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, 2011
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. Employer
incorporation 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 x   No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ Accelerated filer    ¨ Non-accelerated filer ¨ Smaller reporting company   x

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

3,778,898 shares of Common Stock, without par value, were outstanding at August 1, 2011.
 
 
 

 
 
FORM 10-Q

SCI ENGINEERED MATERIALS, INC.
 
Table of Contents

     
Page No.
       
PART I.
 
FINANCIAL INFORMATION
 
       
Item 1.
 
Financial Statements.
 
       
   
Balance Sheets as of June 30, 2011 (unaudited) and December 31, 2010
3
       
   
Statements of Operations for the Three and Six Months Ended June 30, 2011 and 2010 (unaudited)
5
       
   
Statements of Cash Flows for the Six Months Ended June 30, 2011 and 2010 (unaudited)
6
       
   
Statement of Shareholders’ Equity for the Six Months Ended June 30, 2011 (unaudited)
7
       
   
Notes to Financial Statements (unaudited)
8
       
Item 2.
 
Management's Discussion and Analysis of Financial Condition and Results of Operations.
13
       
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk.
N/A
       
Item 4.
 
Controls and Procedures.
22
       
PART II.
 
OTHER INFORMATION
 
       
Item 1.
 
Legal Proceedings.
N/A
       
Item 1A.
Risk Factors
N/A
       
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds.
N/A
       
Item 3.
 
Defaults Upon Senior Securities.
N/A
       
Item 4.
 
(Removed and Reserved).
N/A
       
Item 5.
 
Other Information.
N/A
       
Item 6.
 
Exhibits.
24
       
Signatures.
25

 
2

 
 
PART I.  FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SCI ENGINEERED MATERIALS, INC.

BALANCE SHEETS

   
June 30,
   
December 31,
 
   
2011
   
2010
 
    (UNAUDITED)        
ASSETS
           
             
CURRENT ASSETS
           
Cash
  $ 1,260,613     $ 1,511,752  
Accounts receivable
               
Trade, less allowance for doubtful accounts of $15,000 and $16,000, respectively
    477,886       574,965  
Contract
    16,250       86,501  
Other
    10,446       20,551  
Inventories
    1,517,385       1,344,426  
Deferred income taxes
    156,000       156,000  
Prepaid expenses
    237,955       51,369  
Total current assets
    3,676,535       3,745,564  
                 
PROPERTY AND EQUIPMENT, AT COST
               
Machinery and equipment
    5,550,180       5,267,891  
Furniture and fixtures
    134,666       134,666  
Leasehold improvements
    315,054       315,054  
Construction in progress
    686,107       -  
      6,686,007       5,717,611  
Less accumulated depreciation
    (3,467,648 )     (3,250,237 )
      3,218,359       2,467,374  
                 
OTHER ASSETS
               
Deposits
    49,756       29,621  
Intangibles
    16,997       49,276  
Total other assets
    66,753       78,897  
                 
TOTAL ASSETS
  $ 6,961,647     $ 6,291,835  

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

 
3

 
 
SCI ENGINEERED MATERIALS, INC.

BALANCE SHEETS

   
June 30,
   
December 31,
 
   
2011
   
2010
 
   
(UNAUDITED)
       
LIABILITIES AND SHAREHOLDERS' EQUITY
           
             
CURRENT LIABILITIES
           
Capital lease obligation, current portion
  $ 405,774     $ 399,780  
Notes payable, current portion
    65,263       64,292  
Accounts payable
    871,571       573,741  
Customer deposits
    750,915       366,153  
Accrued compensation
    62,090       71,704  
Accrued expenses and other
    202,831       232,701  
Total current liabilities
    2,358,444       1,708,371  
                 
Capital lease obligation, net of current portion
    485,738       505,758  
Notes payable, net of current portion
    520,051       252,927  
Total liabilities
    3,364,233       2,467,056  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
SHAREHOLDERS' EQUITY
               
Convertible preferred stock, Series B, 10% cumulative, nonvoting, no par value, $10 stated value, optional redemption at 103%; optional shareholder conversion 2 shares for 1; 24,152 shares issued and outstanding
    381,602       393,678  
Common stock, no par value, authorized 15,000,000 shares; 3,778,898 and 3,775,898 shares issued and outstanding, respectively
    9,730,040       9,725,390  
Additional paid-in capital
    1,636,944       1,587,727  
Accumulated deficit
    (8,151,172 )     (7,882,016 )
      3,597,414       3,824,779  
                 
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
  $ 6,961,647     $ 6,291,835  

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, 2011 AND 2010

(UNAUDITED)

   
THREE MONTHS ENDED JUNE 30,
   
SIX MONTHS ENDED JUNE 30,
 
   
2011
   
2010
   
2011
   
2010
 
               
 
       
PRODUCT REVENUE
  $ 2,129,733     $ 2,354,405     $ 4,442,031     $ 4,357,005  
CONTRACT RESEARCH REVENUE
    147,835       206,259       353,171       444,772  
      2,277,568       2,560,664       4,795,202       4,801,777  
                                 
COST OF PRODUCT REVENUE
    1,772,357       1,735,227       3,617,356       3,124,408  
COST OF CONTRACT RESEARCH
    88,382       159,289       213,479       333,519  
      1,860,739       1,894,516       3,830,835       3,457,927  
                                 
GROSS PROFIT
    416,829       666,148       964,367       1,343,850  
                                 
GENERAL AND ADMINISTRATIVE EXPENSE
    275,340       314,981       551,234       596,211  
                                 
RESEARCH AND DEVELOPMENT EXPENSE
    197,548       147,505       362,187       200,761  
                                 
MARKETING AND SALES EXPENSE
    119,915       155,908       275,972       310,230  
                                 
(LOSS) INCOME FROM OPERATIONS
    (175,974 )     47,754       (225,026 )     236,648  
                                 
OTHER INCOME (EXPENSE)
                               
