3.
                Quantitative
      and Qualitative Disclosures About Market Risk.
                N/AItem
      4.
                Controls
      and Procedures.
                19PART
      II.      OTHER INFORMATIONItem
      1.
                Legal
      Proceedings.
                N/AItem 1A.
                Risk
      Factors
                N/AItem
      2.
                Unregistered
      Sales of Equity Securities and Use of Proceeds.
                N/AItem
      3.
                Defaults
      Upon Senior Securities.
                N/AItem
      4.
                (Removed
      and Reserved).
                N/AItem
      5.
                Other
      Information.
                N/AItem
      6.
                Exhibits.
                21Signatures.
                21


2




PART
I.  FINANCIAL INFORMATION
 
 ITEM
1. FINANCIAL STATEMENTS
 
 SCI
ENGINEERED MATERIALS, INC.
 
 BALANCE
SHEETS
 
 ASSETS
 
 June 30,
                  
                  
                  December 31,2010
                  
                  
                  2009(UNAUDITED)CURRENT
      ASSETSCash
                  
                  $
                  1,594,168
                  
                  
                  $
                  1,107,216Accounts
      receivableTrade,
      less allowance for doubtful accounts of $15,753
                  
                  
                  618,539
                  
                  
                  
                  539,398Contract
                  
                  
                  127,550
                  
                  
                  
                  19,714Other
                  
                  
                  8,385
                  
                  
                  
                  11,000Inventories
                  
                  
                  1,410,619
                  
                  
                  
                  1,031,777Deferred
      taxes
                  
                  
                  84,000
                  
                  
                  
                  156,000Prepaid
      expenses
                  
                  
                  322,460
                  
                  
                  
                  977,536Total
      current assets
                  
                  
                  4,165,721
                  
                  
                  
                  3,842,641PROPERTY
      AND EQUIPMENT, AT COSTMachinery
      and equipment
                  
                  
                  5,165,395
                  
                  
                  
                  4,933,855Furniture
      and fixtures
                  
                  
                  130,798
                  
                  
                  
                  127,451Leasehold
      improvements
                  
                  
                  315,054
                  
                  
                  
                  315,054Construction
      in progress
                  
                  
                  93,419
                  
                  
                  
                  22,9665,704,666
                  
                  
                  
                  5,399,326Less
      accumulated depreciation
                  
                  
                  (3,064,061
                  )
                  
                  
                  (2,868,198
                  )2,640,605
                  
                  
                  
                  2,531,128OTHER
      ASSETSDeposits
                  
                  
                  15,655
                  
                  
                  
                  21,909Intangibles
                  
                  
                  39,813
                  
                  
                  
                  41,358Total
      other assets
                  
                  
                  55,468
                  
                  
                  
                  63,267TOTAL
      ASSETS
                  
                  $
                  6,861,794
                  
                  
                  $
                  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
 
 June 30,
                  
                  
                  December 31,2010
                  
                  
                  2009(UNAUDITED)CURRENT
      LIABILITIESCapital
      lease obligation, current portion
                  
                  $
                  390,825
                  
                  
                  $
                  363,270Note
      payable, current portion
                  
                  
                  63,336
                  
                  
                  
                  62,394Accounts
      payable
                  
                  
                  386,297
                  
                  
                  
                  263,468Customer
      deposits
                  
                  
                  830,083
                  
                  
                  
                  1,319,455Accrued
      compensation
                  
                  
                  149,564
                  
                  
                  
                  67,863Accrued
      expenses and other
                  
                  
                  222,065
                  
                  
                  
                  210,294Total
      current liabilities
                  
                  
                  2,042,170
                  
                  
                  
                  2,286,744Capital
      lease obligation, net of current portion
                  
                  
                  709,202
                  
                  
                  
                  738,750Note
      payable, net of current portion
                  
                  
                  285,314
                  
                  
                  
