UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                  -------------

                                    FORM 10-K

(Mark One)

[x]   Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
      Act of 1934

For the fiscal year ended  December 31, 1997

|_|   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: 000-23329

                                    C3, Inc.
- --------------------------------------------------------------------------------
             (Exact name of Registrant as specified in its charter)


                  North Carolina                           56-1928817
(State or other jurisdiction of incorporation)          (I.R.S. Employer 
                                                       Identification No.)

3800 Gateway Boulevard, Suite 310, Morrisville, N.C.         27560
     (Address of principal executive offices)             (Zip Code)

Registrant's telephone number, including area code:       (919) 468-0399

          Securities registered pursuant to Section 12(b) of the Act:

                                      None.
          -----------------------------------------------------------

           Securities registered pursuant to Section 12(g) of the Act:

                      Common Stock, no par value per share
          -----------------------------------------------------------

         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 if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|

         The aggregate market value of the voting stock held by non-affiliates
of the Registrant as of March 25, 1998 was $48,619,184. On March 25, 1998
there were 6,938,476 outstanding shares of the Registrant's Common Stock.


                       DOCUMENT INCORPORATED BY REFERENCE

Certain portions of the Proxy Statement of the Registrant for the Annual Meeting
of Shareholders to be held on June 23, 1998 have been incorporated by reference
into Part III of this Annual Report on Form 10-K.

<PAGE>

                           FORWARD LOOKING STATEMENTS

This Form 10-K contains 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. These forward-looking statements represent the
Company's judgement on future events and, because the Company is in the
development stage and has not yet engaged in significant revenue-producing
activities, are subject to risks and uncertainties that could cause the
Company's actual performance and results to differ materially from those
projected or discussed herein. These risks and uncertainties are discussed in
"Business Risks" in Item 1 below and in "Risk Factors" in the Company's
Prospectus dated November 14, 1997.


                                     PART I


Item 1. BUSINESS.

Introduction

         The Company is finalizing the development of colorless lab-created
moissanite gemstones for sale in the jewelry market. The physical properties of
lab-created moissanite gemstones more closely match those of diamond than any
other known gemstone material. Moissanite, also known by its chemical name,
silicon carbide ("SiC"), is a rare, naturally occurring mineral found primarily
in meteorites. See "-- Moissanite." Moissanite and diamond are both carbon-based
minerals; moissanite is composed of silicon and carbon while diamond is composed
of carbon.

         The Company is currently selling limited amounts of its moissanite
gemstones in the comparable diamond color grades currently available from the
Company's supplier to selected members of the jewelry industry. The Company
plans to sell loose lab-created moissantie gemstone in sizes of 1/2 carat or
less and intends to market larger carat gemstones depending on progress made by
its supplier on meeting certain development targets or other marketing
considerations.

         The Company has interviewed certain retail jewelry chains and
independent retail jewelry stores in selected cities in the United States,
primarily in the southern part of the country, and is seeking to enter into
distribution agreements with jewelers in these cities. The Company is also
actively considering distribution arrangements for certain international cities
and is currently negotiating exclusive distributorships with selected
wholesalers in Asia which could be finalized during the the second quarter of
1998. The Company expects initial customer shipments of production material
gemstones to begin in June 1998. See "--Distribution, Sales and Marketing."


         The Company has been issued a U.S. patent for moissanite gemstones
under which the Company has broad, exclusive rights to manufacture, use and sell
lab-created moissanite gemstones in the United States. The Company has
applications pending in a number of foreign jurisdictions for this same patent.
The Company has also developed certain proprietary methods and processes for the
production of gemstones from lab-grown SiC crystals and has patent applications
pending for certain of these methods and processes. See "-- Intellectual
Property." Accordingly, the Company believes that its lab-created moissanite
gemstones are proprietary products and that there are significant barriers to
prevent other competitors from marketing lab-created moissanite gemstones.

         The Company's lab-created moissanite gemstones are currently made from
SiC crystals grown by Cree Research, Inc. ("Cree"). Cree has an exclusive
license to a patent related to a process for growing large single crystals of
SiC. To the Company's knowledge, there are currently no producers of SiC other
than Cree that could readily supply lab-grown SiC crystals in colors, sizes or
volumes suitable for use as gemstones. The Company has certain exclusive
licenses and supply rights with Cree for SiC materials to be used for gemstone
applications. See "-- Products and Product Development." The President of the
Company and one of the founders of the Company are the brothers of the Chief
Executive Officer of Cree. As of December 28,

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<PAGE>

1997, Cree and certain of its officers and directors own approximately 5% of the
Company's outstanding Common Stock.

         The Company has entered into an agreement with Cree whereby Cree is
attempting to develop a fully repeatable process to grow SiC crystals in the
comparable diamond color grades of "G" through "J" and in specified sizes and
volumes. While Cree has not yet developed a fully repeatable process to grow SiC
crystals in the target color range, Cree has produced SiC crystals in the "K"
through "N" color range and has made improvements in color uniformity. In
January 1998, the Company entered into a supplemental agreement with Cree under
which Cree is obligated to accelerate its efforts to develop a fully repeatable
process for producing larger diameter SiC crystals in the target color range
that had originally been scheduled to be developed by July 1, 1999.

        Although, as of late March, Cree has not yet developed a fully
repeatable process for producing SiC crystals in the comparable diamond color
grades of "G" through "M", Cree has improved the yield of SiC material in the
comparable diamond color grades of "K" through "M" and is on target to produce
larger diameter SiC crystals. If Cree continues to achieve its objectives to
produce larger diameter SiC crystals on a timely basis, the Company expects that
production of larger diameter SiC crystals will begin in the fourth quarter of
1998. The Company believes that the use of larger diameter SiC crystals will
increase the number and size of moissanite gemstones that are produced from each
SiC crystal and reduce the per-carat cost of moissanite gemstones, factors
important to the commercialization of moissanite gemstones. There can be no
assurance that Cree's development efforts will be successful. See "Business
Risks" and "--Products and Product Development."

         The Company believes that a practical, readily available method of
distinguishing colorless lab-created moissanite gemstones from diamond will be
needed by persons who are not well-trained gemologists to prevent fraud. Because
the Company's tests indicate that visual inspection by individuals who are not
well-trained gemologists and commonly used testing devices do not reliably
distinguish colorless lab-created moissanite gemstones from diamond, the Company
is marketing its proprietary test instrument that distinguishes colorless
lab-created moissanite



                                       3

<PAGE>

gemstones from diamonds in the colors and clarities most commonly sold by retail
jewelers. See "-- Products and Product Development -- Moissanite/Diamond Test
Instrument."

Diamond Jewelry Market

         In 1996, worldwide retail diamond jewelry sales were estimated to be in
excess of $52 billion and diamond jewelry sales in the United States were
estimated to be $17.9 billion. In 1996, approximately 29.5 million pieces of
diamond jewelry were sold in the United States, of which approximately 22.8
million pieces used settings other than engagement rings.

         The value of a diamond is determined by its carat size, cut, color and
clarity. Carat size refers to the weight of a diamond with one carat being
equivalent to 1/5 of a gram. The cut, or faceting of a rough diamond into a
gemstone, reveals the natural "fire", brilliance and color of the stone. Color
refers to the amount of tint in a diamond. Clarity refers to the presence and
severity of inclusions (impurities trapped in the diamond during its formation)
and blemishes in a diamond.

         The color grading scale, which is the standard generally accepted by
the diamond industry for color using pregraded master color stones, measures the
color of diamonds. The color grading scale consists of the letters "D" through
"Z". "D" is the designation given to a diamond that is completely colorless,
while a designation of "Z" is given to a colorless diamond that has a yellowish
tint visible to the naked eye. Colored diamonds, such as canary diamonds, use a
different grading scale. Retail jewelry stores most often sell diamonds within
the "G" to "M" range. In 1996, the median color grade of all diamonds sold was
within the range of "H" to "I".

         The clarity grading scale, which is generally accepted by the diamond
industry, is used to identify the severity of defects. The clarity grading scale
is as follows: Flawless (a diamond that has no inclusions and only insignificant
blemishes that are invisible at 10x magnification); Very Very Slightly Included;
Very Slightly Included; Slightly Included; Imperfect-1; Imperfect-2; and
Imperfect-3 (large and/or numerous inclusions that are clearly visible to the
naked eye). Retail jewelry stores predominantly sell diamonds in the range of
Very Slightly Included to Imperfect-1. The clarity grade with the highest number
of diamonds sold in 1996 was Slightly Included.

Moissanite

         Moissanite is a rare, naturally occurring mineral which is found
primarily in meteorites. The naturally occurring moissanite that has been found
has generally been very small in size and dark green or black in color and is
not a commercially viable gemstone material. Therefore, only lab-grown SiC
crystals are expected to provide a meaningful source of moissanite for
gemstones.

         The Company believes that lab-created moissanite gemstones have unique
features that compare favorably to diamond and that make it attractive for use
as a gemstone which will result in market demand for the Company's products. It
is generally accepted that, in addition to carat size, the most important
characteristics of a gemstone are its beauty and durability. The beauty of a
colorless diamond is determined by the absence of color as well as the diamond's
brilliance and "fire." The


                                       4

<PAGE>

brilliance of a gemstone is measured by its refractive index or the extent to
which it reflects light. The "fire" of a gemstone, or the breaking of light rays
into the spectrum of colors, is measured by its dispersion. The gemstone's
hardness also determines the extent to which brilliance and "fire" can be
highlighted by cutting with sharp, highly polished facets. The durability of a
gemstone is determined by the gem's hardness, or resistance to scratching, and
its toughness, or resistance to chipping or cleaving.

         Based on their physical properties, the Company believes that
lab-created moissanite gemstones compare favorably to diamond for beauty and
durability. The Company believes that the unique atomic structure of SiC allows
it to be grown in a wide variety of colors, including colors within the
commercially desirable portion of the diamond grading scale. The refractive
index of colorless lab-created moissanite gemstones is higher than diamond and
is believed by the Company to be closer to diamond than any other hard mineral.
The dispersion of colorless lab-created moissanite gemstones is also higher than
diamond. The Company believes that the hardness of lab-created moissanite
gemstones is greater than all known gemstone materials except diamond. As a
result, the Company believes that lab-created moissanite gemstones, like
diamond, can be cut with sharp, highly polished facets that accentuate their
brilliance and "fire."

         The Company believes that other physical properties of lab-created
moissanite gemstones compare favorably to diamond and will aid in jewelers'
acceptance of its products. Because the specific gravity, or density, of
lab-created moissanite gemstones is very close to that of diamond, the size of a
1 carat lab-created moissanite gemstone is virtually indistinguishable from a 1
carat diamond by the naked eye. In addition, lab-created moissanite gemstones,
like diamond, can withstand high temperatures. This property allows jewelers to
make extensive repairs to the jewelry setting without removing the stone and to
use the same methods that are used to repair diamond jewelry.

         The following table compares the physical properties of lab-created
moissanite gemstones with other gemstone materials:

                         GEMSTONE MATERIAL COMPARISON(1)



<TABLE>
<CAPTION>
                                    Hardness
                                     (MOHS                               REFRACTIVE                           SPECIFIC
      Gemstone Material            SCALE) (2)         TOUGHNESS            INDEX            DISPERSION         GRAVITY
- ------------------------------  ----------------  -----------------  ------------------  ----------------  ---------------
<S>                                 <C>             <C>                  <C>                <C>              <C> 
Diamond.......................         10               Good*               2.42               0.44             3.52
Lab-Created Moissanite (3)....      9.25-9.50         Excellent           2.65-2.69          .090-.104        3.14-3.21
Sapphire & Ruby...............          9             Excellent           1.76-1.78            .018           3.90-4.00
Synthetic Cubic Zirconia......       8.0-8.5            Good              2.09-2.18            .060           5.60-6.06
Emerald.......................         7.5          Poor to Good          1.56-1.60            .014           2.69-2.75
</TABLE>


  *  In cleavage direction, otherwise excellent.