Interest income
    861       1,607       1,586       2,663  
Interest expense
    (19,100 )     (23,109 )     (37,666 )     (44,931 )
Gain on sale of equipment
    -       10,251       425       10,251  
      (18,239 )     (11,251 )     (35,655 )     (32,017 )
                                 
(LOSS) INCOME BEFORE PROVISION FOR INCOME TAX
    (194,213 )     36,503       (260,681 )     204,631  
                                 
INCOME TAX EXPENSE
    (4,237 )     (21,670 )     (8,475 )     (83,367 )
                                 
NET (LOSS) INCOME
    (198,450 )     14,833       (269,156 )     121,264  
                                 
DIVIDENDS ON PREFERRED STOCK
    (6,038 )     (6,074 )     (12,076 )     (12,149 )
                                 
(LOSS) INCOME APPLICABLE TO COMMON SHARES
  $ (204,488 )   $ 8,759     $ (281,232 )   $ 109,115  
                                 
EARNINGS PER SHARE - BASIC AND DILUTED
                               
(Note 6)
                               
                                 
(LOSS) INCOME APPLICABLE TO COMMON SHARES PER COMMON SHARE
                               
Basic
  $ (0.05 )   $ 0.00     $ (0.07 )   $ 0.03  
Diluted
  $ (0.05 )   $ 0.00     $ (0.07 )   $ 0.03  
                                 
WEIGHTED AVERAGE SHARES OUTSTANDING
                               
Basic
    3,778,898       3,742,039       3,778,036       3,727,074  
Diluted
    3,778,898       3,882,826       3,778,036       3,873,231  

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, 2011 AND 2010

(UNAUDITED)

   
2011
   
2010
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net (loss) income
  $ (269,156 )   $ 121,264  
Adjustments to reconcile net (loss) income to net cash from operating activities:
               
Depreciation and accretion
    257,768       239,993  
Amortization
    1,544       1,544  
Stock based compensation
    61,293       103,577  
Patent impairment
    38,726       -  
Gain on sale of equipment
    (425 )     (10,251 )
Deferred income taxes
    -       72,000  
Inventory reserve
    18,000       11,591  
Credit for doubtful accounts
    (530 )     -  
Changes in operating assets and liabilities:
               
Accounts receivable
    177,965       (184,361 )
Inventories
    (190,959 )     (390,433 )
Prepaid expenses
    (186,586 )     655,076  
Other assets
    (28,125 )     6,255  
Accounts payable
    297,830       122,829  
Accrued expenses and customer deposits
    341,964       (399,213 )
Net cash provided by operating activities
    519,309       349,871  
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Proceeds on sale of equipment
    425       10,500  
Purchases of property and equipment
    (820,440 )     (153,742 )
Net cash used in investing activities
    (820,015 )     (143,242 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Proceeds from exercise of common stock options
    4,650       15,145  
Net proceeds from exercise of common stock warrants
    -       490,799  
Proceeds from note payable
    300,000       -  
Principal payments on capital lease obligations and notes payable
    (230,931 )     (225,621 )
Payment of cumulative dividends on preferred stock
    (24,152 )     -  
Net cash provided by financing activities
    49,567       280,323  
                 
NET (DECREASE) INCREASE IN CASH
    (251,139 )     486,952  
                 
CASH - Beginning of period
    1,511,752       1,107,216  
                 
CASH - End of period
  $ 1,260,613     $ 1,594,168  
                 
SUPPLEMENTAL DISCLOSURES OF CASH
               
FLOW INFORMATION
               
Cash paid during the years for:
               
Interest
  $ 37,666     $ 44,931  
Income taxes
    713       1,650  
                 
SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING ACTIVITIES
               
Property and equipment purchased by capital lease
    185,000       192,665  
Increase in asset retirement obligation
    3,312       3,312  

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

 
6

 

SCI ENGINEERED MATERIALS, INC.

STATEMENT OF SHAREHOLDERS' EQUITY

SIX MONTHS ENDED JUNE 30, 2011

(UNAUDITED)

   
Convertible
         
Additional
             
   
Preferred Stock,
   
Common
   
Paid-In
   
Accumulated
       
   
Series B
   
Stock
   
Capital
   
Deficit
   
Total
 
Balance at January 1, 2011
  $ 393,678     $ 9,725,390     $ 1,587,727     $ (7,882,016 )   $ 3,824,779  
                                         
Accretion of cumulative dividends
    12,076       -       (12,076 )     -       -  
                                         
Stock based compensation expense (Note 3)
    -       -       61,293       -       61,293  
                                         
Payment of cumulative dividends on preferred stock (Note 4)
    (24,152 )     -       -       -       (24,152 )
                                         
Proceeds from exercise of stock options (Note 3)
    -       4,650       -       -       4,650  
                                         
Net loss
    -       -       -       (269,156 )     (269,156 )
                                         
Balance at June 30, 2011
  $ 381,602     $ 9,730,040     $ 1,636,944     $ (8,151,172 )   $ 3,597,414  

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

 
7

 

SCI ENGINEERED MATERIALS, INC.
NOTES TO FINANCIAL STATEMENTS

Note 1.
Nature of Operations

SCI Engineered Materials, Inc. (“SCI”, or the “Company”), formerly Superconductive Components, Inc., an Ohio corporation, was incorporated in 1987.  The Company operates in the physical vapor deposition industry in which it develops, commercializes technologies, and manufactures ceramics and metals for advanced applications in: 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.
 
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, 2010.  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.

