The following discussion should be read in conjunction with the Financial Statements and Notes contained herein and with those in our Form 10-KSB for the year ended December 31, 2007.

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-KSB for the year ended December 31, 2007, and other factors detailed from time to time in our other filings with the Securities and Exchange Commission. One or more of these factors have affected, and in the future could affect our business and financial condition and could cause actual results to differ materially from plans and projections. Although we believe the assumptions underlying the forward-looking statements contained herein are reasonable, there can be no assurance that any of the forward-looking statements included in this Quarterly Report on Form 10-Q will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved.

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

Overview

SCI Engineered Materials, Inc. ("SCI" or the "Company"), formerly Superconductive Components, Inc., an Ohio corporation, was incorporated in 1987. We manufacture ceramic and metal sputtering targets for a variety of industrial applications including: Photonics, Semiconductor, Thin Film Battery and, to a lesser extent HTS materials. Photonics (which includes solar) currently represents the largest market for our targets. Thin Film Battery is a developing market where manufacturers of batteries use our targets to produce very small power supplies with small quantities of stored energy. Semiconductor is a developing market. We hired additional marketing staff during late 2006 to develop opportunities in this market, and we added to our sales staff in late 2007 for the purpose of focusing on opportunities for our products in the Solar industry. We also added staff to our Technology group during the second half of 2007 for the development of innovative products.

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

Executive Summary

For the six months ended June 30, 2008, we had revenues of $3,231,453. This was a decrease of $2,626,298, or 44.8%, compared to the six months ended June 30, 2007. The decrease in revenues can be attributed to a reduction in the cost of a high value raw material. We anticipate that the cost of this high value raw material will continue to be lower for 2008 compared to 2007. Also, as disclosed on Form 8-K dated February 21, 2008, one of our largest customers notified us that its orders for 2008 will be significantly less than 2007. This is due to the customer's improved utilization of targets in their manufacturing process coupled with lower planned inventory levels. Late in the second quarter of 2008 this customer began to increase its orders on certain targets. We anticipate an increase in revenues during the last half of 2008 compared to the first half of 2008.

Reflecting positive benefits from product mix, gross profit declined only 10.8% to $866,872 for the first half of 2008 from $971,748 for the first half of 2007. The decrease was attributable to higher depreciation expense related to investments made to develop new markets and the decrease in revenue mentioned above. Gross margin increased to 26.8% of total revenues for the first six months of 2008 from 16.6% for the same period in 2007.

For the second quarter of 2008 gross profit was $437,847 compared to $429,025 for the first quarter of 2008. This is an increase of 2.1% even though revenues decreased 11.4% during the same period. Gross margin increased to 28.9% for the second quarter of 2008 from 25.0% for the first quarter of 2008. The increase in gross profit and gross margin can be attributed to the product mix.

For the six months ended June 30, 2008, we had net loss applicable to common shares of $187,245 compared to net income of $156,695 for the same period in 2007. This decrease can be largely attributed to additional operating expenses of approximately $196,000 and the decrease in revenue along with the depreciation expense increase mentioned above. We continued to invest in R&D, marketing, and sales to take advantage of current and future market opportunities. During the past 21 months we have been actively marketing to additional customers in select markets. This has resulted in trial and qualification orders that were shipped to customers in the semiconductor and solar industries during the first half of 2008 which totaled approximately 13% of our revenues. We have received additional trial orders that should ship during the second half of 2008.

We received notification during the second quarter of 2007 from the Department of Energy of a Notice of Financial Assistance Award in the amount of $97,900. This award provides support for Phase I of a Small Business Innovative 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 was completed during the first quarter of 2008.

We received notification during the second quarter of 2008 from the Department of Energy of a Notice of Financial Assistance Award in the amount of $99,961. This award provides support for Phase I of a Small Business Innovative Research (SBIR) award entitled "Homogenous BSCCO-2212 Round Wires for Very High Field Magnet Applications." The work on the contract will begin during the third quarter of 2008.

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

RESULTS OF OPERATIONS

Six months ended June 30, 2008 (unaudited) compared to six months ended June 30, 2007 (unaudited):

Revenues

Revenues for the six months ended June 30, 2008 were $3,231,453 compared to $5,857,751, for the same period last year, a decrease of $2,626,298 or 44.8%. The revenue decline can be attributed to the ongoing purchase of raw materials whose prices have historically experienced periods of significant fluctuation. Cost changes for this high value raw material are fully reflected in the final selling price which insulates us from market risk associated with the raw material. We anticipate the cost of this high value raw material will continue to be lower in 2008 compared to 2007. This will result in lower revenues. As disclosed on Form 8-K dated February 21, 2008, one of our largest customers notified us that its orders for 2008 will be significantly less than 2007. This is due to the customer's improved utilization of targets in their manufacturing process coupled with lower planned inventory levels. This customer has placed orders for the third quarter of 2008 and we anticipate an increase in revenues during the last half of 2008 compared to the first half of 2008.

Gross Profit

Gross profit for the six months ended June 30, 2008 was $866,872 compared to $971,748 for the six months ended June 30, 2007. The decrease in gross profit was attributable to the decrease in revenue and higher depreciation expense related to investments made to develop new markets. Gross margin as a percentage of revenue was 26.8% for the six months ended June 30, 2008 versus 16.6% for the six months ended June 30, 2007. The increase in gross margin was primarily due to less cost related to the high value raw material which has low margins and product mix.

Marketing and Sales Expense

Marketing and Sales expense for the six months ended June 30, 2008 increased 30.9% to $272,032 from $207,851 for the same period in 2007. The increase was due to the addition of staff and increased travel. We added a sales engineer late in 2007 to focus marketing efforts on applications in Thin Film Solar which is a rapidly expanding industry.