                                       5

<PAGE>

(1) Sources: GEMOLOGICAL INSTITUTE OF AMERICA, GEM REFERENCE GUIDE FOR THE GIA
COLORED STONES, GEM IDENTIFICATION AND COLORED STONE GRADING COURSES 32-35,
65-82, 87-90 (1995); CORNELIUS S. HURLBURT, JR. & ROBERT C. KAMMERLING, GEMOLOGY
320-324 (2d ed. 1991); KIRK-OTHMER ENCYCLOPEDIA OF CHEMICAL TECHNOLOGY 891-906
(4th ed. 1994); INSTITUTION OF ELECTRICAL ENGINEERS, PROPERTIES OF SILICON
CARBIDE 3 (Gary L. Harris, ed., 1995); ROBERT WEBSTER, GEMS: THEIR SOURCES,
DESCRIPTIONS AND IDENTIFICATION 889-940 (5th ed. 1994); W. VON MUENCH, "SILICON
CARBIDE" IN LANDOLT-BOEMSTEIN NUMERICAL DATA AND FUNCTIONAL RELATIONSHIPS IN
SCIENCE AND TECHNOLOGY, NEW SERIES, GROUP III, VOL. 17C, PP. 403-416 AND 585-592
(M. Schultz and H. Weiss, eds., 1984).

(2) The Mohs Scale is approximately logarithmic and quantitative comparisons of
different gemstone materials cannot be made directly using the Mohs Scale.
Lab-created moissanite gemstones are approximately one-third as hard as diamond
and synthetic cubic zirconia is approximately one-sixth as hard as diamond.
Lab-created moissanite gemstones are approximately twice as hard as synthetic
cubic zirconia.

(3) The physical properties of lab-created moissanite gemstones set forth in the
preceding table utilized materials from SiC crystals produced by parties other
than the Company or Cree. These crystals had various sizes, colors and atomic
structures that the Company believes made them unsuitable for use as a diamond
alternative. The Company has conducted tests on the hardness, toughness and
refractive index of samples of its lab-created gemstones, and the results of
these tests are consistent with the results reported in this table. Because a
fully repeatable process for producing gemstone quality SiC crystals has not yet
been developed, the specific properties of the lab-created moissanite gemstones
that will eventually be commercialized are not now known. However, the Company
believes that the physical properties of its lab-created moissanite gemstones
will fall within the ranges of the lab-created moissanite shown in this table.

Products and Product Development

         Moissanite Gemstones. The Company is currently selling limited
quantities of moissanite gemstone samples of 1/2 carat or less in color grades
currently available from Cree to selected members of the jewelry industry.


                                       6

<PAGE>

The Company is also selling a limited edition of moissanite gemstones set in
gold jewelry in limited quantities in the United States in a nonpublic
distribution. For the foreseeable future, the Company plans to sell loose round
brilliant cut moissanite gemstones primarily in sizes of 1/2 carat or less. Over
time, the Company intends to market larger carat gemstones depending on progress
made by Cree in meeting certain development targets or other market
considerations. In addition, the Company may elect to offer additional cuts or
colored lab-created moissanite gemstones.

         The Company has not yet determined the price at which it will market
its lab-created moissanite gemstones. The Company's moissanite gemstone samples
are presently being sold at a price of $18 to $80 per sample for samples of
three to five millimeters in diameter. The Company intends to price its
gemstones after assessing the results of market research currently being
conducted for the Company by its marketing agency. There can be no assurance
that the Company will be able to sell its products at the prices ultimately
established by the Company or at any other prices that would be profitable to
the Company.

         Development Agreement with Cree. Under a June 6, 1997 Development
Agreement (the "Development Agreement") with Cree, the Company is funding Cree's
efforts to develop a fully repeatable process for producing SiC crystals in the
comparable diamond color grades "G" through "J", with at least 50% in the "G" to
"H" range. The Development Agreement also provides for a five-year focused
development effort by Cree to increase crystal size while maintaining color
grade and uniformity and establishes milestones for crystal production to be met
by July 1 of each year. The Company has the right to terminate the Development
Agreement if Cree does not meet any milestone. Recent SiC crystals produced by
Cree have yielded gemstones primarily in the comparable diamond color range of
"K" through "N." While fluctuations in color range occur, Cree is operating
crystal growth systems in development programs aimed at improving crystal color
and diameter as well as process uniformity. The Company is continuing to
evaluate progress under the development agreements in assessing its business
strategies.

         In January 1998, the Company elected to continue funding the
Development Agreement with Cree even though Cree had not developed a fully
repeatable process in the target color range by January 1, 1998. On January 8,
1998, the Company and Cree entered into a Supplemental Development Agreement
(the "Supplemental Agreement") under which Cree is obligated to accelerate its
efforts to develop a fully repeatable process for producing larger diameter SiC
crystals in the target color range that had originally been scheduled to be
developed by July 1, 1999. If the diameter and color objectives are achieved by
Cree in the earliest time frames under the Supplemental Agreement, the Company
could pay Cree up to an additional $2.3 million. The Supplemental Agreement,
which expires on December 31, 1998, provides that if Cree is unable to develop a
fully repeatable process in the target color range by a specified date the
Company has the right, for a period of ten days after that date, to terminate
the Supplemental Agreement.

        Although, as of late March, Cree has not yet developed a fully
repeatable process for producing SiC crystals in the comparible diamond color
grades of "G" through "M", Cree has improved the yield of SiC material in the
comparable diamond color grades of "K" through "M" and is on target to produce
larger diameter SiC crystals. If Cree continues to achieve its objectives to
produce larger diameter SiC crystals on a timely basis, the Company expects that
the crystal growth systems provided by Cree under the Exclusive Supply Agreement
will begin production of larger diameter SiC crystals in the fourth quarter of
1998.

                                       7

<PAGE>

         Exclusive Supply Agreement with Cree. On June 6, 1997, the Company and
Cree entered into the Exclusive Supply Agreement whereby the Company has agreed
to purchase from Cree at least 50%, by dollar volume, of the Company's
requirements for SiC crystals for the production of gemstones in each calendar
quarter and Cree is obligated to supply this amount of crystals to the Company.
Although the Company is obligated to purchase only 50% of its requirements from
Cree, the Company does not believe there are currently any other alternative
sources of supply for SiC crystals suitable for gemstones. Therefore, at the
present time, the Company is dependent on Cree as its sole source of supply of
lab-grown SiC crystals. The price for SiC crystals is set at Cree's loaded
manufacturing cost plus a margin, which margin may increase if the price of
crystals declines below a specified amount. Under the Exclusive Supply
Agreement, Cree has agreed not to sell SiC crystals for gemstone uses to anyone
other than the Company.

         Cree will have to build additional crystal growth systems in order to
meet the Company's anticipated SiC crystal requirements. Under the Exclusive
Supply Agreement, Cree may elect to have the Company purchase the additional
growth systems that will be needed or to fund the costs on its own and recoup
its costs by incorporating the costs of the systems into the cost of the SiC
crystals purchased by the Company. If the Company funds the costs of the crystal
growth systems, Cree must supply the Company with 100% of the output from these
systems. If Cree elects to fund the cost of these additional growth systems on
its own, there can be no assurance that Cree will supply the Company with all of
the output from these crystal growth systems or fill all of the Company's
orders. Any delay or reduction in the availability of SiC crystals could delay
or limit the Company's ability to deliver and sell its lab-created gemstones,
which would have a material adverse effect on the Company.

         The Exclusive Supply Agreement also restricts the Company from entering
into numerous types of arrangements with identified parties. See "--
Distribution, Marketing and Sales" and "Business Risks -- Anti-Takeover and
Certain Other Provisions." The Exclusive Supply Agreement has an initial term of
ten years, which may be extended for an additional ten years by either party if
the Company orders in any 36-month period SiC crystals with an aggregate
purchase price in excess of $1.0 million. The Company expects to meet this order
threshold and to extend the term of the Agreement.

         Moissanite/Diamond Test Instrument. Gemstone test instruments most
commonly used by jewelry industry employees rely on thermal properties to
distinguish diamond from other gemstones or diamond simulants such as synthetic
cubic zirconia. Because the thermal properties of lab-created moissanite
gemstones are relatively close to those of diamond, such instruments have not,
to date, been able to reliably differentiate between diamond and lab-created
moissanite gemstones. Although gemologists trained in the physical properties of
lab-created moissanite gemstones may find a number of ways to distinguish
lab-created moissanite from diamond, the Company believes that a
moissanite/diamond test instrument must be available to jewelers and pawnbrokers
prior to the introduction of lab-created moissanite gemstones to help prevent
fraud.


                                       8

<PAGE>

         The Company began marketing its moissanite/diamond test instrument, the
Tester Model 590, at a list price of $525 during the fourth quarter of 1997 for
delivery in the first quarter of 1998. This instrument, which distinguishes
moissanite gemstones from diamonds in the colors and clarities most commonly
sold by retail jewelers, is used in conjunction with existing thermal test
instruments. A patent application by the Company is pending for its
moissanite/diamond test instrument. A number of other companies have announced
plans to introduce, or have introduced, devices that claim to distinguish
moissanite gemstones from diamonds. There can be no assurance that a significant
market will develop for the Company's test instrument, that other competing
devices will not be introduced or that other readily available means will not be
developed which can effectively distinguish lab-created moissanite gemstones
from diamond.

         Moissanite/Diamond Test Instrument Component. Under a letter agreement
(the "Instrument Agreement") dated February 12, 1996, Cree is also the sole
supplier of a component proprietary to Cree used in the Company's
moissanite/diamond test instrument. The Instrument Agreement, which expires in
2016, obligates the Company to purchase all of the components used in the test
instrument from Cree and gives the Company the exclusive right to purchase those
components from Cree. The Company is also obligated to pay Cree a royalty of 2
1/2% of net sales of all test instruments incorporating the Cree component. If
Cree were to fail to deliver this component, as required, the Company would not
be able to manufacture its test instrument.

Intellectual Property

         Intellectual Property of the Company. The Company has been issued a
U.S. patent for moissanite gemstones under which the Company has broad,
exclusive rights to manufacture, use and sell lab-created moissanite gemstones
in the United States. The Company has applications pending in a number of
foreign jurisdictions for this same patent. The Company also has applications
pending related to certain methods of producing lab-created moissanite gemstones
and for its moissanite/diamond test instrument. Although the Company intends to
enforce its patent rights and vigorously prosecute all its patent applications,
there can be no assurance that such actions will be successful, that any
additional patents will be issued, that any issued patent will not be
challenged, invalidated or circumvented or that any issued patent will have any
competitive or commercial value.

         The Company's success and ability to compete successfully is heavily
dependent upon its proprietary technology. In addition to its patent and pending
patents, the Company relies on trade secret laws and employee, consultant and
customer confidentiality agreements to protect certain aspects of its
technology. There can be no assurance that the Company will be able to protect
its proprietary technology from disclosure or that others will not develop
technologies that are similar or superior to its technology. See "Business Risks
- -- Dependence on Intellectual Property."

         While the Company has not received any claims that its products or
processes infringe on the proprietary rights of third parties, there can be no
assurance that third parties will not assert such claims against the Company
with respect to its existing and future products. In the event of litigation to
determine the validity of any third party's claims, such litigation could result
in


                                       9

<PAGE>

significant expense to the Company and divert the efforts of the Company's
technical and management personnel, whether or not such litigation is determined
in favor of the Company. In the event of an adverse result of any such
litigation, the Company could be required to expend significant resources to
develop non-infringing technology or to obtain licenses to, and pay royalties on
the use of, the technology which is the subject of the litigation. There can be
no assurance that the Company would be successful in such development or that
any such license would be available on commercially reasonable terms.

         Proprietary Technology of Cree. Cree, the Company's current source for
development and supply of lab-grown SiC crystals, has developed or licensed
numerous proprietary processes for the growth of SiC crystals that it uses in
semiconductor, laser and other non-gemstone applications. The founders of the
Company recognized the potential use of SiC crystal for lab-grown gemstones, and
the Company has obtained the exclusive right to purchase SiC crystals from Cree
for gemstones and gemological instrumentation. The Company believes that Cree is
currently the only producer of SiC crystals in sizes suitable for commercial
production of gemstones. In addition, Cree is the only producer of SiC known by
the Company to be developing colorless SiC crystals suitable for use as
gemstones at the present time.