                  317,219Total
      liabilities
                  
                  
                  3,036,686
                  
                  
                  
                  3,342,713COMMITMENTS
      AND CONTINGENCIES
                  
                  
                  -
                  
                  
                  
                  -SHAREHOLDERS'
      EQUITYConvertible
      preferred stock, Series B, 10% cumulative, nonvoting, no par value, $10
      stated value, optional redemption at 103%;   24,297 shares
      issued and outstanding
                  
                  
                  383,760
                  
                  
                  
                  371,612Common
      stock, no par value, authorized 15,000,000 shares; 3,773,008 and 3,571,755
      shares issued and outstanding, respectively
                  
                  
                  9,719,118
                  
                  
                  
                  9,209,424Additional
      paid-in capital
                  
                  
                  1,500,061
                  
                  
                  
                  1,412,382Accumulated
      deficit
                  
                  
                  (7,777,831
                  )
                  
                  
                  (7,899,095
                  )3,825,108
                  
                  
                  
                  3,094,323TOTAL
      LIABILITIES AND SHAREHOLDERS' EQUITY
                  
                  $
                  6,861,794
                  
                  
                  $
                  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 SIX MONTHS ENDED JUNE 30, 2010 AND 2009
 
 (UNAUDITED)
 
 THREE MONTHS ENDED JUNE 30,
                          
                          
                          SIX MONTHS ENDED JUNE 30,2010
                          
                          
                          2009
                          
                          
                          2010
                          
                          
                          2009PRODUCT
      REVENUE
                          
                          $
                          2,354,405
                          
                          
                          $
                          1,055,404
                          
                          
                          $
                          4,357,005
                          
                          
                          $
                          2,710,514CONTRACT
      RESEARCH REVENUE
                          
                          
                          206,259
                          
                          
                          
                          254,649
                          
                          
                          
                          444,772
                          
                          
                          
                          501,0742,560,664
                          
                          
                          
                          1,310,053
                          
                          
                          
                          4,801,777
                          
                          
                          
                          3,211,588COST
      OF PRIODUCT REVENUE
                          
                          
                          1,735,227
                          
                          
                          
                          881,904
                          
                          
                          
                          3,124,408
                          
                          
                          
                          2,169,047COST
      OF CONTRACT RESEARCH
                          
                          
                          159,289
                          
                          
                          
                          179,159
                          
                          
                          
                          333,519
                          
                          
                          
                          366,0311,894,516
                          
                          
                          
                          1,061,063
                          
                          
                          
                          3,457,927
                          
                          
                          
                          2,535,078GROSS
      PROFIT
                          
                          
                          666,148
                          
                          
                          
                          248,990
                          
                          
                          
                          1,343,850
                          
                          
                          
                          676,510MARKETING
      AND SALES EXPENSE
                          
                          
                          155,908
                          
                          
                          
                          146,358
                          
                          
                          
                          310,230
                          
                          
                          
                          314,450GENERAL
      AND ADMINISTRATIVE EXPENSE
                          
                          
                          314,981
                          
                          
                          
                          288,347
                          
                          
                          
                          596,211
                          
                          
                          
                          703,383RESEARCH
      AND DEVELOPMENT EXPENSE
                          
                          
                          147,505
                          
                          
                          
                          79,247
                          
                          
                          
                          200,761
                          
                          
                          
                          204,577INCOME
      (LOSS) FROM OPERATIONS
                          
                          
                          47,754
                          
                          
                          
                          (264,962
                          )
                          
                          
                          236,648
                          
                          
                          
                          (545,900
                          )OTHER
      INCOME (EXPENSE)Interest
      income
                          
                          
                          1,607
                          
                          
                          
                          2,352
                          
                          
                          
                          2,663
                          
                          
                          
                          4,846Interest
      expense
                          
                          
                          (23,109
                          )
                          
                          
                          (28,635
                          )
                          
                          
                          (44,931
                          )
                          