Note 3.
Common Stock and Stock Options

Stock Based Compensation - Compensation cost for all stock-based awards is based on the grant date fair value and recognized over the required service (vesting) period.  Non cash stock based compensation expense was $61,293 and $103,577 for the six months ended June 30, 2011 and 2010, respectively.   Unrecognized compensation expense was $663,549 as of June 30, 2011 and will be recognized through 2017.  There was no tax benefit recorded for this compensation cost as the expense primarily relates to incentive stock options that do not qualify for a tax deduction until, and only if, a qualifying disposition occurs.

During the six months ended June 30, 2011, a total of 3,000 stock options were exercised at a price of $1.55.  The total cash proceeds were $4,650.

 
8

 

SCI ENGINEERED MATERIALS, INC.
NOTES TO FINANCIAL STATEMENTS

Note 3.
Common Stock and Stock Options (continued)

The cumulative status of options granted and outstanding at June 30, 2011, and December 31, 2010, as well as options which became exercisable in connection with the Stock Option Plans are summarized as follows:

Employee Stock Options
         
Weighted
 
          
Average
 
    
Stock Options
   
Exercise Price
 
             
Outstanding at January 1, 2010
    796,250     $ 4.31  
Granted
    -       -  
Exercised
    (11,000 )     1.55  
Expired
    (1,500 )     2.88  
Outstanding at December 31, 2010
    783,750     $ 4.35  
Granted
    -       -  
Exercised
    (3,000 )     1.55  
Expired
    (30,000 )     1.90  
Outstanding at June 30, 2011
    750,750     $ 4.46  
Shares exercisable at December 31, 2010
    411,800     $ 2.94  
Shares exercisable at June 30, 2011
    433,375     $ 3.35  

Non-Employee Director Stock Options
         
Weighted
 
         
Average
 
   
Stock Options
   
Exercise Price
 
             
Outstanding at January 1, 2010
    319,500     $ 3.52  
Granted
    -       -  
Exercised
    (1,000 )     2.13  
Expired
    (36,000 )     2.97  
Outstanding at December 31, 2010
    282,500     $ 3.60  
Granted
    -       -  
Exercised
    -       -  
Expired
    (5,000 )     1.30  
Outstanding at June 30, 2011
    277,500     $ 3.64  
Shares exercisable at December 31, 2010
    252,500     $ 3.31  
Shares exercisable at June 30, 2011
    277,500     $ 3.64  

Exercise prices for options range from $1.00 to $6.00 at June 30, 2011.  The weighted average option price for all options outstanding is $4.24 with a weighted average remaining contractual life of 4.7 years.

 
9

 

SCI ENGINEERED MATERIALS, INC.
NOTES TO FINANCIAL STATEMENTS

Note 4.
Preferred Stock

On February 21, 2011, the Board of Directors voted to authorize the payment of a cash dividend in the amount of $24,152 on convertible preferred stock, Series B, to shareholders of record as of December 31, 2010.  This payment was made in June 2011.  Dividends on the Series B preferred stock accrue at 10% annually on the outstanding shares.  Accrued dividends on the Series B preferred stock were $6,038 and $6,074 for the three months ended June 30, 2011 and 2010, respectively, and $12,076 and $12,149 for the six months ended June 30, 2011 and 2010, respectively.

Note 5.
Inventories

Inventories consist of the following:

   
June 30,
   
December 31,
 
    
2011
   
2010
 
    
(unaudited)
       
Raw materials
  $ 338,288     $ 338,971  
Work-in-process
    983,302       866,853  
Finished goods
    263,795       188,602  
Inventory reserve
    (68,000 )     (50,000 )
    $ 1,517,385     $ 1,344,426  

Note 6.
Earnings Per Share

Basic income (loss) per share is calculated as income (loss) available to common stockholders divided by the weighted average of common shares outstanding.  Diluted earnings per share is calculated as diluted income available to common stockholders divided by the diluted weighted average number of common shares.  Diluted weighted average number of common shares gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method and convertible preferred stock using the if-converted method.  Diluted earnings per share exclude all diluted potential shares if their effect is anti-dilutive.  For the three and six months ended June 30, 2011, all (138,047) common stock options were anti-dilutive due to the net loss.  The following is provided to reconcile the earnings per share calculations:

   
Three months ended June 30,
   
Six months ended June 30,
 
                          
   
2011
   
2010
   
2011
   
2010
 
(Loss) income applicable to common shares
  $ (204,488 )   $ 8,759     $ (281,232 )   $ 109,115  
                                 
Weighted average common shares outstanding – basic
    3,778,898       3,742,039       3,778,036       3,727,074  
                                 
Effect of dilutions
    -       140,787       -       146,157  
                                 
Weighted average shares outstanding – diluted
    3,778,898       3,882,826       3,778,036       3,873,231  

 
10

 

SCI ENGINEERED MATERIALS, INC.
NOTES TO FINANCIAL STATEMENTS
Note 7.
Notes Payable

On April 11, 2011, the Company issued a Promissory Note (the “Note”) to The Huntington National Bank, as Lender.  The Note is collateralized by the Company’s inventories, equipment and accounts receivable.  This Note matures on April 13, 2012 and replaced a note previously signed on December 21, 2010.  As of June 30, 2011 there was no outstanding balance on the Note.

Among other items, the Note provides for the following:

 
·
At no time shall the outstanding balance of the principal sum of the 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 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 0.243% per annum.  The interest rate to be applied to the unpaid principal balance during the term will be at a rate of 2.75 percentage points over the index.

 
·
Accrued interest is payable monthly.  The outstanding principal and accrued interest owed on the Note matures on April 13, 2012.

On January 6, 2011, the Company issued a Promissory Note (the “Promissory Note”) in the amount of not more than $840,000 to The Huntington National Bank, as Lender.  This Promissory Note is collateralized by the Company’s inventories, equipment and accounts receivable.  As of June 30, 2011 there was a balance of $300,000 on the Promissory Note.