         Cree has significant proprietary rights related to its processes for
growing SiC crystals. Cree has an exclusive license on a patent for a process of
growing large single crystals of SiC. This patent expires in years ranging from
2006 to 2011, depending on the country in which issued. In addition, Cree has a
patent for a process for growing colorless SiC and other patents relating to
certain aspects of its SiC crystal growth process. To further protect its
proprietary SiC crystal growth process, Cree internally produces the crystal
growth systems used to produce its SiC crystals. The Company has a royalty-free,
perpetual license for the use in gemstone applications of the technology covered
by Cree's patent for growing colorless SiC.

         At the present time, the Company's success and ability to compete is
heavily dependent upon Cree's ability to successfully complete the objectives of
the Development Agreement and on Cree's proprietary technology. See "Business
Risks -- Dependence on Intellectual Property."

Manufacturing

         The production of lab-created moissanite gemstones includes (i) growing
SiC crystals, (ii) cutting crystals into preforms that will yield gemstones of
an approximate carat size, (iii) faceting preforms into gemstones, and (iv)
inspecting, sorting and grading faceted gemstones.

         Growth of SiC Crystals. SiC crystals are grown for the Company by Cree
in accordance with the terms of the Exclusive Supply Agreement. Under the
Exclusive Supply Agreement, Cree is required to sell to the Company all of the
crystals grown in a specified number of crystal growth systems without charging
the Company for such crystal growth systems. Upon its receipt of an order from
the Company for a quantity of crystals that will require the acquisition of
additional crystal growth systems, Cree may elect to have the Company purchase
the additional growth systems


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<PAGE>

that will be needed or to fund the costs on its own and recoup its costs by
incorporating the costs of the systems into the cost of the SiC crystals
purchased by the Company.

         In addition to crystal growth systems being used for development
activities, Cree is now using all of the crystal growth systems that it is
obligated to provide at its expense under the Exclusive Supply Agreement to
produce SiC crystals for the Company. These growers went on line at various
times during the first quarter of 1998 and are running the best process
currently available from Cree. The Company is obligated to purchase all of the
output from these growers through various dates in the third quarter of 1998.
The Company is currently building an inventory of moissanite gemstones of 1/2
carat or less from current production of these growers.

        The Company is continuing to evaluate Cree's progress under the
development agreements and the color and size of SiC crystals being produced by
Cree in determining when to place additional orders with Cree that will require
the acquisition of crystal growth systems that Cree is not obligated to provide
at its expense. One order placed with Cree during the fourth quarter of 1997,
which was contingent on Cree meeting certain development milestones for color
range, has lapsed without being filled.

         The Company expects to place orders for SiC crystals in advance of
actual demand for moissanite gemstones in an effort to have adequate quantities
of gemstones available to meet anticipated market demand. As a result, the
Company may spend significant amounts of its capital to acquire additional
crystal growth systems or purchase SiC crystals at a time when there is no
existing demand to justify such expenditures. There can be no assurance that the
Company will be able to sell lab-created moissanite gemstones in accordance with
its objectives. If the Company underestimates demand, the Company may be unable
to rapidly increase its production of lab-created moissanite gemstones to
satisfy the demand as a result of the several months that may elapse between the
Company placing an order for crystals and the time that additional growth
systems needed could begin producing crystals.

         Preforms. The Company divides all SiC crystals through slicing and
dicing processes into preforms in carat sizes suitable for faceting into
predetermined calibrated-size gemstones. The Company has begun to acquire
readily available automated and computerized equipment used in the semiconductor
industry to slice and dice crystals into preforms. The Company believes that
this equipment will enable it to maximize, with minimal additional investment or
employee training, the number of preforms obtained from each SiC crystal.

         Faceting Gemstones. The faceting of preforms is a critical stage in
obtaining quality gemstones. The techniques and skills used in faceting
lab-created moissanite gemstones differ somewhat from those used in faceting
diamonds. The Company is, and expects to continue, outsourcing the faceting of
its moissanite gemstones, other than faceting for research and product
development purposes which it conducts internally. The Company has entered into
an agreement with John M. Bachman, Inc. ("JMB") under which an affiliate of JMB
is faceting lab-created moissanite preforms. Pursuant to this agreement, the
Company has advanced certain funds to JMB to expand production capability at its
affiliate. The Company has committed to supply certain minimum quantities of
preforms to JMB, and JMB has agreed to have such quantities faceted to mutually
agreed specifications at agreed upon prices. The agreement renews annually
unless sooner terminated by either party upon no less than 60 days notice prior
to the end of the then applicable


                                       11

<PAGE>

term or due to breaches of the agreement or the occurrence of certain other
events. Under this agreement, JMB has agreed to grant, and to cause its
affiliates to grant, to the Company a perpetual, non-exclusive, royalty-free
license to use any inventions or proprietary information developed by or for JMB
or its affiliates that is useful in the faceting of lab-created moissanite
gemstones.

         The Company has identified two additional suppliers of faceting
services, has qualified their faceting skills on a sample basis and is currently
assessing these other vendors' production capabilities. There is, however, no
assurance that these vendors will be suitable for reliable supply arrangements
or that the Company will be able to enter into agreements with these additional
vendors or with other reliable, quality faceting providers on terms acceptable
to the Company. Even if these agreements can be reached, the Company intends
during the early stages of commercialization of its products to source faceting
services primarily from JMB and will be dependent on JMB's ability to provide an
adequate quantity of quality faceted lab-created moissanite gemstones. The
Company has not yet begun placing commercial production orders with JMB, and
therefore is unable to assess, with certainty, whether JMB will be able to
produce faceted lab-created moissanite gemstones to the Company's quality
specifications and within the Company's quantity and time requirements.

         Inspection, Sorting and Grading. Faceted lab-created moissanite
gemstones are currently returned to the Company for inspection, sorting and
grading. During this stage, specially trained personnel individually examine and
grade each faceted lab-created moissanite gemstone for color, cut and clarity.
This phase of manufacturing is relatively labor-intensive and requires skills
not readily available in the general work force. In the future, the Company may
elect to outsource a significant portion of this stage of the manufacturing
process to an independent third party. If the Company does elect to outsource
this phase of manufacturing, the Company intends to establish rigorous quality
control and monitoring standards over its vendors' operations. There can be no
assurance that the Company will be able to hire or retain sufficient numbers of
appropriately skilled personnel for this phase of manufacturing, find and enter
into acceptable agreements with third party vendors or that such vendors will be
able to provide accurate inspection, sorting and grading services on a timely
basis.

         Moissanite/Diamond Test Instrument. The Company has contracted with an
unaffiliated third party for the assembly of its moissanite/diamond test
instrument from components produced by third parties. The Company believes that,
other than with respect to a component containing a proprietary semiconductor
chip that the Company obtains from Cree under the Instrument Agreement, the
components and assembly functions would be readily available from a wide variety
of other suppliers.

Distribution, Marketing and Sales

         The Company intends to focus its initial U.S. sales efforts in selected
cities, primarily in the southern part of the country, through retail jewelry
chains and independent retail jewelry stores. The Company has targeted the
United States because it believes that the United States represents a
significant portion of the worldwide jewelry market and will be relatively


                                       12

<PAGE>

accepting of a new gemstone that compares favorably to diamond. The Company has
interviewed certain retail jewelry chains and independent retail jewelry stores
in its initial target markets and will seek to enter into distribution
agreements with distributors in these cities during the second quarter of 1998.
The Company currently anticipates that distributors will be granted the right to
be the exclusive retail store or chain selling lab-created moissanite gemstones
in a limited geographic territory. The Company is evaluating the most
appropriate structure for exclusive distribution arrangements and may, in
certain circumstances, enter into other types of distribution arrangements. The
Company is also actively considering distribution arrangements for certain
international cities and is currently negotiating exclusive distribution
agreements with several wholesalers in Asia which may be finalized in the second
quarter of 1998.

         The Company believes that exclusive distribution agreements will
provide retailers with an opportunity to earn a profit margin that compares
favorably to other jewelry products and will allow the retailer to distinguish
its product line from other jewelers in the highly competitive retail jewelry
market. The Company also believes that the profit margins associated with its
products will create incentives for these retailers to maximize their sales and
promotions efforts, resulting in additional consumer demand for the Company's
lab-created moissanite gemstones. As the Company's supply of lab-created
moissanite gemstones increases, the Company plans to increase the number of
markets in which its products are available. After the introduction of
lab-created moissanite gemstones in its initial target markets, the Company's
sales staff will divide its time between providing sales support to its existing
network of retailers and entering new target markets and new distribution
arrangements.

         The Company believes that marketing loose stones will allow retail
jewelers to individually select the most appropriate jewelry settings for their
individual market areas. The sale of round brilliant cut stones also provides
the jeweler with a wide range of uses for the stones in rings, earrings,
pendants and bracelets. However, consumer perception and acceptance of the
Company's products will be directly impacted by the quality, design and
workmanship of the settings chosen by the retailers, and the Company will have
no control over these individual decisions.

         The Company and DDB Needham of Dallas ("DDB Needham"), an international
marketing agency to whom the Company has outsourced substantially all of the
Company's marketing functions, have designed a comprehensive marketing plan for
lab-created moissanite gemstones. As part of the marketing plan, the Company and
DDB Needham are developing a substantial marketing effort for the jewelry
industry and consumers. The marketing plan includes cooperative advertising with
jewelers and other distributors, point of purchase displays, educational
brochures and materials, jeweler and distributor training in selling moissanite
gemstones, jeweler assistance in selecting appropriate jewelry settings for
moissanite gemstones and other marketing support services. The Company and DDB
Needham have based the marketing plan on the results of market research and a
series of market studies designed to gather information on jeweler and consumer
reaction to lab-created moissanite gemstones. DDB Needham is continuing to
conduct market research and additional market studies to refine the marketing
plan and to assist the Company in identifying and selecting additional target


                                       13

<PAGE>

markets. Implementation of key aspects of the marketing plan will be dependent
on the Company having sufficient quantities of gemstones in desirable color
ranges to satisfy demand in the Company's initial markets and to expand into
additional markets.

         The Company is selling its moissanite/diamond test instrument directly
to jewelers, gemologists and pawnbrokers through direct mailings, advertisements
in trade publications and trade shows. The Company may retain non-exclusive
distributors to distribute the test instrument in some markets or enter into
other distribution agreements as it deems appropriate.

         The Exclusive Supply Agreement prohibits the Company, without Cree's
consent, from entering into an exclusive marketing or distribution agreement
with DeBeers or any party that Cree reasonably believes is affiliated with
DeBeers; the Central Selling Organization (the international cartel of diamond
producers); any party whose primary business is the development, manufacture,
marketing or sale of diamond gemstones; or any non-gemstone and non-jewelry
industry competitor of Cree. These provisions may limit the avenues of
distribution potentially available to the Company and could prevent the Company
from entering into certain potentially profitable transactions.

Competition

         Moissanite Gemstones. Competition in the market for gemstones is
intense. Gemstone materials can be grouped into three types: (i) natural
gemstone, which is found in nature; (ii) synthetic gemstone, which has the same
chemical composition and characteristics of natural gemstone but is created in a
lab; and (iii) simulated or substitute material, which is similar in appearance
to natural gemstone but does not have the same chemical composition. The
Company's lab-created moissanite gemstones will compete with natural and treated
diamonds and existing synthetic gemstones such as synthetic cubic zirconia
presently in commercial distribution. The Company may also face competition from
additional gemstones such as synthetic diamonds, synthetic diamond films and
other sources of synthetic moissanite not presently available in colors, sizes
and volumes suitable for use as gemstones. Most of the suppliers of diamonds and
existing synthetic gemstones, as well as the potential suppliers of other
synthetic gemstones, have substantially greater financial, technical,
manufacturing and marketing resources and greater access to distribution
channels than the Company.

         The worldwide market for large, uncut high-quality diamonds is
significantly consolidated through the Central Selling Organization, a cartel
led by DeBeers. The cartel has a major impact on the worldwide supply and
pricing of these diamonds at both the wholesale and retail levels. Although the
Company believes that its gemstones will appeal primarily to the consumer who
would not otherwise purchase comparable diamond jewelry, diamond producers may
undertake additional marketing or other activities designed to protect the
diamond jewelry market against sales erosion from consumer acceptance of
lab-created moissanite gemstones.