                          
                          (57,223
                          )Financing
      expense
                          
                          
                          -
                          
                          
                          
                          (76,387
                          )
                          
                          
                          -
                          
                          
                          
                          (76,387
                          )Gain
      on disposal of equipment
                          
                          
                          10,251
                          
                          
                          
                          -
                          
                          
                          
                          10,251
                          
                          
                          
                          -(11,251
                          )
                          
                          
                          (102,670
                          )
                          
                          
                          (32,017
                          )
                          
                          
                          (128,764
                          )INCOME
      (LOSS) BEFORE PROVISION FOR INCOME TAX
                          
                          
                          36,503
                          
                          
                          
                          (367,632
                          )
                          
                          
                          204,631
                          
                          
                          
                          (674,664
                          )INCOME
      TAX EXPENSE
                          
                          
                          (21,670
                          )
                          
                          
                          (287
                          )
                          
                          
                          (83,367
                          )
                          
                          
                          (575
                          )NET
      INCOME (LOSS)
                          
                          
                          14,833
                          
                          
                          
                          (367,919
                          )
                          
                          
                          121,264
                          
                          
                          
                          (675,239
                          )DIVIDENDS
      ON PREFERRED STOCK
                          
                          
                          (6,074
                          )
                          
                          
                          (6,108
                          )
                          
                          
                          (12,149
                          )
                          
                          
                          (12,215
                          )INCOME
      (LOSS) APPLICABLE TO COMMON SHARES
                          
                          $
                          8,759
                          
                          
                          $
                          (374,027
                          )
                          
                          $
                          109,115
                          
                          
                          $
                          (687,454
                          )EARNINGS PER SHARE -
      BASIC AND DILUTED (Note
      6)INCOME
      (LOSS) APPLICABLE TO COMMON SHARES PER COMMON SHAREBasic
                          
                          $
                          0.00
                          
                          
                          $
                          (0.10
                          )
                          
                          $
                          0.03
                          
                          
                          $
                          (0.19
                          )Diluted
                          
                          $
                          0.00
                          
                          
                          $
                          (0.10
                          )
                          
                          $
                          0.03
                          
                          
                          $
                          (0.19
                          )WEIGHTED
      AVERAGE SHARES OUTSTANDINGBasic
                          
                          
                          3,742,039
                          
                          
                          
                          3,562,259
                          
                          
                          
                          3,727,074
                          
                          
                          
                          3,562,149Diluted
                          
                          
                          3,882,826
                          
                          
                          
                          3,562,259
                          
                          
                          
                          3,873,231
                          
                          
                          
                          3,562,149
 
 The
accompanying notes are an integral part of these financial
statements.
  5
 
 SCI
ENGINEERED MATERIALS, INC.
 
 STATEMENTS
OF CASH FLOWS
 
 SIX
MONTHS ENDED JUNE 30, 2010 AND 2009
 
 (UNAUDITED)
 
 2010
                          
                          
                          2009CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      income (loss)
                          
                          $
                          121,264
                          
                          
                          $
                          (675,239
                          )Adjustments
      to reconcile net income (loss) to net cash from operating
      activities:Depreciation
      and accretion
                          
                          
                          239,993
                          
                          
                          
                          227,329Amortization
                          
                          
                          1,544
                          
                          
                          
                          1,544Stock
      based compensation
                          
                          
                          103,577
                          
                          
                          
                          281,203Financing
      expense related to warrant expiration date extension
                          
                          
                          -
                          
                          
                          
                          76,387Gain
      on sale of equipment
                          
                          
                          (10,251
                          )
                          
                          
                          -Deferred
      taxes
                          
                          
                          72,000
                          
                          
                          
                          -Inventory
      reserve
                          
                          
                          11,591
                          
                          
                          
                          12,000Credit
      for doubtful accounts
                          
                          
                          -
                          
                          
                          
                          (8,947
                          )Changes
      in operating assets and liabilities:Accounts
      receivable
                          