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

 
·
Interest is subject to change from time to time based on changes in an independent index (LIBOR).  The index at the inception of the Promissory Note was 0.261% per annum.  The interest rate applied to the unpaid principal balance is at a rate of 2.75 percentage points over the index.  Under no circumstance will the interest rate be less than 4.00% per annum or more than the maximum rate allowed by applicable law.

 
·
Accrued interest is payable monthly.  The outstanding principal and accrued interest matures on December 31, 2012.  It is anticipated that this Promissory Note will be repaid through the proceeds received from the Ohio Department of Development loan and the Ohio Air Quality Development Authority loan described below .

During 2010, the Company applied and was approved for a 166 Direct Loan in the amount of $744,250 with the Ohio Department of Development (ODOD).  This loan was finalized in February of 2011.  The term of the loan is 84 months at a fixed interest rate of 3%.  There is also a 0.25% annual servicing fee to be charged monthly on the outstanding principal balance.   The loan is to be amortized over 84 months beginning on the first day of the calendar month immediately following the first full calendar month after the initial disbursement of the loan proceeds, which is expected during the third quarter of 2011.  The loan is collateralized by the project equipment.  As of June 30, 2011 there was no outstanding balance on this loan.

 
11

 

SCI ENGINEERED MATERIALS, INC.
NOTES TO FINANCIAL STATEMENTS

Note 7.
Notes Payable (continued)

During 2010, the Company also applied and was approved for a 166 Direct Loan through the Advanced Energy Program with The Ohio Air Quality Development Authority (OAQDA) for approximately $1.4 million.  This loan was finalized in February of 2011.  The term of the loan is 84 months at a fixed interest rate of 3%.  There is also a 0.25% annual servicing fee to be charged monthly on the outstanding principal balance.  The loan is to be amortized over 84 months beginning on the first day of the calendar month immediately following the first full calendar month after the initial disbursement of the loan proceeds, which is expected during the third quarter of 2011.  The loan is collateralized by the project equipment.  As of June 30, 2011 there was no outstanding balance on this loan.

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 and were used for the purchase of production equipment and to reduce the Company’s capital lease obligations on certain equipment.  The term of the loan is 84 months at a fixed interest rate of 3%. There is also a 0.25% annual servicing fee to be charged monthly on the outstanding principal balance.  The Company is making monthly servicing fee, interest and principal payments of approximately $6,000.  The loan principal balance will be fully amortized at the end of the term in August 2015.  The loan is collateralized by the project equipment.  As of June 30, 2011 the loan had a balance of $285,314.

Note 8.
Income Taxes

Income tax expense consists of the following for the three and six months ended June 30, 2011 and 2010:

   
Three months ended
   
Six months ended
 
    
June 30,
   
June 30,
 
                          
   
2011
   
2010
   
2011
   
2010
 
Federal – deferred
  $ -     $ 17,000     $ -     $ 72,000  
State and local
    4,237       4,670       8,475       11,367  
    $ 4,237     $ 21,670     $ 8,475     $ 83,367  
 
 
12

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

The following discussion should be read in conjunction with the Financial Statements and Notes contained herein and with those in our Form 10-K for the year ended December 31, 2010.
 
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, 2010, 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”, “we” or the “Company”), formerly Superconductive Components, Inc., an Ohio corporation, was incorporated in 1987.  We operate in the physical vapor deposition industry in which we develop, commercialize technologies, and manufacture ceramics and metals for advanced applications in: Photonics, Solar, Thin Film Battery, Semiconductor, and, to a lesser extent High Temperature Superconductor (“HTS”) materials.  Photonics currently represents the largest market for our targets.  Solar is an industry that is exhibiting rapid growth.  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. 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.
 
 
13

 

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

Executive Summary

During the first half of 2011 we continued to develop transparent conductive oxide systems for the solar industry and added domestic and international customers for solar products.   The solar industry is projected to have strong growth for the next few decades, and in addition, the Thin Film Solar (TFS) market share is expected to increase during that period.  Given current market opportunities, we continue to invest in expanding production, research & development, marketing, and sales.  These investments have resulted in trial and qualification orders that were shipped to customers in the solar industry throughout 2010 and the first six months of 2011.  Current orders and the conversion of customer forecasts are expected to be catalysts as we transition our business from product trials to full production.  This should allow us to gain market share and to be poised to receive large orders in targeted applications.  We anticipate that our financial performance will begin to improve during the final three months of 2011.  The conversion of these trials into production orders represents another important step toward realization of our strategic goals which include expanding our base of solar customers globally.

In the previous three years (2008 – 2010) we invested over $1.6 million in new equipment to increase our manufacturing capacity and advanced test equipment to position the Company to become a meaningful supplier of Zinc Oxide based Transparent Conductive Oxides (TCO) to the Thin Film Solar industry.  During the first six months of 2011 we positioned the Company for continued growth by finalizing two loans with agencies of the State of Ohio for approximately $2.1 million.  These loans carry attractive interest rates of 3% plus a 0.25% annual service fee.  In addition to the loans we expect to invest an additional $900,000 in the expansion project and to add approximately 50 employees during the next three years.  These funds are expected to be provided by operating activities.  As part of this project we invested over $1 million in new equipment during the first half of 2011.

We had total revenue of $4,795,202 and $4,801,777 for the six months ended June 30, 2011 and June 30, 2010, respectively.  Product revenue increased to $4,442,031 from $4,357,005, an increase of $85,026, or 2.0% for the six months ended June 30, 2011 from the same period in 2010.  Product revenue increased due to customer demand and increased cost of a high priced raw material.    During the first quarter of 2011, a customer asked us to purchase and process this raw material resulting in higher revenue compared to the first quarter of 2010.  During the first quarter of 2010, this customer purchased the raw material directly and shipped it to us for processing.