         The Company may also face competition from treated diamonds. Treated
diamonds, which are natural diamonds with imperfections or flaws that have been
altered in some manner to enhance


                                       14

<PAGE>

their appearance, are presently available in the jewelry industry and are
generally less expensive than diamonds of similar size, cut and color which have
not been altered.

         Synthetic diamond in gemstones or film form may also become available
in the marketplace and compete with the Company's gemstones. Synthetic diamonds
are regularly produced for industrial applications, but the Company believes
that gemstone quality synthetic diamonds presently cannot be produced at prices
competitive with those expected to be offered for the Company's colorless
lab-created moissanite gemstones. The primary producers of these synthetic
diamonds are DeBeers, Sumitomo and GE. There are also a number of Russian
producers of synthetic diamonds for industrial uses. Synthetic diamond films can
be grown at commercially viable prices in thicknesses that can be applied to
other surfaces but these films adhere well to only a few minerals such as
diamond, silicon and SiC (moissanite). There could, however, be technological
advances that would enable competitively priced synthetic diamond in gemstone or
film form to be offered.

         Although the Company believes that its products have a proprietary
position, it could face competition from other companies who develop competing
SiC technologies. Some of these technologies could be spawned by producers of
SiC used for other industrial applications. Manufacturers of industrial SiC
products include The Carborundum Corporation (abrasive uses) and Cree, Siemens
AG, ABB and Northrup Grumman Corporation (semiconductor uses). The Company
believes that Cree is presently the only supplier of SiC crystals in colors,
sizes and volumes suitable for gemstone applications and believes that the
patents owned or pending by Cree or the Company provide substantial
technological, legal and cost barriers to other companies' development of
colorless lab-created moissanite gemstones. It is possible, however, that these
or other producers of SiC could develop SiC crystals suitable for gemstone
applications and produce lab-created moissanite gemstones until the Company
could obtain judicial enforcement of its patent rights.

         The Company's products may also face competition from synthetic cubic
zirconia, the principal existing diamond simulant. Two of the largest producers
of synthetic cubic zirconia gemstones are D. Swarovski & Co. and Golay Buchel.
In addition, there are a significant number of other producers of synthetic
cubic zirconia jewelry. Three of the largest retailers of synthetic cubic
zirconia jewelry in the United States are QVC, Home Shopping Network and
Wal-Mart. Some of the major retailers of synthetic cubic zirconia, including
QVC, have captive manufacturing divisions that produce synthetic cubic zirconia
jewelry. These producers and sellers may see their markets being eroded by the
introduction of the Company's lab-created moissanite gemstones. The Company
believes that price is the primary basis upon which these products will compete
with its lab-created moissanite gemstones.

         The Company intends to compete primarily on the basis that the unique
qualities of its lab-created moissanite gemstones compare favorably to diamond
at a significant cost advantage to diamond. Its ability to compete successfully
is dependent on its ability to: (i) achieve jeweler and consumer acceptance of
its products; (ii) obtain quantities of lab-grown SiC crystals in acceptable
color and quality; (iii) obtain reliable and high quality faceting services from
third parties; (iv) respond to market entries of other gemstone materials with
technological or cost


                                       15

<PAGE>

improvements; and (v) meet consumer demand for its lab-created moissanite
gemstones. There can be no assurance that the Company will be able to obtain the
materials and services needed to deliver its products or to otherwise be able to
compete successfully in the marketplace.

         Moissanite/Diamond Test Instrument. The Company's proprietary,
patent-pending moissanite/diamond test instrument, the Tester Model 590, faces
competition from several other devices that distinguish moissanite gemstone from
diamond. The Tester Model 590, working in conjunction with existing thermal test
instruments, readily distinguishes loose moissanite gemstones and moissanite
gemstones set in jewelry from diamond in the colors and clarities most often
sold by jewelers. The Gemological Institute of America has recently begun to
market a test instrument that is capable of distinguishing primarily loose
moissanite gemstones from diamond. Another company has introduced a device that
is capable of distinguishing primarily large loose moissanite gemstones from
diamond. In addition, Ceres Corporation has announced the planned introduction
of a device that it claims is capable of distinguishing moissanite from diamond.
Other competitors may also introduce devices that compete with the Company's
Tester Model 590 or gemologists trained in the physical properties of moissanite
gemstones may develop less expensive methods of distinguishing moissanite
gemstones from diamond. There can be no assurance that a market for
moissanite/diamond test instruments will develop or that the Company will be
able to successfully compete in that market, if it develops.

Government Regulation

         The Company's products will be subject to regulation by the Federal
Trade Commission (the "FTC"). The FTC has issued regulations and guidelines
governing the marketing of diamond simulants and substitutes and other gemstones
that have physical properties similar to diamond that require diamond simulants
and substitutes and other gemstones to be clearly identified in any promotional
or marketing materials. While the Company intends to comply fully with all FTC
regulations, there can be no assurance that the FTC or a competitor will not
challenge the Company's promotional or marketing activities. Such a challenge
could result in significant expense to the Company and divert the efforts of the
Company's management, whether or not such challenge is resolved in favor of the
Company. If the Company's actions were found to be in violation of FTC
regulations, the Company could be forced to suspend marketing and sales of its
products and could incur significant expenses in developing new marketing
strategies and materials that would not violate FTC regulations. There can be no
assurance that the Company would be successful in developing new marketing
strategies and materials that would comply with FTC regulations or that such
strategies, once developed, would allow the Company to market its products
profitably.


                                       16

<PAGE>

Employees

         At March 10, 1998, the Company had 34 full-time employees, 1 part-time
employee, 4 temporary employees and 2 independent contractors. The Company
believes that its future prospects will depend, in part, on its ability to
obtain additional management, scientific and technical personnel. Competition
for such personnel is intense, and the number of persons with relevant
experience is limited. None of the Company's employees is represented by a labor
union. The Company believes that its employee relations are good.

Backlog

         At March 10, 1998, the Company had orders for gemstone samples and
jewelry featuring its lab-created moissanite gemstones which are anticipated to
result in approximately $33,000 of revenues.


BUSINESS RISKS

         In addition to the other information in this Form 10-K, readers should
carefully consider the following important factors that in some cases have
affected, and in the future could affect, the Company's actual performance and
results and could cause the Company's actual results of operations to differ
materially from those expressed in any of the forward-looking statements made
by, or on behalf of, the Company.

Lack of Operating History; Development Stage Company

         The Company, which was incorporated in June 1995, is in the development
stage and has not yet engaged in any significant revenue-producing business
activities. The timing or existence of any significant revenues is dependent on
the successful development of a fully repeatable process to produce SiC crystals
in the colors, sizes and volumes desired for use in gemstones and on market
acceptance of lab-created moissanite gemstones. The Company's business is also
subject to the risks inherent in the transition from pilot production to
commercial production. Likewise, the Company's products are in an early stage of
development and are subject to the risks inherent in the development and
marketing of new products, including unforeseen design, manufacturing or other
problems or failure to develop market acceptance. Failure by the Company to
complete development of its products or to develop the ability to produce such
products in commercial quantities would have a material adverse effect on the
Company's business, operating results and financial condition. Accordingly, the
Company's prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in their early stage of
development, particularly technology-based companies operating with undeveloped
and unproven products.


                                       17

<PAGE>

Need for Further Product Development

         Although the Company is selling limited quantities of colorless
lab-created moissanite gemstone samples, the Company's current supplier of SiC
crystals, Cree, has not yet established a fully repeatable process for producing
lab-grown SiC crystals in the colors, sizes and volumes desired for the
Company's products. If Cree is unable to develop and sustain a fully repeatable
process for growing SiC crystals in the desired color grades, sizes and volumes,
the Company's business, operating results and financial condition would be
materially adversely affected.

Reliance on Cree Research, Inc.

         The Company is currently dependent on a single source, Cree, for
development and supply of SiC crystals. Cree has certain proprietary rights
relating to its process for growing large single crystals of SiC and its process
for growing colorless SiC crystals. The Company's effort to develop colorless
SiC crystals in colors, sizes and volumes desired for use as lab-created
gemstones is currently concentrated entirely with Cree and is dependent on
Cree's expertise in SiC technology which Cree uses in connection with
semiconductor, laser and other nongemstone applications.

         Under the Company's Exclusive Supply Agreement with Cree, the Company
is obligated to buy from Cree and Cree is obligated to sell to the Company 50%,
by dollar volume, of the Company's requirements for SiC material for the
production of gemstones in each calendar quarter. Although the Company is only
required to purchase 50% of its SiC requirements from Cree, the Company does not
currently believe that any other SiC producer could readily supply crystals in
the colors, sizes and volumes needed for the Company's products. Therefore, at
the present time, the Company is dependent on Cree as its sole source for its
principal raw material.

         Cree will have to build additional crystal growth capacity in order to
grow enough SiC crystals to meet the Company's anticipated requirements. Under
the Exclusive Supply Agreement, Cree may elect to have the Company purchase the
additional crystal growth systems that will be needed, and Cree would be
obligated to supply the Company with 100% of the output from systems funded by
the Company. If, however, Cree elects to fund the cost of these additional
growth systems on its own, then there can be no assurance that Cree will supply
the Company with all of the output from these crystal growth systems or fill all
of the Company's orders for SiC crystals. Any delay or reduction in the
availability of SiC crystals could delay or limit the Company's ability to
deliver and sell its lab-created gemstones, which would have a material adverse
effect on the Company's business, operating results and financial condition.

         The Company also obtains from Cree a component proprietary to Cree used
in the production of the Company's moissanite/diamond test instrument. See
"Business -- Products and Product Development --Moissanite/Diamond Test
Instrument." If Cree were unable to deliver this component in the quantities and
at the times needed by the Company, the Company's ability to provide the market
with its test instrument would be adversely affected.


                                       18

<PAGE>

         As a result of the Company's reliance on Cree, Cree's failure to
complete the desired development objectives and to supply the Company with SiC
crystals or components for its moissanite/diamond test instrument would have a
material adverse effect on the Company's business, operating results and
financial condition and could result in a curtailment, suspension, cessation or
significant change in the strategic direction of the Company's business. See
"Business -- Products and Product Development."

Undeveloped Markets; Unproven Acceptance of the Company's Products

         There currently is no market among retail jewelers or consumers for
colorless lab-created moissanite gemstones, and the Company believes that retail
jewelers and consumers are generally unaware of the existence and attributes of
these lab-created gemstones. As is the case with any new or potential product,
market acceptance and demand are subject to a significant amount of uncertainty.
The Company's future financial performance will depend upon consumer acceptance
of the Company's lab-created gemstones as a realistic and affordable alternative
to diamond, which may be impacted by jewelers' acceptance of lab-created
gemstones. The Company has not conducted extensive market tests to predict
retail jeweler or consumer reaction to its products. Although retail jewelers
typically purchase finished jewelry rather than loose gemstones, the Company
plans to market loose lab-created gemstones to retailers. The retailers will
then select the jewelry into which the stones will be set and will be
responsible for completing the setting. The quality, design and workmanship of
the jewelry settings selected by retail jewelers, which will not be within the
Company's control, could impact the consumer's perception and acceptance of the
Company's lab-created gemstones. Thus, the Company's future financial
performance may be impacted by (i) the willingness of retail jewelers to
purchase loose stones and undertake setting of the loose stones, (ii) the
ability of retail jewelers to select jewelry settings that encourage consumer
acceptance of and demand for the Company's lab-created gemstones and (iii) the
ability of retail jewelers to set loose lab-created gemstones in jewelry with
high quality workmanship.

         Because no market now exists for lab-created moissanite gemstones, it
is difficult to predict the size of the market for the Company's products and
its future growth rate, if any. In order to build inventory to meet anticipated
future demand, the Company expects to place orders for SiC crystals in advance
of actual demand for the Company's products. As a result, the Company may spend
significant amounts of its capital to acquire additional SiC crystal growth
systems or to purchase crystals at a time when there is not demand for the
Company's products at a level to fund those expenditures.

         The market for the Company's lab-created gemstones may never develop or
may develop at a slower pace than expected as a result of lack of acceptance of
lab-created gemstones by retail jewelers or by consumers. If the market fails to
develop or develops more slowly than expected, or if the Company's products do
not achieve significant market acceptance, the Company's business, operating
results and financial condition would be materially adversely affected. See
"Business -- Products and Product Development" and " Business -- Distribution,
Marketing and Sales."