                          
                          (184,361
                          )
                          
                          
                          138,422Inventories
                          
                          
                          (390,433
                          )
                          
                          
                          393,752Prepaid
      expenses
                          
                          
                          655,076
                          
                          
                          
                          (683,116
                          )Other
      assets
                          
                          
                          6,255
                          
                          
                          
                          (4,518
                          )Accounts
      payable
                          
                          
                          122,829
                          
                          
                          
                          24,856Accrued
      expenses and customer deposits
                          
                          
                          (399,213
                          )
                          
                          
                          158,394Net
      cash from operating activities
                          
                          
                          349,871
                          
                          
                          
                          (57,933
                          )CASH
      FLOWS FROM INVESTING ACTIVITIESProceeds
      on sale of equipment
                          
                          
                          10,500
                          
                          
                          
                          -Purchases
      of property and equipment
                          
                          
                          (153,742
                          )
                          
                          
                          (106,250
                          )Net
      cash used in investing activities
                          
                          
                          (143,242
                          )
                          
                          
                          (106,250
                          )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
                          
                          
                          (225,621
                          )
                          
                          
                          (171,492
                          )Net
      cash provided by (used in) financing activities
                          
                          
                          280,323
                          
                          
                          
                          (194,372
                          )NET
      INCREASE (DECREASE) IN CASH
                          
                          
                          486,952
                          
                          
                          
                          (358,555
                          )CASH - Beginning of
      period
                          
                          
                          1,107,216
                          
                          
                          
                          1,399,050CASH - End of
      period
                          
                          $
                          1,594,168
                          
                          
                          $
                          1,040,495SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATIONCash
      paid during the years for:Interest,
      net
                          
                          $
                          44,931
                          
                          
                          $
                          57,223Income
      taxes
                          
                          
                          1,650
                          
                          
                          
                          2,450SUPPLEMENTAL
      DISCLOSURES OF NONCASH FINANCING ACTIVITIESProperty
      and equipment purchased by capital lease
                          
                          
                          192,665
                          
                          
                          
                          555,700Machinery
      & equipment accrued asset retirement obligation
    increase
                          
                          
                          3,312
                          
                          
                          
                          3,312Financing
      expense related to warrant extension
                          
                          
                          -
                          
                          
                          
                          76,387
 
 The
accompanying notes are an integral part of these financial
statements.
  6




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.





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 $103,577 and $281,203 for the six
months ended June 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.





Reclassification





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


7


SCI
ENGINEERED MATERIALS, INC.


NOTES
TO FINANCIAL STATEMENTS





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.





A total
of 99,585 common stock warrants at a price of $2.88 expired on May 31,
2010.  The Company has 246,639 common stock warrants at a price of
$3.00 due to expire in October 2010.  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 June 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 June 30, 2010
                    
                    
                    787,350
                    
                    
                    $
                    4.34Shares
      exercisable at December 31, 2009
                    
                    
                    369,325
                    
                    
                    $
                    2.52Shares
      exercisable at June 30, 2010
                    
                    
                    415,200
                    
                    
                    $
                    2.94


8


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 June 30, 2010
                    
                    
                    317,500
                    
                    
                    $
                    3.53Shares
      exercisable at December 31, 2009
                    
                    
                    259,500
                    
                    
                    $
                    2.95Shares
      exercisable at June 30, 2010
                    
                    
                    287,500
                    
                    
                    $
                    3.27





Exercise
prices for options range from $1.00 to $6.00 at June 30, 2010.  The
weighted average option price for all options outstanding is $4.11 with a
weighted average remaining contractual life of 5.3 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.  Accrued dividends on the Series B
preferred stock were $12,149 and $12,215 for the six months ended June 30, 2010
and 2009, respectively.