Total revenue remained constant for the first six months of 2011 compared to the same period in 2010 despite the loss of a customer which closed its manufacturing facility during the first quarter of 2011.  We shipped approximately $450,000 to this customer during the first half of 2011 versus approximately $1 million during the first half of 2010.  Revenue from this customer was approximately $1.9 million for the entire year of 2010.    We expect the loss of revenue from this customer to be offset by increased sales of solar products, especially our innovative transparent conductive oxide systems for the solar industry and from core customers in other markets.  The sales of solar products are expected to accelerate during the fourth quarter of 2011 and are based on revenue from current customers and product trials being converted into production orders.    Our products continue to be evaluated by a growing number of companies engaged in the global solar market.
 
Gross profit was $964,367 for the six months ended June 30, 2011 compared to $1,343,850 for the same six months in 2010.  This was a decrease of $379,483, or 28.2%.  The decrease in gross profit can be attributed to a change in product mix and continued scale-up expenses related to transparent conductive oxide for solar applications products in addition to the closing of a manufacturing facility by a customer previously disclosed.  We anticipate gross profit to begin to improve during the fourth quarter of 2011 compared to each of the previous quarters in 2011 due to the expected increased revenue.  Gross margin was 20.1% for the first six months of 2011 compared to 28.0% for the same period in 2010.  The decrease in gross margin can be principally attributed to the increased volume of the high priced raw material, which had a lower margin and also to the large customer that closed its facility.
 
 
14

 

Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
 
We continue to invest in developing new products for the solar industry including transparent conductive oxide systems.  These efforts include accelerating time to market for those products and involve research and development expense beyond the scope of specific government grants and awards.  Research and development expense increased $161,426 to $362,187, an increase of 80.4% for the first six months of 2011 compared to the first six months of 2010.  Research and development is integral to the sales process, which involves a long selling cycle of product trials prior to full production orders.  Investments we have made to date are expected to accelerate revenues later this year.

For the six months ended June 30, 2011, we had a loss before provision for income taxes of $260,681 compared to net income of $204,631 for the six months ended June 30, 2010.  We had a loss applicable to common shares of $281,232 for the six months ended June 30, 2011 compared to income of $109,115 for the same period in 2010.  This decrease can be attributed to the decrease in gross profit previously mentioned and an increase in research and development expenses of approximately $161,000.

RESULTS OF OPERATIONS

Six and three months ended June 30, 2011 (unaudited) compared to six and three months ended June 30, 2010 (unaudited):

Revenue

Revenue for the six months ended June 30, 2011 was $4,795,202 compared to $4,801,777, for the same period last year, a decrease of $6,575 or 0.1%.

Product revenue increased $85,026, or 2.0%, for the six months ended June 30, 2011 from the same period in 2010.  This increase was primarily due to customer demand and increased cost of a high priced raw material.    Contract research revenue decreased to $353,171 from $444,772 for the first half of 2011 compared to the first half of 2010.   This decrease was due to one contract drawing to a close late in 2010 and another during the first half of 2011.

Revenue for the three months ended June 30, 2011 was $2,277,568 compared to $2,560,664, for the same period last year, a decrease of $283,096 or 11.1%.  Product revenue decreased $224,672, or 9.5%, for the three months ended June 30, 2011 from the same period in 2010.  This decrease can be attributable to a customer closing its manufacturing facility as previously discussed (revenue to this customer was approximately $490,000 during the second quarter of 2010).  This decrease in revenue was partially offset by increased revenue from core customers.  Contract research revenue decreased to $147,835 for the second quarter of 2011 compared to $206,259 for the second quarter of 2010, due to the completion of certain milestones related to these programs.

 
15

 

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

Revenue from product sales is recognized upon shipment to customers.  Provisions for discounts and rework costs for returns are established when products are shipped based on historical experience.  Customer deposits represent cash received in advance of revenue earned.
 
Revenue from contract research provided for third parties is recognized on the percentage of completion method.  Contract research revenue is recognized during the period qualifying expenses are incurred for the research that is performed as set forth under the terms of the grant award agreements.

Gross Profit

Gross profit for the six months ended June 30, 2011 was $964,367, which represented gross margin of 20.1% of total revenue compared to $1,343,850 and 28.0% of total revenue for the six months ended June 30, 2010.  In addition to a customer’s closing of its manufacturing facility as previously disclosed, the decrease in gross profit can be attributed to a change in product mix and continued scale-up expenses related to transparent conductive oxide for solar applications products.

Gross profit for the three months ended June 30, 2011 was $416,829, which represented gross margin of 18.3% of total revenue compared to $666,148 and 26.0% of total revenue for the three months ended June 30, 2010.  This was a decrease of $249,319, or 37.4%.  In addition to a customer’s closing of its manufacturing facility, the decrease in gross profit can be attributed to a change in product mix and continued scale-up expenses related to transparent conductive oxide for solar applications products.

General and Administrative Expense

General and administrative expense for the six months ended June 30, 2011 decreased to $551,234 from $596,211, or 7.5%, for the six months ended June 30, 2010.  The decrease was the result of non-cash stock based compensation expense being reduced by approximately $38,000 and wages and compensation being approximately $13,000 lower.

General and administrative expense for the three months ended June 30, 2011 was $275,340 compared to $314,981 for the three months ended June 30, 2010, a decrease of 12.6%.  The decrease was the result of less non-cash stock based compensation expense of approximately $19,000, lower legal fees of approximately $19,000 and less wages and compensation of approximately $5,000.

Professional Fees

Included in general and administrative expense was $121,173 and $124,758 for professional fees for the six months ended June 30, 2011 and 2010, respectively.  These expenses are primarily related to SEC compliance costs for legal, accounting and stockholder relations’ fees.