                                       19

<PAGE>

Undeveloped Distribution Channels

         The Company currently plans to introduce its products in selected
cities in the United States through retail jewelry chains and independent retail
jewelry stores. While the Company anticipates that it will grant to selected
retail jewelry stores or chains the right to be the exclusive distributor of
lab-created moissanite gemstones in a limited geographic territory, the Company
has not yet finalized the terms of its distribution arrangements and has not yet
entered into distribution arrangements with any retailer or distributor. There
can be no assurance that the Company will be able to enter into distribution
agreements with retail jewelers or other distributors on terms acceptable to the
Company or that such retail jewelers or other distributors will be successful in
their efforts to market the Company's gemstones to consumers. The inability of
the Company to enter into favorable arrangements with retail jewelers or other
distributors or to achieve its desired distribution of its lab-created
moissanite gemstones or the inability of the Company's distributors to
successfully market moissanite gemstones to consumers would have a material
adverse effect on the Company's business, operating results and financial
condition. See "Business -- Distribution, Marketing and Sales."

Dependence on Intellectual Property

         The Company has been issued a patent for moissanite gemstones which
provides the Company with broad, exclusive rights to manufacture, use and sell
lab-created moissanite gemstones in the United States. The Company has
applications pending in a number of foreign jurisdictions for this same patent.
The Company believes that this patent creates substantial technological barriers
to its potential competitors.

         The Company also has patent applications pending for certain methods of
producing lab-created moissanite gemstones and has an application pending for
its moissanite/diamond test instrument. There can be no assurance that any other
patents will be granted or that any issued patent will have any commercial or
competitive value.

         At the present time, the Company is also dependent on Cree's technology
for the production of SiC crystals. Cree is exclusively licensed to use a patent
concerning a process for growing large single crystals of SiC, has certain
patents of its own relating to growth of large single crystals of SiC and has a
patent for a process for growing colorless SiC.

         There can be no assurance that any patents issued to or licensed by or
to the Company or Cree will provide any significant commercial protection to the
Company or Cree, that the Company or Cree will have sufficient resources to
prosecute its respective patents or that any patents will be upheld by a court
should the Company, Cree or Cree's licensor seek to enforce their respective
rights against an infringer.

         The existence of valid patents does not prevent other companies from
independently developing competing technologies. Existing producers of SiC or
others may refine existing processes for growing SiC crystals or develop new
technologies for growing large single crystals


                                       20

<PAGE>

of SiC or colorless SiC crystals in a manner that does not infringe patents
owned or licensed by or to the Company or Cree. In addition, existing producers
of SiC, existing producers of other diamond simulants or other parties may
develop new technologies for producing lab-created moissanite gemstones in a
manner that does not infringe patents owned or licensed by or to the Company or
Cree.

         As a result of the foregoing factors, existing and potential
competitors may be able to develop products that are competitive with or
superior to the Company's products, and such competition could have a material
adverse effect on the Company's business, operating results and financial
condition. See "Business -- Competition."

Dependence on Third Parties

         In addition to its current dependence on Cree and on third party
distribution channels, the Company's prospects depend upon its ability to
identify, reach agreements with and work successfully with other third parties.
In particular, the Company expects to rely on third parties to facet its
lab-created gemstones. Faceting lab-created moissanite gemstones requires
different techniques than faceting diamond and other gemstones. There can be no
assurance that the Company can enter into contracts with faceting vendors on
terms satisfactory to the Company or that faceting vendors will be able to
provide faceting services in the quality and quantities required by the Company.
In addition, the Company relies on third parties to manufacture components for
and assemble its moissanite/diamond test instrument. There can be no assurance
that the Company will be successful in maintaining its relationships with these
component manufacturers and assemblers or that the Company will be able to find
suitable replacements if the Company is unable to maintain such relationships.
Failure by the Company to achieve any of the above would have a material adverse
effect on the Company's business, operating results and financial condition. See
"Business -- Manufacturing."

Competition

         Competition in the market for gemstones is intense. The Company's
lab-created moissanite gemstones will face competition from established
producers and sellers of diamonds, synthetic gemstones and may compete with
diamond simulants such as synthetic cubic zirconia. In addition, other companies
could seek to introduce synthetic diamonds or other competing products. Although
the Company's patent provides it with the exclusive right to manufacture, use
and sell lab-created moissanite gemstones, other companies could challenge the
patent or compete against the Company with infringing products until the Company
could obtain judicial enforcement of its patent rights. The Company believes
that the more successful it is in creating market acceptance for colorless
lab-created moissanite gemstones, the more competition can be expected to
increase. Increased competition could result in a decrease in the price charged
by the Company for its products or a reduction in the demand for the Company's
products, which would have a material adverse effect on the Company's business,
operating results and financial condition.


                                       21

<PAGE>

         The Company's proprietary moissanite/diamond test instrument also faces
competition from other test devices. During the first quarter of 1998, three
competitors have introduced, or announced plans to introduce, moissanite/diamond
test devices. The Company believes that a successful commercialization of
lab-created moissanite gemstones would result in additional competition. In
addition, gemologists trained in the physical properties of moissanite gemstones
may develop less expensive methods of distinguishing moissanite gemstones from
diamond. Increased competition or the introduction of less expensive methods of
distinguishing moissanite gemstones from diamond could reduce the price charged
by the Company for its moissanite/diamond test instrument or cause a reduction
in the Company's sales which could have a material adverse effect on the
Company's business, operating results and financial condition.

         The Company's current and potential competitors have significantly
greater financial, technical, manufacturing and marketing resources and greater
access to distribution channels than the Company. There can be no assurance that
the Company will be able to compete successfully with its existing or potential
competitors. See "Business -- Competition."

International Operations

         The Company intends to target certain international markets for its
products. In addition, it expects to use certain companies based outside the
United States to facet its lab-created moissanite gemstone products. Due to the
Company's reliance on development of foreign markets and use of foreign vendors,
the Company is subject to the risks of conducting business outside of the United
States. These risks include unexpected changes in, or impositions of,
legislative or regulatory requirements, delays resulting from difficulty in
obtaining export licenses, tariffs and other trade barriers and restrictions and
the burdens of complying with a variety of foreign laws and other factors beyond
the Company's control. The Company is also subject to general geopolitical risks
in connection with its international operations, such as political, social and
economic instability, potential hostilities and changes in diplomatic and trade
or business relationships. There can be no assurance that such factors will not
adversely affect the Company's operations in the future or require the Company
to modify its anticipated business practices.

Governmental Regulation

         The Company is subject to governmental regulations in the manufacture
and sale of lab-created moissanite gemstones and the moissanite/diamond test
instrument. In particular, the FTC has the power to restrict the offer and sale
of products that could deceive or have the tendency or effect of misleading or
deceiving purchasers or prospective purchasers with regard to the type, kind,
quality, character, origin or other characteristics of a diamond. The Company
may be under close scrutiny both by governmental agencies and by competitors in
the gemstone industry, any of which may challenge the Company's promotion and
marketing of its gemstone products. If the Company's production or marketing of
its lab-created gemstones is challenged by governmental agencies or competitors,
or if regulations are issued that restrict the ability of the Company to produce
and market its products, the Company's business, operating results and financial
condition could be materially adversely affected. See "Business -- Government
Regulation."


                                       22

<PAGE>

Imitation Moissanite

         If the Company's products achieve market acceptance, it is possible
that low-quality gemstones or synthetics could be marketed as lab-created
moissanite. The sale of low-quality products as lab-created moissanite could
damage the perception of lab-created moissanite gemstones as a unique gemstone
that compares favorably to diamond, damage the Company's reputation among retail
jewelers and consumers and result in a loss of consumer confidence in the
Company's products. The introduction of low-quality imitation moissanite
gemstones and the inability of the Company to limit the adverse effects thereof
could have a material adverse effect on the Company's business, operating
results and financial condition.

Management of Rapid Growth

         The Company has recently experienced a period of rapid and significant
growth and expects such growth to continue in the future with the
commercialization of moissanite gemstones. Periods of rapid growth place a
significant strain on the Company's resources. The Company's ability to manage
its growth effectively will require it to implement and improve operational and
financial systems and to expand, train and manage its employee base. The Company
also will be required to manage multiple relationships with various suppliers,
customers and other third parties. The Company's future operating results will
also depend on its ability to expand its sales and marketing, research and
development and administrative support organizations. The Company's executive
officers have no significant experience in managing rapidly growing businesses.
If the Company is unable to manage growth effectively, the Company's business,
financial condition and results of operations would be materially adversely
affected.

Dependence upon Key Personnel; Need for Additional Personnel

         The Company's success depends in part upon retaining the services of
certain executive officers and other key employees. The Company has entered into
employment agreements with the Company's President, Chief Financial Officer,
Director of Technology, Director of Manufacturing and Director of Sales. While
the Company maintains "key man" life insurance policies on its President and
Chief Financial Officer, each policy provides coverage of only $1 million per
individual. The loss of the services of the Company's executive officers or
other key employees could have a material adverse effect on the Company's
business, operating results and financial condition.

         Because of the Company's early stage of development, the Company is
also dependent on its ability to recruit, retain and motivate personnel with
technical, manufacturing and gemological skills. There are a limited number of
personnel with these qualifications and competition for such personnel is
intense. The inability of the Company to attract and retain additional qualified
personnel would materially adversely affect the Company's business, operating
results and financial condition.


                                       23

<PAGE>

Operating Losses

         The Company had net losses of $27,187 for the period from June 28, 1995
(inception) to December 31, 1995, $382,608 for the year ended December 31, 1996
and $4,920,159 for the year ended December 31, 1997. The Company expects to
incur substantial additional costs to complete the development of its products
and to market and distribute such products. The Company expects to incur losses
through at least 1998, and there can be no assurance that the Company will ever
achieve profitability or, if achieved, that such profitability will be
sustained. See "Selected Financial Data" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

Potential for Fluctuations in Quarterly Results

         Because the Company has no operating history, management has very
little data upon which to estimate operating revenues and expenses. The
Company's revenues will be affected by many factors, including those discussed
in "Business Risks." At the same time, the Company's expenses will be growing to
support anticipated rapid expansion. The Company will likely experience
substantial quarterly fluctuations in its operating results. As a result, the
Company believes that period-to-period comparisons of its results of operations
are not necessarily meaningful and should not be relied upon as an indication of
future performance. Moreover, it is likely that in some future quarters the
Company's operating results will be below the expectations of public market
analysts and investors. In such event, the price of the Common Stock would
likely be materially adversely affected.

Volatility of Stock Price

         Since its initial public offering, the trading price of the Common
Stock has experienced significant volatility and substantial and sudden
fluctuations. The trading price of the Common Stock may continue to be subject
to wide fluctuations in response to quarterly variations in operating results,
changes in financial estimates by securities analysts, announcements of
technological innovations or new products by the Company or its competitors, or
other events or factors. In addition, the stock market has experienced extreme
price and volume fluctuations that have particularly affected the market prices
for many technology and small capitalization companies. These broad market
fluctuations may materially and adversely affect the market price of the Common
Stock.

Anti-Takeover and Certain Other Provisions

Articles of Incorporation and Bylaws

         A number of provisions of the Company's articles of incorporation and
bylaws deal with matters of corporate governance and the rights of shareholders.
Certain of these provisions may be deemed to have an anti-takeover effect and
may delay or prevent takeover attempts not first approved by the Board of
Directors (including takeovers that certain shareholders may deem to be


                                       24

<PAGE>

in their best interests). These provisions also could delay or frustrate the
removal of incumbent directors or the assumption of control by shareholders. The
Company believes that these provisions are appropriate to protect the interests
of the Company and all of its shareholders.

Exclusive Supply Agreement

         Under the terms of the Exclusive Supply Agreement, the Company is
prohibited from entering into an exclusive marketing or distribution agreement
with DeBeers or its affiliates or the Central Selling Organization (the
international cartel of diamond producers) or any party whose primary business
is the development, manufacture, marketing or sale of diamond gemstones or any
non-gemstone and non-jewelry industry competitor of Cree (collectively, the
"Prohibited Parties"). The agreement also prohibits the Company from entering
into certain merger, acquisition, sale of assets or similar transactions with a
Prohibited Party. These provisions of the Exclusive Supply Agreement could limit
the price that third parties might be willing to pay in the future for some or
all of the shares of the Company's Common Stock. In addition, this agreement
could prevent the Company from entering into certain potentially profitable
transactions with Prohibited Parties.