Note
      5.
            Inventories





Inventories
      are comprised of the following:





June
      30,
                  
                  
                  December 31,2010
                  
                  
                  2009(unaudited)Raw
      materials
                  
                  $
                  406,942
                  
                  
                  $
                  371,060Work-in-progress
                  
                  
                  844,965
                  
                  
                  
                  506,288Finished
      goods
                  
                  
                  219,345
                  
                  
                  
                  204,026Inventory
      reserve
                  
                  
                  (60,633
                  )
                  
                  
                  (49,597
                  )$
                  1,410,619
                  
                  
                  $
                  1,031,777


9


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.  At June 30, 2009 all
      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 June 30,
                    
                    
                    For
      six months ended June 30,2010
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2009Income
      (loss) applicable to common shares
                    
                    $
                    8,759
                    
                    
                    $
                    (374,027
                    )
                    
                    $
                    109,115
                    
                    
                    $
                    (687,454
                    )Weighted
      average common shares outstanding – basic
                    
                    
                    3,742,039
                    
                    
                    
                    3,562,259
                    
                    
                    
                    3,727,074
                    
                    
                    
                    3,562,149Effect
      of dilutions
                    
                    
                    140,787
                    
                    
                    
                    -
                    
                    
                    
                    146,157
                    
                    
                    
                    -Weighted
      average shares outstanding – diluted
                    
                    
                    3,882,826
                    
                    
                    
                    3,562,259
                    
                    
                    
                    3,873,231
                    
                    
                    
                    3,562,149





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 June 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.


10


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 proceeds were used to reduce the balance on
outstanding capital lease obligations.  The term of the loan is 84
months at an interest rate of 3%. There is also a one-quarter percent annual
servicing fee to be charged monthly on the outstanding principal
balance.  During each of the first 12 months the Company made only
monthly servicing fee and interest payments per the loan
agreement.  During months 13 through 84, the Company is making monthly
servicing fee, interest and principal payments.  The loan principal
balance will be fully amortized over the last 72 months.  The Note is
secured by a Security Agreement granting the Lender a security interest in the
project equipment.





Note
8.                Concentration
Risk





At June
30, 2010 the Company had a prepaid expense of approximately $200,000 to a
supplier for the purchase of raw material.  The supplier, with revenues of
several billion dollars, continues to deliver the raw material as agreed
upon.





At June
30, 2010 the Company had a receivable of approximately $190,000 from a
customer.  This balance is consistent with month end balances for the
past year.  None of the outstanding balance was past due as of June
30, 2010.





Note
9.                Income
Taxes





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





2010
                  
                  
                  2009Federal
      – deferred
                  
                  $
                  72,000
                  
                  
                  $
                  -State
      and local
                  
                  
                  11,367
                  
                  
                  
                  575$
                  83,367
                  
                  
                  
                  575


11


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.




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 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.


12


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





Executive
Summary





For the
six months ended June 30, 2010, we had revenues of $4,801,777.  This
was an increase of $1,590,189, or 49.5%, compared to the six months ended June
30, 2009.  The increase in revenues can be attributed to an increase
in product revenue, particularly in the Solar market.  Product revenue
increased $1,646,491, or 60.7%, for the six months ended June 30, 2010 from the
same period in 2009.   Contract research revenue decreased to
$444,772 from $501,074 for the first half of 2010 compared to the first half of
2009, due to the completion of certain milestones related to these
programs.





Gross
profit increased $667,340 to $1,343,850, or 98.6% for the six months ended June
30, 2010 compared to the same six months in 2009.  The increase in
gross profit can be attributed to the increase in product revenue as mentioned
above, particularly in the Solar market.  During the second quarter of
2010 we incurred higher costs related to qualification of new products versus
the same period last year.  Our products continue to be evaluated by a
growing number of companies engaged in the global solar market.  Gross
margin was 28.0% of total revenues for the first six months of 2010 compared to
21.1% for the same period in 2009, reflecting higher product volume and improved
product mix.