Research and Development Expense

Research and development expense for the six months ended June 30, 2011 was $362,187 compared to $200,761 for the same period in 2010, an increase of 80.4%.  We continue to develop innovative transparent conductive oxide systems to further align our activities with customer needs, as well as trial orders which resulted in increased research and development expense.  These new research and development endeavors have moved us beyond the scope of our current federal and state grants and awards.

 
16

 

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

Research and development expense for the three months ended June 30, 2011 was $197,548 compared to $147,505 for the same period in 2010, an increase of 33.9%.

We have decided not to pursue a patent application entitled “A Method for making composite sputtering targets and the targets made in accordance with the method".   The patent office did not validate the patent.  SCI appealed the examiner’s decision and the examiner also rejected the arguments contained in the appeal.  As a result we recorded a non-cash impairment charge of approximately $39,000 during the second quarter of 2011.

Marketing and Sales Expense

Marketing and sales expense for the six months ended June 30, 2011, decreased 11.0% to $275,972 from $310,230 for the same period in 2010.  The decrease was due primarily to less commission expense to outside manufacturing representatives of approximately $38,000 and less wages and compensation of approximately $6,000.

Marketing and sales expense for the three months ended June 30, 2011 decreased 23.1% to $119,915 from $155,908 for the same period in 2010.  The decrease was due to a reduction in manufacturer’s sales representative commissions of approximately $27,000 and reduced travel expenses of approximately $6,000 in the second quarter of 2011 compared to the same period in 2010.

Stock Compensation Expense

Included in operating expenses were non-cash stock based compensation costs of $58,824 and $97,171 for the six months ended June 30, 2011 and 2010, respectively.    Compensation cost for all stock-based awards is based on the grant date fair value and recognized over the required service (vesting) period .   Total unrecognized non-cash stock based compensation expense was $663,549 as of June 30, 2011 and will be recognized through 2017.

Interest Expense

Interest expense was $37,666 and $44,931 for the six months ended June 30, 2011 and 2010, respectively.  Interest expense was $19,100 and $23,109 for the three months ended June 30, 2011 and 2010, respectively.  The decrease was due to the maturity of some capital leases plus more principal and less interest being applied to ongoing capital lease payments.

Income Tax Expense

Income tax expense for the six months ended June 30, 2011 and 2010 was $8,475 and $83,367 respectively.  Income tax expense for the three months ended June 30, 2011 and 2010 was $4,237 and $21,670 respectively.  We had deferred income taxes of $156,000 at June 30, 2011 and December 31, 2010.    We record a valuation allowance against our deferred tax asset to an amount that is more likely than not to be realized.  We have considered future taxable income and used ongoing prudent and feasible tax planning strategies in assessing the need for valuation allowances.  If we were to determine that we would be able to realize deferred tax assets in the future in excess of the recorded amount, an adjustment to the deferred tax asset would increase income in the period that such determination was made. Likewise, should we determine that we would not be able to realize all or part of the deferred tax asset in the future, an adjustment to the deferred tax asset would decrease income in the period such determination was made. We regularly evaluate the need for a valuation allowance against our deferred tax asset.

 
17

 

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

(Loss)/Income Applicable to Common Shares

Loss applicable to common shares was ($281,232) for the six months ended June 30, 2011 compared to income of $109,115 for the six months ended June 30, 2010.  Loss applicable to common shares was ($204,488) for the three months ended June 30, 2011 compared to income of $8,759 for the three months ended June 30, 2010.  This decrease can be attributed to the decrease in gross profit previously mentioned and an increase in research and development expenses of approximately $161,000.

Common Shares
 
The following schedule represents our outstanding common shares during the period of 2011 through 2019 assuming all outstanding stock options are exercised during the year of expiration.  If each shareholder exercises his or her options, it would increase our common shares by 1,028,250 to 4,807,148 by December 31, 2019.  Assuming all such options are exercised in the year of expiration, the effect on shares outstanding is illustrated as follows:
 
    
Options
due to
expire
   
Potential
shares
outstanding
   
Weighted
average
exercise
price
 
2011
    27,500       3,806,398     $ 1.50  
2012
    155,000       3,961,398     $ 1.55  
2013
    30,250       3,991,648     $ 1.00  
2014
    180,000       4,171,648     $ 4.36  
2015
    140,000       4,311,648     $ 2.97  
2016
    36,000       4,347,648     $ 3.25  
2017
    -       4,347,648       -  
2018
    9,500       4,357,148     $ 3.10  
2019
    450,000       4,807,148     $ 6.00  

Liquidity and Capital Resources

Cash

As of June 30, 2011, cash on-hand was $1,260,613.  Cash was $1,511,752 at December 31, 2010.  We invested approximately $786,000 in new production equipment related to the two loans with agencies of the State of Ohio.  We anticipate receiving the initial proceeds (approximately $340,000) from these loans for this equipment during the third quarter of 2011.

Working Capital

At June 30, 2011, working capital was $1,318,091 compared to $2,037,193 at December 31, 2010, a decrease of $719,102, or 35.3%.  Cash decreased approximately $251,000.  Accounts receivable decreased approximately $177,000 which was related to less revenue in the second quarter.  Inventories increased approximately $173,000 and prepaid expenses primarily related to customer deposits increased approximately $187,000.  Accounts payable increased approximately $298,000 due to investments in new equipment.  Customer deposits increased approximately $385,000 during the first half of 2011 for expected shipments during the second half of 2011.