I
tem 2. PROPERTIES.

         The Company leases approximately 12,700 square feet of mixed use space
(general office, light manufacturing and laboratory) in the Research Triangle
Park area of North Carolina from an unaffiliated third party. This space houses
the Company's executive offices, sales offices and research and development
facilities. The Company believes that comparable mixed use space could be
obtained from other parties on terms substantially the same as the Company's
current lease. This space is considered by management to be sufficient for the
Company's foreseeable needs over the next 12 months. From February 1997 through
January 1998, the Company leased approximately 3,000 square feet of mixed use
space from a subsidiary of Cree. This space previously housed the Company's
offices and research and development facilities.


Item 3. LEGAL PROCEEDINGS.

         The Company is not a party to any material legal proceedings.


Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

         A Special Substitute Annual Meeting of the Shareholders of the Company
(the "Special Meeting") was held on October 27, 1997. The Special Meeting was
held to elect a slate of directors to serve until the next annual meeting of the
Company, to authorize an increase in the number of shares of Common Stock
issuable under the 1996 Stock Option Plan of C3, Inc. (the "1996 Plan"), to
adopt the 1997 Omnibus Stock Plan of C3, Inc. (the "1997 Plan") and to approve
and adopt the Company's Amended and Restated Articles of Incorporation. As of
October 12, 1997, the record date of the Special Meeting, there were 2,261,101
shares of Common Stock, 105,000 shares of Series A Preferred Stock and 682,500
shares of Series B Preferred Stock outstanding and entitled to vote, of


                                       25

<PAGE>

which 1,777,847 shares of Common Stock, 69,000 shares of Series A Preferred
Stock and 501,667 shares of Series B Preferred Stock were present in person or
by proxy.

         At the Special Meeting, Jeff N. Hunter, Kurt Nassau, Howard Rubin,
Frederick A. Russ, Kurt Leutzinger, David B. Stewart and Ollin B. Sykes were
elected as directors of the Company to serve until the next annual meeting of
the shareholders of the Company. All of the shares present in person or by proxy
voted for the election of Messrs. Hunter, Nassau, Rubin, Russ, Stewart and Sykes
and no shares abstained or voted against the election of these directors. All of
the shares of Series A Preferred Stock and Series B Preferred Stock and
1,756,547 shares of Common Stock voted for the election of Mr. Leutzinger,
21,300 shares of Common Stock voted against the election of Mr. Leutzinger and
no shares abstained.


         The shareholders of the Company authorized an increase in the number of
shares of Common Stock issuable under the 1996 Plan from 120,000 to 777,450. All
of the shares of Series A Preferred Stock and Series B Preferred Stock and
1,772,522 shares of Common Stock voted in favor of the increase, 5,325 shares of
Common Stock voted against the increase and no shares abstained.

         The shareholders of the Company also adopted the 1997 Plan which
provides for the grant of stock options, stock appreciation rights and
restricted awards to selected employees, directors and consultants of the
Company. The maximum number of shares of Common Stock that may be delivered
under the 1997 Plan is initially 477,979, subject to increase as provided in the
1997 Plan. All of the shares of Series A Preferred Stock and Series B Preferred
stock and 1,772,522 shares of Common Stock voted in favor of adopting the 1997
Plan, 5,325 shares of Common Stock voted against adopting the 1997 Plan and no
shares abstained.

         In addition, the shareholders of the Company voted to approve and adopt
the Amended and Restated Articles of Incorporation of the Company. The Amended
and Restated Articles of Incorporation provide for (i) an increase in the number
of shares of capital stock that the Company is authorized to issue from 15
million to 60 million, of which 50 million are Common Stock and 10 million are
Preferred Stock, (ii) the automatic conversion of the Series A Preferred Stock
and Series B Preferred Stock into Common Stock on the consummation of the
Company's initial public offering or any other public offering having net
proceeds to the Company of $12 million or more and (iii) procedures governing
any proposed business combination involving the Company and any individual or
group that owns ten percent or more of the Company's voting securities. All of
the shares of Series A Preferred Stock and Series B Preferred Stock and
1,772,522 shares of Common Stock voted in favor of approving and adopting the
Amended and Restated Articles of Incorporation, 5,325 shares of Common Stock
voted against approving and adopting the Amended and Restated Articles of
Incorporation and no shares abstained.

                      EXECUTIVE OFFICERS OF THE REGISTRANT

Name                    Age     Position with the Company
- ----                    ---     -------------------------
Jeff N. Hunter          41      President and Chairman of the Board
Mark W. Hahn            35      Chief Financial Officer, Treasurer and Secretary
Thomas G. Coleman       38      Director of Technology

         JEFF N. HUNTER, one of the founders of the Company, has served as the
Company's President and Chairman of the Board since June 1996 and as a director
since the Company's inception in June 1995. Mr. Hunter served as Treasurer and
Secretary of the Company from June 1995 to June 1996. From July 1980 to May
1996, he was employed in various capacities with North


                                       26

<PAGE>

Carolina State University, including as Director of Business, Finance and
Research Administration for the College of Engineering. Mr. Hunter received his
Master of Science degree in management science from North Carolina State
University.

         MARK W. HAHN has served as the Chief Financial Officer of the Company
since October 1996 and as Treasurer and Secretary since August 1997. From
January 1984 to October 1996, Mr. Hahn was employed with Ernst & Young LLP,
including as Senior Manager in the Entrepreneurial Services Group. He earned his
Bachelor of Business Administration degree with concentrations in accounting and
finance from the University of Wisconsin in Milwaukee and is a Certified Public
Accountant.

         THOMAS G. COLEMAN has served as Director of Technology of the Company
since March 1997. From August 1996 to March 1997, Mr. Coleman provided technical
consulting services to the Company. Mr. Coleman co-founded Cree and was employed
by Cree as a senior process development engineer from December 1987 to July
1995. He earned an electronic technology degree from Patterson Technical
College.


                                     PART II


Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

Market Information

         The Company's Common Stock is traded on the Nasdaq National Market
under the symbol "CTHR." The following table presents the high and low sales
prices of the Company's Common Stock for the period indicated during 1997, as
reported by the Nasdaq National Market. The Company completed its initial public
offering in the fourth quarter of 1997 at a price of $15.00 per share. As of
March 13, 1998, there were 184 shareholders of record of the Common Stock.

                                                     Sales Price Per Share
                                                     ---------------------
                                                     High             Low
         November 14, 1997 to December 31, 1997      $15 5/8          $11


         The Company has never paid dividends on its capital stock. The Company
intends to retain earnings, if any, for use in its business and does not
anticipate paying any cash dividends in the foreseeable future.

Use of Proceeds

         On November 14, 1997, the Securities and Exchange Commission declared
the Company's Registration Statement on Form S-1 (File No. 333-36809) to be
effective. The Registration


                                       27

<PAGE>

Statement provided for the registration of (i) 3,450,000 shares of the Company's
Common Stock, which included 450,000 shares of Common Stock which the several
underwriters had the option of purchasing solely to cover over-allotments, at an
aggregate maximum offering price of $51,750,000, (ii) a warrant (the
"Representative's Warrant") to purchase 300,000 shares of Common Stock at an
aggregate maximum offering price of $30, which was issued to Paulson Investment
Company, Inc., the managing underwriter of the offering (the "Representative"),
and (iii) 300,000 shares of Common Stock issuable upon the exercise of the
Representative's Warrant at an aggregate maximum offering price of $5,400,000.
All of the securities registered on the Registration Statement were for the
account of the Company.

         The Company commenced the initial public offering of 3,000,000 shares
of its Common Stock at a price of $15 per share on November 14, 1997. The
Company completed the sale of these 3,000,000 shares on the same day for
aggregate sales proceeds of $45,000,000, prior to expenses, and issued the
Representative's Warrant to the Representative for an aggregate consideration of
$30. The net proceeds of the offering to the Company were $41,072,982 after
deduction of offering expenses of $3,927,018 which consisted of an underwriters'
discount of 6.1% or $2,745,000, a non-accountable underwriters' expense
allowance of $450,000, $15,000 in other underwriting expenses and reimbursements
and an additional $717,018 in other expenses associated with the offering. No
underwriting commissions or offering expenses were paid to officers, directors
or affiliates of the Company or owners of ten percent or more of the Company's
outstanding Common Stock or any of their respective associates.

         As of December 31, 1997, the Company had invested approximately
$39,836,000 of the net proceeds of the offering in money market accounts, debt
instruments having an original maturity of three months or less and other highly
liquid investments. Approximately $790,000 of the proceeds have been devoted to
research and development. The Company also used approximately $210,000 to
acquire an inventory of its moissanite/diamond test instruments for sale in the
first quarter of 1998. The Company also expended approximately $187,000 to
conduct market research, interview potential distributors of its products and
market its moissanite/diamond test instrument. In addition, the Company made a
$50,000 down payment on certain computerized slicing and dicing equipment to be
used in manufacturing its moissanite gemstones. None of the proceeds of the
offering were paid to officers, directors or affiliates of the Company or owners
of ten percent or more of the Company's outstanding Common Stock or any of their
respective associates.

Recent Sales of Unregistered Securities

         In June 1995, the Company granted Cree an option to purchase one
percent of the outstanding Common Stock of the Company for an aggregate
consideration of $500. The Company retained the right to waive the payment of
the consideration and issue the Common Stock at any time during the option
period. On January 2, 1997, the Company issued 24,601 shares of Common Stock to
Cree in accordance with the terms of this option. Such shares were issued in
reliance on the exemption from registration provided by Section 4(2) of the
Securities Act of 1933, as amended (the "Securities Act").


                                       28

<PAGE>

         Between January 9, 1997 and March 17, 1997, the Company issued an
aggregate of 682,500 shares of 1997 Series B Preferred Stock to certain
individual and institutional investors in exchange for an aggregate
consideration of $5,016,375 in reliance on the exemption from registration
provided by Rule 506 under the Securities Act. When issued, each share of 1997
Series B Preferred Stock was convertible into one share of Common Stock, subject
to adjustment for subsequent stock splits and certain other events.

         Between March 1, 1997 and August 18, 1997, the Company issued options
covering 461,571 shares of Common Stock to certain employees, directors and
consultants of the Company pursuant to the 1996 Stock Option Plan of C3, Inc.
and in consideration of services rendered and to be rendered to the Company. The
options have exercise prices between approximately $3.45 per share and
approximately $7.62 per share. The Company granted the options in reliance on
the exemptions from registration provided by Section 4(2) and Rule 701 under the
Securities Act.

         In September 1997, the Company issued options covering 310,000 shares
of Common Stock to certain employees, directors and consultants of the Company
pursuant to the 1997 Omnibus Plan and in consideration of services rendered and
to be rendered to the Company. The options have an exercise price of $15, the
offering price of a share of Common Stock in the Company's initial public
offering. The Company granted these options in reliance on the exemptions from
registration provided by Section 4(2) and Rule 701 under the Securities Act.

         On November 14, 1997, the Company issued 1,677,375 shares of Common
Stock upon the automatic conversion of 105,000 shares of 1996 Series A Preferred
Stock and 682,500 shares of 1997 Series B Preferred Stock. These shares were
issued in reliance on the exemption provided by Section 3(a)(9) of the
Securities Act and reflected a 2.13-for-1 split of the Common Stock effected on
September 25, 1997.

         On December 10, 1997, the Company issued options covering 167,000
shares of Common Stock to certain employees, directors and consultants of the
Company pursuant to the 1997 Omnibus Plan and in consideration of services
rendered and to be rendered to the Company. The options have an exercise price
of $13 7/8, the closing price of a share of Common Stock on the date on which
such options were issued. The Company granted these options in reliance on the
exemptions from registration provided by Section 4(2) and Rule 701 under the
Securities Act.



Item 6.  SELECTED FINANCIAL DATA.