For the
six months ended June 30, 2010, we had income before provision for income tax of
$204,631 compared to a loss of $674,664 for the six months ended June 30,
2009.  We had income applicable to common shares of $109,115 for the
six months ended June 30, 2010 compared to a loss of $687,454 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 $115,000. Non-cash stock based compensation expenses decreased to
approximately $100,000 in the first half of 2010 from approximately $281,000 in
the first half of 2009.  In addition, the first half of 2009 included
a one time non-cash charge of $76,387 for a financing charge related to the
extension of expiration dates for common stock purchase warrants.





Given
current market opportunities, we continued to invest in expanding production,
R&D, marketing, and sales.  This has resulted in trial and
qualification orders that were shipped to customers in the solar industry
throughout 2009 and the first half of 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.





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.


13


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





During
the third quarter of 2009 we received notification from the Department of Energy
(DOE) of an Assistance Agreement in the amount of approximately $750,000 which
was subject to final approval by the DOE.   The award was
subsequently finalized at 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.





In July
2009, we were selected by a customer as a subcontractor for an award 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 tasks which
we had been involved are not expected to be completed and it is anticipated that
the program will conclude during the third quarter of 2010.   We
could not provide material that met the customer’s revised timeline and
specifications.  We billed approximately $5,000 to the customer for
our work on the contract and we do not expect to perform any additional
work.  The original amount of the subcontract work to be performed by
us was $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 the first quarter of 2011.





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.


14


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





RESULTS
      OF OPERATIONS





Six
and three months ended June 30, 2010 (unaudited) compared to six and three
months ended June 30, 2009 (unaudited):





Revenues





Revenues
for the six months ended June 30, 2010 were $4,801,777 compared to $3,211,588,
for the same period last year, an increase of $1,590,189 or
49.5%.  The increase in revenues can be attributed to an increase in
product revenue, particularly in the Solar market.  Product revenue
increased $1,646,491, or 60.7%, for the six months ended June 30, 2010 from the
same period in 2009.  Contract research revenue decreased to $444,772
from $501,074 for the first half of 2010 compared to the first half of
2009.   Revenues for the three months ended June 30, 2010 were
$2,560,664 compared to $1,310,053, for the same period last year, an increase of
$1,250,611 or 95.5%.  As previously mentioned this increase can be
attributed to an increase in product revenue, particularly in the Solar
market.  Product revenue increased $1,299,001, or 123.1%, for the
three months ended June 30, 2010 from the same period in 2009. Contract research
revenue decreased to $206,259 from $254,649 for the second quarter of 2010
compared to the second quarter of 2009, due to the completion of certain
milestones related to these programs.





Gross
      Profit





Gross
profit for the six months ended June 30, 2010 was $1,343,850, which represented
gross margin of 28.0% of total revenue compared to $676,510 and 21.1% of total
revenue for the six months ended June 30, 2009.  Gross profit for the
three months ended June 30, 2010 was $666,148, which represented gross margin of
26.0% of total revenue compared to $248,990 and 19.0% of total revenue for the
three months ended June 30, 2009.  The increase in gross profit and
gross margin can be attributed to the increase in product revenue previously
mentioned, particularly in the Solar market.  During the second
quarter of 2010 we incurred higher costs related to qualification of new
products versus the same period last year.  Our products continue to
be evaluated by a growing number of companies engaged in the global solar
market.





Marketing
and Sales Expense





Marketing
and Sales expense for the six months ended June 30, 2010 decreased 1.3% to
$310,230 from $314,450 for the same period in 2009.  The decrease was
due to less non-cash stock based compensation expense of approximately $21,000
as well as less travel related expenses of approximately
$7,000.  These reductions, along with a slight decrease in wages
helped offset an increase of approximately $36,000 in manufacturer’s sales
representative commissions in the first half of 2010.  Marketing and Sales
expense for the three months ended June 30, 2010 increased 6.5% to $155,908 from
$146,358 for the same period in 2009.  The increase was due to higher
manufacturer’s sales representative commissions in the second quarter of 2010
compared to the same period in 2009.