 
18

 

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

Cash from Operations

Net cash provided by operating activities was approximately $519,000 during the six months ended June 30, 2011.  In addition to the changes in various current assets and liabilities mentioned above, non cash expenses for depreciation, accretion and amortization increased to approximately $259,000 during the first six months of 2011 from approximately $242,000 during the first six months of 2010, an increase of 7.4%.  This increase was related to the purchase of new machinery and equipment.  Included in expenses were non-cash stock based compensation costs of $61,293 and $103,577 for the six months ended June 30, 2011 and 2010, respectively.   Net cash provided by operating activities was approximately $350,000 during the six months ended June 30, 2010.

Cash from Investing Activities

Cash of approximately $820,000 and $143,000 was used for investing activities for the six months ended June 30, 2011 and 2010, respectively.  The amounts invested were used to purchase machinery and equipment for increased production capacity and new product lines.  Included in 2011 was a deposit for new equipment in the amount of $300,000.  This equipment is expected to be delivered during the third quarter of 2012.

Cash from Financing Activities

Cash of approximately $50,000 was provided by financing activities for the six months ended June 30, 2011.  Principal payments to third parties for capital lease obligations and a note payable approximated $231,000.  Proceeds received from the exercise of common stock options were $4,650.  Proceeds from a new note payable were $300,000.  Payment of cumulative dividends on preferred stock was approximately $24,000.  We incurred a capital lease obligation of $185,000 for new production equipment during the first half of 2011.

During the six months ended June 30, 2010, cash of approximately $280,000 was provided by financing activities.  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 approximately $491,000.  Proceeds received from the exercise of common stock options were approximately $15,000.  We incurred new capital lease obligations of approximately $193,000 for new production equipment during the first half of 2010.

Debt Facilities

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, 2011 there was no outstanding balance on the Revolving Note.

We also have the ability to draw on a Promissory Note from The Huntington National Bank.  The principal amount of the Note is $840,000.  As of June 30, 2011 there was a balance of $300,000 on the Promissory Note.

 
19

 

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

Closing documents were signed in February 2011 for a 166 Direct Loan in the amount of $744,250 with the Ohio Department of Development (ODOD).  ODOD also recommended that the Ohio Tax Credit Authority approve a tax credit equal to 45 percent of employee income tax withholdings resulting from the project for five years.  This credit has an estimated value of $86,000 during the entire term.  ODOD also is prepared to offer funding from the Rapid Outreach Grant for up to $25,000 for costs associated with the acquisition and installation of machinery and equipment.

Closing documents were also signed in February 2011 for a 166 Direct Loan through the Advanced Energy Program with The Ohio Air Quality Development Authority (OAQDA) for approximately $1.4 million.  The OAQDA and ODOD loans can fund approximately 70% of the current capital requirements of approximately $3 million to support our planned growth.

Debt Outstanding

Total debt outstanding increased during the six months ended June 30, 2011 from approximately $1,223,000 to $1,477,000, or 20.8%.  We paid cash of approximately $231,000 towards capital lease obligations during the first half of 2011.   During the first half of 2011 we incurred a capital lease obligation of $185,000 for new production equipment and proceeds received from a note payable were $300,000, which was used as a down payment for new production equipment which has a lead time in excess of twelve months.

Government Grants and Contracts
 
During the fourth quarter of 2009 we were notified we had been awarded a grant in the amount of $775,400 by the Ohio Department of Development’s Third Frontier Photovoltaic Program (TFPVP) to commercialize advanced technology for high power density rotatable ceramic sputtering targets.  These targets are used in the manufacture of thin film photovoltaics.  This technology will enable manufacturers to operate rotatable sputtering targets at higher power densities than current technology.   The approval of the grant was received during January 2010 and the work on the contract commenced in the first quarter of 2010.  Revenue totaled $107,807 during the first half of 2011 compared to $38,076 in the first half of 2010.  Total expenditures for the project through June 30, 2011 were $288,073.  The work on the contract is expected to continue through the first quarter of 2012.

During the third quarter of 2009 we received notification from the Department of Energy (DOE) of an Assistance Agreement in the amount of approximately $650,000.  This grant provides support for Phase II of a Small Business Innovation Research (SBIR) award entitled “Homogenous BSCCO-2212 Round Wires for Very High Field Magnet Applications.”  Revenue was $193,430 for the six months ended June 30, 2011 compared to $93,541 for the same period in 2010.  Total revenue of the project through June 30, 2011 was $544,377.   The work on the contract is expected to continue through the third quarter of 2011.

We received notification during the fourth quarter of 2008 from the Ohio Department of Development’s Third Frontier Advanced Energy Program (TFAEP) of an award in the amount of $708,715.  This grant provided 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 was completed late in 2010.  Revenue was $187,791 for the six months ended June 30, 2010.

 
20

 

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

During the third quarter of 2008 we received notification from the Department of Energy of a Notice of Financial Assistance Award in the amount of approximately $750,000.  This grant provides support for Phase II of a Small Business Innovation Research (SBIR) award entitled “Flux Pinning Additions to Increase Jc Performance in BSCCO-2212 Round Wire for Very High Field Magnets.”  Revenue was $51,934 during the first six months of 2011 and $123,497 for the first six months of 2010.  Total revenue of the project through June 30, 2011 was $741,852.  The work on the contract began during the third quarter of 2008 and was completed during the second quarter of 2011.

The granting agency may suspend or terminate the award in whole or in part if we fail to materially comply with the terms and conditions.  We expect to complete each award while complying with the terms and conditions.
 
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, 2010 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.  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.

 
21

 

Item 4.
Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Due to a segregation of duties material weakness described below, and based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that as of June 30, 2011, the Company’s disclosure controls and procedures were not effective, at the reasonable assurance level, in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act and in ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Accounting Officer, as appropriate to allow timely discussions regarding required disclosure.  The Company continued to remain current for reports filed and submitted under the Exchange Act.  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.  Accordingly, we believe that the financial statements included in this report fairly present, in all material respects, our financial condition, results of operation, changes in shareholder’s equity and cash flows for all periods presented.