         The following selected statement of operations data for the period from
inception through December 31, 1995 and for the years ended December 31, 1996
and 1997 and the selected balance sheet data at December 31, 1995, 1996 and 1997
have been derived from, and are qualified by reference to, the Company's
financial statements included elsewhere in this report, which have been audited
by Deloitte & Touche LLP, independent auditors. The selected financial data set
forth below should be read in conjunction with "Management's Discussion and
Analysis of Financial


                                       29

<PAGE>

Condition and Results of Operations" and the Financial Statements and Notes
thereto included elsewhere in this report.

                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)


<TABLE>
<CAPTION>
                                                                                                  CUMULATIVE
                                          PERIOD FROM                                               FOR THE
                                           INCEPTION                                                 PERIOD
                                        (JUNE 28, 1995)                                          JUNE 28, 1995
                                               TO             YEAR ENDED        YEAR ENDED             TO
                                          DECEMBER 31,       DECEMBER 31,      DECEMBER 31,       DECEMBER 31,
                                              1995               1996              1997               1997
                                          ------------       ------------      ------------       ------------
<S>                                        <C>               <C>                <C>                <C>        
STATEMENT OF OPERATIONS
DATA:
Revenues ...........................                --                --                 --                 --
Operating Expenses:
   Marketing and sales .............       $    10,313       $    47,019        $   535,329        $   592,661
   General and administrative (1) ..            10,024           131,097          2,718,744          2,859,865
   Research and development ........             6,052           236,047          2,111,062          2,353,161
   Depreciation and amortization ...               798             3,618             26,154             30,570
                                           -----------       -----------        -----------        -----------
Operating Loss .....................            27,187           417,781          5,391,289          5,836,357
Interest income, net ...............                --           (35,173)          (471,130)          (506,303)
                                           -----------       -----------        -----------        -----------
Net Loss ...........................       $    27,187       $   382,608        $ 4,920,159        $ 5,329,954
Basic and diluted net loss per share       $       .02       $       .19        $      1.73        $      2.32
                                           ===========       ===========        ===========        ===========
Shares used in computing basic and
diluted net loss per share (2) .....         1,704,000         2,036,813          2,845,773          2,293,834


<CAPTION>
                                                                                DECEMBER 31
                                                                                -----------
                                                                 1995              1996               1997
                                                                 ----              ----               ----
<S>                                                          <C>               <C>                 <C>        
BALANCE SHEET DATA:
Cash and equivalents......................................   $     9,109       $  1,167,458        $43,980,385
Working capital...........................................         8,355          1,161,603         43,687,405
Total assets..............................................        32,913          1,226,134         44,873,089
Shareholders' equity......................................        22,813          1,213,279         44,046,281
</TABLE>



(1) For the year ended December 31, 1997, includes $66,000 of compensation
expense related to the January 2, 1997 issuance of Common Stock to Cree pursuant
to a stock option agreement and $1,632,504 of compensation expense related to
the issuance of other stock options. See Note 5 of Notes to Financial
Statements.


                                       30

<PAGE>

(2) The calculation of shares for all periods reflects a 2.13-for-1 common stock
split effected in September 1997. The calculation also gives effect to the
automatic conversion of the Series A Preferred Stock and Series B Preferred
Stock into 2.13 shares of Common Stock for each share of Preferred Stock
effective upon completion of the Company's initial public offering. See Notes 2,
3 and 4 of Notes to Financial Statements.



Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATION.

Overview

         Since its organization in June 1995, the Company has devoted its
resources to funding research and development of colorless lab-created
moissanite gemstones, market research, qualifying potential retail jewelers and
other potential customers for distribution arrangements and assembling a
management team. As a development stage company, the Company is subject to all
the risks inherent in establishing a new business, including the risk that
full-scale operations may not occur.

         The Company did not produce sales revenues in 1997 and does not
anticipate having significant product sales in the first half of 1998. The
Company has been unprofitable since inception and anticipates that it will
continue to incur increasingly significant expenses as it transitions from the
development stage to full-scale production. Historic spending levels are not
indicative of anticipated future spending levels because the Company is entering
a period in which it will rapidly increase spending to refine its lab-created
moissanite gemstone products, exploit its technology, introduce its products
into the market, establish distribution channels, expand manufacturing capacity,
optimize SiC crystal yields and market its moissanite/diamond test instrument.
For these reasons, the Company expects to continue operating at a loss through
at least the first half of 1998. Moreover, there can be no assurance that the
Company will ever achieve profitability or if profitability is achieved, that
such profitability can be sustained. See "Business Risks -- Lack of Operating
History; Development Stage Company."

Results of Operations

         Year ended December 31, 1997 compared with Year ended December 31,
1996. Research and development expenses for the year ended December 31, 1997
increased by $1,875,015 over research and development expenses for the year
ended December 31, 1996. The increase was attributable to expanded colorless SiC
crystal development efforts at Cree, internal development of prototype gemstone
pre-forming and faceting operations, qualifying of vendors for production and
development of production-quality prototypes of the moissanite/diamond test
instrument.

         Marketing and sales expenses for the year ended December 31, 1997
increased by $488,310 over expenses for the year ended December 31, 1996. The
increase was due to the compensation expense of additional sales staff hired
since the prior period, increased market research expenditures


                                       31

<PAGE>

and the development of preliminary advertising and marketing materials. Prior to
May 1, 1996, the Company had no paid employees.

         General and administrative expenses for the year ended December 31,
1997 increased by $2,587,647 over general and administrative expenses for the
year ended December 31, 1996. Of this increase, approximately $1,600,000
represented compensation expense related to the issuance of stock options to
employees and directors of the Company and an additional $66,000 represented
compensation expense related to the exercise of Cree's option to acquire 24,601
shares of Common Stock on January 2, 1997. The balance of the increase was
primarily attributable to the compensation expense of additional staff hired
since the prior period and occupancy expenses. The Company had no paid employees
before May 1, 1996. Prior to February 4, 1997, the Company conducted its
operations from the home of two of its founders and did not incur any lease or
rent expenses during that time.

         Interest income for the year ended December 31, 1997 increased by
$435,957 over interest income for the year ended December 31, 1996. The increase
generally reflected interest earned on cash and cash equivalents, consisting
primarily of U.S. Treasury Bills and U.S. Treasury money market funds acquired
by investing the proceeds from the Company's initial public offering of Common
Stock in November 1997 and its Series B Preferred Stock offering in January,
February and March 1997.

         Year ended December 31, 1996 compared with Seven-Month Period ended
December 31, 1995. Research and development expenses for the year ended December
31, 1996 increased $229,995 over research and development expenses for the
seven-month period ended December 31, 1995. The increased expenses reflected the
commencement of the Company's external development of colorless SiC crystals
through Cree and increased activity in the development of prototype lab-created
gemstones and a prototype moissanite/diamond test instrument.

         Marketing and sales expenses for the year ended December 31, 1996
increased by $36,706 over similar expenses for the seven-month period ended
December 31, 1995. The increase was primarily due to the compensation expense of
additional sales and marketing staff hired since the prior period. The Company
had no paid employees before May 1, 1996.

         General and administrative expenses for the year ended December 31,
1996 increased by $121,073 over general and administrative expenses for the
seven-month period ended December 31, 1995. The increases were primarily due to
the compensation expense of additional staff hired since the prior period and
occupancy expenses. The Company had no paid employees before May 1, 1996. Prior
to February 4, 1997, the Company's operations were conducted from the home of
two of its founders; consequently, the Company did not incur any lease or rent
expenses prior to that time.

         Interest income was $35,173 for the year ended December 31, 1996. The
Company had no interest income in the seven-month period ended December 31,
1995. The interest was earned on cash and cash equivalents, consisting primarily
of U.S. Treasury Bills and U.S. Treasury money


                                       32

<PAGE>

market funds acquired by investing the proceeds from the Company's sale of
Common Stock in May 1996 and the Company's Series A Preferred Stock offering in
August 1996.

Liquidity and Capital Resources

         The Company has financed its operations since inception primarily
through the net proceeds of its initial public offering of Common Stock in
November 1997 and, prior to such offering, through private equity sales. Net
proceeds from the Company's initial public offering were $41,072,982 and net
proceeds of the Company's private sale of Series B Preferred Stock was
$4,981,375. In 1997 the Company used $2,908,076 to fund operations and $333,354
to fund capital expenditures and patent expenses. At December 31, 1997, the
Company had $43,980,385 of cash and cash equivalents and $43,687,405 of working
capital.

         The Company has ordered a quantity of crystals that requires the use of
all of the crystal growth systems that Cree is required to provide at its
expense under the Exclusive Supply Agreement and the Company is obligated to
purchase the output of these growth systems through various dates in the third
quarter of 1998. The Company is continuing to evaluate Cree's progress under the
Development Agreement and Supplemental Agreement and the color and size of SiC
crystals currently being produced by Cree in assessing its plans for larger
orders which will require the acquisition of additional crystal growth systems.
Under the terms of the Exclusive Supply Agreement, Cree has the option of
building the growth systems at its own cost or requiring the Company to purchase
the growth systems from Cree. The Company also intends to purchase certain
automated and computerized equipment to slice and dice lab-grown SiC crystals
into preforms. The Company plans to engage in substantial marketing activities
to support the introduction of lab-created moissanite gemstones. Such activities
may include advertising campaigns, cooperative advertising with retail jewelers
and distributors, point-of-purchase displays, educational materials and
individualized jeweler training.

         The Company has no committed external sources of capital. Based on its
current operating plan, the Company anticipates that its existing capital
resources will be adequate to satisfy its capital requirements for at least the
remainder of 1998. There may be circumstances, however, particularly a delay in
the introduction of the Company's proposed products or lower than anticipated
sales, that might accelerate the use of the Company's existing capital
resources. In those circumstances, the Company may be required to raise
substantial additional funds in the future, through public or private sources or
other relationships. No assurance can be given that additional financing will be
available, or if available, that it will be available on terms acceptable to the
Company.


                                       33

<PAGE>

Net Operating Loss Carryforward

         As of December 31, 1997 the Company had a net operating loss ("NOL")
carryforward of approximately $3,373,000, which expires in 2012. In accordance
with Section 382 of the Internal Revenue Code of 1986, as amended, a change in
equity ownership of greater than 50% of the Company within a three-year period
results in an annual limitation on the Company's ability to utilize its NOL
carryforwards that were created during tax periods prior to the change in
ownership. As a result of the Company's private equity offerings to date and
certain shareholder transactions, the utilization of the Company's NOL
carryforwards has become limited.

Newly Issued Accounting Pronouncement

         In June 1997, Statement of Financial Accounting Standards No. 130 ("FAS
130") Comprehensive Income, was issued. This Statement establishes standards for
reporting and display of comprehensive income and its components (revenues,
expenses, gains and losses) in a full set of general-purpose financial
statements. FAS 130 is effective for fiscal years beginning after December 15,
1997. Reclassification of financial statements for earlier periods is required.
However, this Statement does not currently apply to the Company since it has no
items of other comprehensive income in any period presented.


I
tem 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

         Not Required.



                                       34

<PAGE>


Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

         The report of independent auditors and financial statements of the
Company are set forth below:


                          INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Shareholders of C3, Inc.
Research Triangle Park, North Carolina

         We have audited the accompanying balance sheets of C3, Inc. (a
development stage company) as of December 31, 1997 and 1996, and the related
statements of operations, shareholders' equity, and cash flows for the years
ended December 31, 1997 and 1996, the seven-month period ended December 31,
1995, and the period from June 28, 1995 (date of inception) to December 31,
1997.

         We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

         In our opinion, such financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 1997
and 1996 and the results of its operations, and its cash flows for the years
ended December 31, 1997 and 1996, the seven-month period ended December 31,
1995, and the period from June 28, 1995 (date of inception) to December 31, 1997
in conformity with generally accepted accounting principles.

         As discussed in note 2 to the financial statements, the Company changed
its method of computing earnings per share effective January 1, 1997 in
accordance with Statement of Financial Accounting Standards No. 128.