General
      and Administrative Expense





General
and administrative expense for the six months ended June 30, 2010 decreased to
$596,211 from $703,383, or 15.2%, for the six months ended June 30,
2009.  The decrease was the result of less non-cash stock based
compensation expense of approximately $135,000. General and administrative
expense for the three months ended June 30, 2010 was $314,981 compared to
$288,347 for the three months ended June 30, 2009, an increase of
9.2%.  The increase was the result of the reinstatement of wage cuts
introduced during the second quarter of 2009 as well as higher professional
fees.





Research
      and Development Expense





Research
and development expense for the first six months of 2010 was $200,761 compared
to $204,577 for the same period in 2009, a decrease of
1.9%.    Research and development expense for the three
months ended June 30, 2010 was $147,505 compared to $79,247 for the same period
in 2009, an increase of 86.1%.  During the first quarter of 2010 most
of our research and development resources were applied to ongoing R&D
contracts.  The second quarter saw a return to more internal research
involved with the solar industry.


15


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





Interest
      Income and Expense





Interest
income was $2,663 and $4,846 for the six months ended June 30, 2010 and 2009,
respectively.   Interest income was $1,607 and $2,352 for the
three months ended June 30, 2010 and 2009, respectively.   The
decrease in interest rates reduced the amount of interest earned.





Interest
expense was $44,931 and $57,223 for the six months ended June 30, 2010 and 2009,
respectively.  Interest expense was $23,109 and $28,635 for the three
months ended June 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.





Other
      Expense





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





Income
      Tax Expense





Income
      tax expense for the six months ended June 30, 2010 was $83,367 compared to
      $575 for the six months ended June 30, 2009.  Income tax expense
      for the three months ended June 30, 2010 was $21,670 compared to $287 for
      the three months ended June 30, 2009.  The deferred tax benefit
      of $156,000 at December 31, 2009 was reduced by $72,000 during the first
      half of 2010 to account for the expected usage of prior net operating
      losses against current year income.





INCOME
      (LOSS) APPLICABLE TO COMMON SHARES





Income
applicable to common shares was $109,115, or $0.03 per common share, for the six
months ended June 30, 2010 compared to a loss applicable to common shares of
$687,454, or $(0.19) per common share for the six months ended June 30,
2009.  The income or loss applicable to common shares includes income
or loss after provision for income tax 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 were $12,149 and $12,215 for the six months ended June
30, 2010 and 2009, respectively.  Basic income or loss per common
share before provision for income tax was $0.05 and $(0.19) for the six months
ended June 30, 2010 and 2009, respectively.




Income
applicable to common shares was $8,759, or $0.00 per common share, for the three
months ended June 30, 2010 compared to a loss applicable to common shares of
$374,027, or $(0.10) per common share for the three months ended June 30,
2009.  The income or loss applicable to common shares includes income
or loss after provision for income tax 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 $6,074 and $6,108 for the three months ended June
30, 2010 and 2009, respectively.  Basic income or loss per common
share before provision for income tax was $0.01 and $(0.10) for the three months
ended June 30, 2010 and 2009, respectively.




16


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




Basic and
diluted income applicable to common shares for the six months ended June 30,
2010 was $0.03 per common share based on 3,727,074 and 3,873,231 weighted
average shares outstanding, respectively.  The weighted averaged
shares outstanding were 3,562,149 at June 30, 2009.  All outstanding
common stock equivalents were anti-dilutive for the six months ended June 30,
2009 due to the net loss.




Basic and
diluted income applicable to common shares for the three months ended June 30,
2010 was $0.00 per common share based on 3,742,039 and 3,882,826 weighted
average shares outstanding, respectively.  The weighted averaged
shares outstanding were 3,562,259 at June 30, 2009.  All outstanding
common stock equivalents were anti-dilutive for the three months ended June 30,
2009 due to the net loss.