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.

 
22

 

Item 4.
Controls and Procedures (continued)
 
Management previously disclosed a material weakness in internal control over financial reporting in its annual report on Form 10-K, filed on February 28, 2011 for the year ended December 31, 2010, 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 would 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 three months ended June 30, 2011 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.

 
23

 

Part II.   Other Information

Item 6.
Exhibits

 
3.1
 
Certificate of Second Amended and Restated Articles of Incorporation of Superconductive Components, Inc. (Incorporated by reference to Exhibit 3(a) to the Company’s initial Form 10-SB, filed on September 28, 2000)
       
 
3.2
 
Restated Code of Regulations of Superconductive Components, Inc. (Incorporated by reference to Exhibit 3(b) to the Company’s initial Form 10-SB, filed on September 28, 2000)
       
 
3.3
 
Amendment to Articles of Incorporation recording the change of the corporate name to SCI Engineered Materials, Inc.  (Incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-QSB filed November 7, 2007).
       
 
4.1
 
SCI Engineered Materials, Inc. 2011 Stock Incentive Plan (Incorporated by reference to the Company’s Definitive Proxy Statement for the 2011 Annual Meeting of Shareholders held on June 10, 2011, filed April 28, 2011).
       
 
4.2
 
Superconductive Components, Inc. 2006 Stock Incentive Plan (Incorporated by reference to Appendix A to the Company’s Definitive Proxy Statement for the 2006 Annual Meeting of Shareholders held on June 9, 2006, filed May 1, 2006).
       
 
4.3
 
Description of the Material Terms of the Stock Option Grant and Cash Bonus Plan for Executive Officers (Incorporated by reference to the Company’s Current Report on Form 8-K, dated June 19, 2006, filed June 23, 2006)
       
 
4.4
 
Form of Incentive Stock Option Agreement under the Superconductive Components, Inc. 2006 Stock Incentive Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated June 19, 2006, filed June 23, 2006).
       
 
4.5
 
Form of Non-Statutory Stock Option Agreement under the Superconductive Components, Inc. 2006 Stock Incentive Plan (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K dated June 19, 2006, filed June 23, 2006).
       
 
4.6
 
Description of the Material Terms of the Stock Option Grant for Executive Officers and Board of Directors (Incorporated by reference to the Company’s Current Report on Form 8-K dated January 2, 2009, filed January 6, 2009).
       
 
4.7
 
Fourth Amended and Restated 1995 Stock Option Plan (Incorporated by reference to Exhibit 4(a) to the Company’s Registration Statement on Form S-8 (Registration No. 333-97583), filed on August 2, 2002)
       
 
4.8
  
Form of Non-Statutory Stock Option Agreement Under the Superconductive Components, Inc. Fourth Amended and Restated 1995 Stock Option Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed on December 22, 2005)
 
 
24

 

Item 6.
Exhibits (continued)

 
22.1
 
Description of matters submitted to vote of security holders (Incorporated by reference to the Company’s Current Report on Form 8-K, dated June 13, 2011).
       
 
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 August 8, 2011, entitled “SCI Engineered Materials, Inc. Reports Six Month and Second Quarter 2011 Results.”
       
 
101
  
The Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets at June 30, 2011 and December 31, 2010 (ii) Consolidated Statements of Operations for the three and six months ended June 30, 2011 and 2010, (iii) Consolidated Statement of Changes in Equity for the six months ended June 30, 2011, (iv) Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010, (v) Notes to Financial Statements, tagged as blocks of text.

* 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:  August 8, 2011
/s/ Daniel Rooney
 
 
Daniel Rooney, Chairman of the Board of Directors, President and Chief Executive Officer
 
(Principal Executive Officer)
   
 
/s/ Gerald S. Blaskie
 
 
Gerald S. Blaskie, Vice President and Chief Financial Officer
 
(Principal Financial Officer and Principal Accounting Officer)
 
 
25

 

Exhibit 31.1
 
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Daniel Rooney, certify that:

 
1.
I have reviewed this Quarterly Report on Form 10-Q of SCI Engineered Materials, Inc.;

 
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:

 
a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;
 
c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 8, 2011
/s/ Daniel Rooney
 
Daniel Rooney
 
Chairman of the Board of Directors,
 
President and Chief Executive Officer
 
(Principal Executive Officer)
 
 
 

 

Exhibit 31.2
 
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Gerald S. Blaskie, certify that:

 
1.
I have reviewed this Quarterly Report on Form 10-Q of SCI Engineered Materials, Inc.;

 
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:

 
a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;
 
c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 8, 2011
/s/ Gerald S. Blaskie
 
Gerald S. Blaskie
 
Vice President and Chief Financial Officer
 
(Principal Financial Officer and Principal Accounting Officer)

 
 

 

Exhibit 32.1
 
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
In connection with the Quarterly Report of SCI Engineered Materials, Inc.  (the “Company”) on Form 10-Q for the period ending June 30, 2011 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Daniel Rooney, Chairman of the Board of Directors, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
 
(1)           The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
(2)           The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

 
/s/ Daniel Rooney
 
Daniel Rooney
 
Chairman of the Board of Directors,
 
President and Chief Executive Officer of
 
SCI Engineered Materials, Inc.
 
(Principal Executive Officer)
 
August 8, 2011

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
In connection with the Quarterly Report of SCI Engineered Materials, Inc.  (the “Company”) on Form 10-Q for the period ending June 30, 2011 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Gerald S. Blaskie, Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
 
(1)           The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
(2)           The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

 
/s/ Gerald S. Blaskie
 
Gerald S. Blaskie
 
Vice President and Chief Financial Officer of
 
SCI Engineered Materials, Inc.   (Principal Financial Officer and Principal Accounting Officer)
 
August 8, 2011