General and Administrative Expense

General and administrative expense for the six months ended June 30, 2008 increased to $510,461 from $456,312 for the six months ended June 30, 2007, or 11.9%. The increase was due to an increase in staff and professional fees.

Research and Development Expense

Research and development expense for the first six months of 2008 was $222,719 compared to $145,037 for the same period in 2007, an increase of 53.6%. The increase was due to increased staff and continued development efforts associated with applications in Photonic, Solar, Thin Film Battery and Semiconductor markets.

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

Interest Income and Expense

Interest income was $14,175 and $26,988 for the six months ended June 30, 2008 and 2007, respectively.

Interest expense was $51,997 and $24,116 for the six months ended June 30, 2008 and 2007, respectively. The increase was due to additional capital lease obligations incurred for the purchase of production equipment for increased production capacity.

(LOSS) INCOME APPLICABLE TO COMMON SHARES

(Loss) income applicable to common shares was $(187,245), or $(0.05) per basic common share compared to $156,695, or $0.05 per basic common share for the six months ended June 30, 2008 and 2007, respectively. Basic net (loss) income per common share before dividends on preferred stock was $(0.05) and $0.05 for the six months ended June 30, 2008 and 2007, respectively. The income applicable to common shares includes net (loss) income from operations and the accretion of Series B preferred stock dividends. Dividends on the Series B preferred stock accrue at 10% annually on the outstanding shares. Dividends accrued during the six months ended June 30, 2008 and 2007, was $12,283 and $12,592, respectively.

Basic net loss for the six months ended June 30, 2008 was $0.05 per common share based on 3,500,419 weighted average shares outstanding compared to income of $0.05 per common share based on 3,451,032 weighted average shares outstanding for the six months ended June 30, 2007.

Diluted net loss per common share for the six months ended June 30, 2008 was $0.05 based on 3,500,419 weighted average shares outstanding compared to income of $0.04 per share based on 4,240,350 weighted average shares outstanding for the six months ended June 30, 2007. All outstanding common stock equivalents were anti-dilutive for the three months and six months ended June 30, 2008 due to the net loss.

The following schedule represents our outstanding common shares during the period of 2008 through 2018 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 1,154,807 to 4,714,878 by December 31, 2018. Exercise prices for options and warrants range from $1.00 to $4.00 at June 30, 2008. 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 Outstanding

    2008                                      0                        3,560,071
    2009                                160,418                        3,720,489
    2010                                443,389                        4,163,878
    2011                                 62,500                        4,226,378
    2012                                170,000                        4,396,378
    2013                                 30,500                        4,426,878
    2014                                 90,000                        4,516,878
    2015                                140,000                        4,656,878
    2016                                 37,000                        4,693,878
    2017                                      0                        4,693,878
    2018                                 21,000                        4,714,878

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

LIQUIDITY AND WORKING CAPITAL

At June 30, 2008, working capital was $1,347,791 compared to $1,590,286 at June 30, 2007. We used cash from operations of approximately $153,000 for the six months ended June 30, 2008. We provided cash from operations of approximately $752,000 for the six months ended June 30, 2007. Significant non-cash items including depreciation, accretion and amortization, stock based compensation expense, inventory reserve on excess and obsolete inventory, and provision for doubtful accounts were approximately $221,000 and $173,000, respectively, for the six months ended June 30, 2008 and 2007. Accounts receivable, inventory, prepaid expenses and other assets increased approximately $1,558,000 for the six months ended June 30, 2008. Accounts receivable, inventory, prepaid expenses and other assets decreased approximately $243,000 for the six months ended June 30, 2007. Accounts payable, accrued expenses and customer deposits increased approximately $1,360,000 for the six months ended June 30, 2008 and approximately $171,000 for the same period in 2007. Cash of approximately $75,000 and $63,000 was used for investing activities for the six months ended June 30, 2008 and 2007, respectively. The amounts invested were used to purchase machinery and equipment for increased production capacity and new product lines.

Cash of approximately $108,000 was used for financing activities during the six months ended June 30, 2008. Cash payments to third parties for capital lease obligations approximated $142,000. Proceeds received from the exercise of common stock warrants were approximately $68,000. Proceeds received from the exercise of common stock options were $10,250. Cash payments for services provided for the registration of common stock were approximately $20,000. A cash payment related to Series B preferred stock dividend was approximately $25,000. We incurred new capital lease obligations of approximately $159,000 for new production equipment during the first six months of 2008.

Cash of approximately $34,000 was used for financing activities during the six months ended June 30, 2007. Cash payments to third parties for capital lease obligations approximated $52,000. Proceeds received from the exercise of common stock warrants were approximately $27,000. Cash payments for services provided for the registration of common stock were approximately $8,000. We incurred new capital lease obligations of approximately $889,000 for new production equipment during the first six months ended June 30, 2007.

RISK FACTORS

We desire to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. The following factors, as well as the factors listed under the caption "Risk Factors" in our Form 10-KSB filed with the Securities and Exchange Commission on March 9, 2008, have affected or could affect our actual results and could cause such results to differ materially from those expressed in any forward-looking statements made by us. Investors should consider carefully these risks and speculative factors inherent in and affecting our business and an investment in our common stock.

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

While we have had profitable operations in 2007 and 2006, profits have not been consistent and we have financed the losses primarily from additional investments and loans by our major shareholders and private offerings of common stock and warrants to purchase common stock.

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

We cannot assure you, however, 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.

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-KSB for the year ended December 31, 2007 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 collectibility 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.