The
following schedule represents our outstanding common shares during the period of
2010 through 2019 assuming all outstanding stock options and stock warrants are
exercised during the year of expiration.  If each shareholder
exercises his or her options or warrants, it could increase our common shares by
1,371,489 to 5,144,497 by December 31, 2019.  Exercise prices for
options and warrants range from $1.00 to $6.00 at June 30,
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
                    
                    
                    301,639
                    
                    
                    
                    4,074,6472011
                    
                    
                    62,500
                    
                    
                    
                    4,137,1472012
                    
                    
                    160,600
                    
                    
                    
                    4,297,7472013
                    
                    
                    30,250
                    
                    
                    
                    4,327,9972014
                    
                    
                    180,000
                    
                    
                    
                    4,507,9972015
                    
                    
                    140,000
                    
                    
                    
                    4,647,9972016
                    
                    
                    37,000
                    
                    
                    
                    4,684,9972017
                    
                    
                    -
                    
                    
                    
                    4,684,9972018
                    
                    
                    9,500
                    
                    
                    
                    4,694,4972019
                    
                    
                    450,000
                    
                    
                    
                    5,144,497





LIQUIDITY
AND WORKING CAPITAL





At June
30, 2010, working capital was $2,123,551 compared to $1,266,378 at June 30,
2009. We provided cash from operations of approximately $350,000 for the six
months ended June 30, 2010.  We used approximately $58,000 in cash
from operations for the six months ended June 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 $429,000 and $590,000, respectively, for
the six months ended June 30, 2010 and 2009.  Accounts receivable,
inventory, prepaid expenses and other assets decreased approximately $87,000 for
the six months ended June 30, 2010.  Accounts receivable, inventory,
prepaid expenses and other assets increased approximately $155,000 for the six
months ended June 30, 2009.  Accounts payable, accrued expenses and
customer deposits decreased approximately $276,000 for the six months ended June
30, 2010.  Accounts payable, accrued expenses and customer deposits
increased approximately $183,000 for the six months ended June 30,
2009.  Cash of approximately $143,000 and $106,000 was used for
investing activities for the six months ended June 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 $280,000 was provided by financing activities during the six
months ended June 30, 2010.  Principal payments to third parties for
capital lease obligations and a note payable approximated
$226,000.  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 six months ended June 30, 2009 cash of approximately $194,000 was used for
financing activities.  Principal payments to third parties for capital
lease obligations approximated $171,000.  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
June 30, 2010, cash on-hand was $1,594,168.  We believe, based on
forecasted sales and expenses, that funding will be adequate to sustain
operations at least through June 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 June 30, 2010 there was no outstanding balance on the
Revolving Note.





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 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.





While we
have had profitable operations in three of the past four 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 it will be
successful in efforts to raise additional funds.


Off
Balance Sheet Arrangements





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


18


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





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.





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 June 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.


19





Item
      4.
            Controls
      and Procedures (continued)





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.





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





Changes
in Internal Controls over Financial Reporting





There
were no changes in our internal controls over financial reporting for the six
months ended June 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.


20


Part
II.   Other Information





Item
      6.
            Exhibits.





10.1
                            Description
      of exercise of 40,833 common stock warrants (Incorporated by reference to
      the Company’s Current Report on Form 8-K, dated June 4,
    2010).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 July 27, 2010, entitled “SCI Engineered Materials, Inc.
      Reports Second 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:  July
      27, 2010
            /s/ Daniel RooneyDaniel
      Rooney, Chairman of the Board of
              Directors,
      President and Chief Executive Officer(Principal
      Executive Officer)/s/ Gerald S. BlaskieGerald
      S. Blaskie, Vice President and Chief
              Financial
      Officer(Principal
      Financial Officer and Principal
              Accounting
      Officer)


21