Deloitte & Touche LLP

Raleigh, North Carolina
February 26, 1998



                                       35

<PAGE>

                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)

                                 BALANCE SHEETS


<TABLE>
<CAPTION>
                                                                                          1997                1996
                                                                                          ----                ----
<S>                                                                                  <C>                 <C>
ASSETS:
CURRENT ASSETS:
         Cash and equivalents ................................................       $ 43,980,385        $  1,167,458
         Interest receivable .................................................            177,654
         Inventory ...........................................................            278,602
         Prepaid expenses and other assets ...................................             77,572               7,000
                                                                                     --------------------------------
                  Total current assets .......................................         44,514,213           1,174,458
EQUIPMENT, net of accumulated depreciation of $21,720 and $2,352 at
December 31, 1997 and 1996, respectively .....................................            214,990              14,081
PATENT AND LICENSE RIGHTS, net of accumulated amortization of
$7,950 and $2,064 at December 31, 1997 and 1996, respectively ................            143,886              37,595
                                                                                     --------------------------------
                  TOTAL ASSETS ...............................................       $ 44,873,089        $  1,226,134
                                                                                     ================================

LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:

         Accounts Payable:
                  Cree Research, Inc. (Note 7) ...............................       $    567,110
                  Other ......................................................            237,186        $     12,855
         Deferred revenue ....................................................             22,512
                                                                                     --------------------------------
                  Total current liabilities ..................................            826,808              12,855
                                                                                     --------------------------------
COMMITMENTS (Note 7)

SHAREHOLDERS' EQUITY (Notes 3, 4, and 5):

1996 Series A preferred stock, no par value; 105,000 shares authorized,
issued and outstanding at December 31, 1996...................................                                593,271
Common stock, no par value; 10 million shares authorized; 6,938,476 shares and
2,236,500 shares, issued and outstanding at December 31, 1997
and 1996, respectively .......................................................         47,743,431           1,029,803
Additional paid-in capital -- stock options ..................................          1,632,804
Deficit accumulated during the development stage .............................         (5,329,954)           (409,795)
                                                                                     --------------------------------
                  Total shareholders' equity .................................         44,046,281           1,213,279
                                                                                     --------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ...................................       $ 44,873,089        $  1,226,134
                                                                                     ================================
</TABLE>



                       See notes to financial statements.


                                       36

<PAGE>

                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)

                            STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>
                                                                                                         CUMULATIVE FOR THE
                                                                                          SEVEN-MONTH   PERIOD JUNE 28, 1995
                                                     YEAR ENDED         YEAR ENDED        PERIOD ENDED          TO
                                                     DECEMBER 31,      DECEMBER 31,       DECEMBER 31,      DECEMBER 31,
                                                        1997               1996               1995             1997
                                                    -------------------------------------------------------------------
<S>                                                 <C>                <C>                <C>               <C>
OPERATING EXPENSES:
  Marketing & sales .........................       $   535,329        $    47,019        $    10,313       $   592,661

  General & administrative ..................         2,718,744            131,097             10,024         2,859,865

  Research & development ....................         2,111,062            236,047              6,052         2,353,161

  Depreciation & amortization ...............            26,154              3,618                798            30,570
                                                    -------------------------------------------------------------------

OPERATING LOSS ..............................         5,391,289            417,781             27,187         5,836,257

INTEREST INCOME, net ........................          (471,130)           (35,173)                --          (506,303)
                                                    -------------------------------------------------------------------
NET LOSS ....................................       $ 4,920,159        $   382,608        $    27,187       $ 5,329,954
                                                    ===================================================================
Basic and diluted net loss per share (Note 2)       $      1.73        $      0.19        $      0.02              2.32
                                                    ===================================================================
Weighted-average common shares, basic and
diluted (Note 2) ............................         2,845,773          2,036,813          1,704,000         2,293,834
                                                    ===================================================================
</TABLE>



                       See notes to financial statements.


                                       37

<PAGE>

                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)

                       STATEMENTS OF SHAREHOLDERS' EQUITY


<TABLE>
<CAPTION>


                                  1996                  1997
                                SERIES A              SERIES B
                             PREFERRED STOCK       PREFERRED STOCK          COMMON STOCK                   ADDITIONAL    DEFICIT
                         ---------------------- ---------------------  ---------------------                PAID-IN    ACCUMULATED
                           NUMBER                 NUMBER                 NUMBER                 CAPITAL    DURING THE     TOTAL
                             OF                     OF                     OF                    STOCK     DEVELOPMENT SHAREHOLDERS'
                           SHARES      AMOUNT     SHARES    AMOUNT       SHARES     AMOUNT      OPTIONS       STAGE       EQUITY
                         ----------- ---------- --------- -----------  --------- ------------ ----------- ------------ -----------
<S>                      <C>         <C>        <C>       <C>          <C>       <C>          <C>         <C>          <C>
BALANCE
JUNE 28, 1995 (date of
inception)
Issuance of common stock
to founders and
independent contractors
for cash and
consideration of
services to                                                                                                             $   50,000
be provided                                                            1,704,000    $  50,000
         Net Loss                                                                                            $(27,187)     (27,187)
                         ----------- ---------- --------- -----------  --------- ------------ ----------- ------------ -----------
BALANCE
DECEMBER 31,  1995                                                     1,704,000       50,000                 (27,187)      22,813
Issuance of common stock,
net of offering costs of
$20,197                                                                  532,500      979,803                              979,803
Issuance of 1996 Series A
preferred stock, net of
offering costs of $10,479
                             105,000   $593,271                                                                            593,271
         Net Loss                                                                                            (382,608)    (382,608)
                         ----------- ---------- --------- -----------  --------- ------------ ----------- ------------ -----------
BALANCE                      105,000    593,271                        2,236,500    1,029,803                (409,795)   1,213,279
DECEMBER 31, 1996
Exercise of stock option                                                  24,601       66,000                               66,000
Issuance of 1997 Series B
preferred stock, net of
offering costs of $34,999                         682,500  $4,981,375                                                    4,981,375
Compensation expense
related to stock options                                                                       $1,632,804                1,632,804
Proceeds from IPO, net of
offering costs of $3,927,018                                           3,000,000   41,072,982                           41,072,982
Conversion of preferred
stock to common stock       (105,000)  (593,271) (682,500) (4,981,375) 1,677,375    5,574,646
         Net Loss                                                                                          (4,920,159)  (4,920,159)
                         ----------- ---------- --------- -----------  --------- ------------ ----------- ------------ -----------
BALANCE
DECEMBER 31, 1997                                                      6,938,476  $47,743,431  $1,632,804 $(5,329,954) $44,046,281
                         =========== ========== ========= ===========  ========= ============ =========== ============ ===========
</TABLE>


                       See notes to financial statements.


                                       38

<PAGE>

                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
                            STATEMENTS OF CASH FLOWS



<TABLE>
<CAPTION>
                                                                                                                    CUMULATIVE FOR
                                                                                                 SEVEN-MONTH       THE PERIOD JUNE
                                                      YEAR ENDED            YEAR ENDED          PERIOD ENDED          28, 1995 TO
                                                  DECEMBER 31, 1997     DECEMBER 31, 1996     DECEMBER 31, 1995    DECEMBER 31, 1997
                                                  -----------------     -----------------     -----------------    -----------------
<S>                                                  <C>                   <C>                   <C>                   <C>
OPERATING ACTIVITIES:
Net loss ...................................         $ (4,920,159)         $   (382,608)         $    (27,187)         $ (5,329,954)

Adjustments:
Depreciation and amortization ..............               26,154                 3,618                   798                30,570
Compensation expense related to
exercise and issuance of
stock options ..............................            1,698,804                                                         1,698,804
Changes in assets and liabilities:
Interest  receivable .......................             (177,654)                                                         (117,654)
Inventory ..................................             (278,602)                                                         (278,602)
Prepaid expenses and other assets ..........              (70,572)                2,346                (9,346)              (77,572)
Accounts payable ...........................              791,441                12,855                                     804,296
Deferred revenue ...........................               22,512                                                            22,512
                                                     ------------------------------------------------------------------------------
Net cash used in operating activities ......           (2,908,076)             (363,789)              (35,735)           (3,307,600)
                                                     ------------------------------------------------------------------------------

INVESTING ACTIVITIES:
Purchase of equipment ......................             (221,177)              (10,331)               (6,102)             (237,610)
Patent costs ...............................             (112,177)              (30,505)               (9,154)             (151,836)
                                                     ------------------------------------------------------------------------------
Net cash used in investing activities ......             (333,354)              (40,836)              (15,256)             (389,446)
                                                     ------------------------------------------------------------------------------

FINANCING ACTIVITIES:
Proceeds from notes payable ................                                     53,000                10,100                63,100
Repayment of notes payable .................                                    (63,100)                                    (63,100)
Proceeds from common stock offerings, net of
costs ......................................           41,072,982               979,803                50,000            42,102,785
Proceeds from preferred stock offerings, net
of costs ...................................            4,981,375               593,271                                   5,574,646
                                                     ------------------------------------------------------------------------------
Net cash provided by financing activities ..           46,054,357             1,562,974                60,100            47,677,431
                                                     ------------------------------------------------------------------------------

INCREASE IN CASH AND
EQUIVALENTS ................................           42,812,927             1,158,349                 9,109            43,980,385
CASH AND EQUIVALENTS, BEGINNING
OF PERIOD ..................................            1,167,458                 9,109
                                                     ------------------------------------------------------------------------------
CASH AND EQUIVALENTS, END OF
PERIOD .....................................         $ 43,980,385          $  1,167,458          $      9,109          $ 43,980,385
                                                     ==============================================================================
</TABLE>



                       See notes to financial statements.


                                       39

<PAGE>

                  C3, INC. (A COMPANY IN THE DEVELOPMENT STAGE)

NOTES TO FINANCIAL STATEMENTS - YEARS ENDED DECEMBER 31, 1997 AND 1996,
SEVEN-MONTH PERIOD ENDED DECEMBER 31, 1995, AND PERIOD FROM JUNE 28, 1995 (DATE
OF INCEPTION) TO DECEMBER 31, 1997.

1. ORGANIZATION AND BASIS OF PRESENTATION

         C3, Inc. ("C3" or the "Company"), was incorporated in North Carolina on
June 28, 1995, and is engaged in the development and commercialization of
silicon carbide ("moissanite") as a gemstone material. In addition to the
development of lab-created moissanite gemstones (hereinafter referred to as
"moissanite" or "moissanite gemstones"), the Company has developed and began
selling, in 1998, a test instrument which distinguishes colorless moissanite
gemstones from diamond.

         C3 is a development stage company which has devoted substantially all
of its efforts to research and product development and did not, through December
31, 1997, generate any revenues, nor is there any assurance of significant
future revenues. The ability of the Company to successfully develop, manufacture
and market its proprietary products is dependent upon many factors. Further,
during the period required to develop and market these products, the Company may
require additional funds which may not be available to it. Accordingly, there
can be no assurance of the Company's future success.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         Cash and Equivalents -- The Company considers all money market
accounts, debt instruments purchased with an original maturity of three months
or less, and other highly liquid investments to be cash equivalents.

         Inventory -- Inventory is stated at the lower of cost or market, and is
determined on a first-in, first-out basis. Inventory at December 31, 1997
consists primarily of moissanite/diamond test instruments and related parts.

         Equipment -- Equipment consists primarily of computer hardware and
research and development equipment. Equipment is recorded at cost and
depreciated on the straight-line method based on estimated useful lives of three
to twelve years.

         Patents and License Rights -- The Company capitalizes costs associated
with obtaining patents issued or pending for inventions and license rights
related to the manufacture of moissanite gemstones and moissanite gemstone test
instruments. Such costs are amortized over seventeen years.

         Income Taxes -- From the date of inception (June 28, 1995) to December
31, 1995, the Company was treated as a C Corporation for federal and state
income tax purposes. Effective January 1, 1996, the Company elected to change
its tax status from a C Corporation to an S


                                       40

<PAGE>

Corporation. On September 4, 1996, in connection with the closing of the 1996
Series A preferred stock offering, the Company's number of shareholders exceeded
the maximum 35 shareholder limitation for S Corporations and, as a result, the
Company's S Corporation status was automatically terminated. Losses of the
Company for the period January 1, 1996 through September 4, 1996 (totaling
$259,533) are included in the personal income tax returns of the common
shareholders as of that date. The tax effect of losses for the year ended
December 31, 1997, the period September 5, 1996 to December 31, 1996 (totaling
$123,075) and the seven-month period ending December 31, 1995 are recorded under
the provisions of Statement of Financial Accounting Standards No. 109 ("FAS
109"), Accounting for Income Taxes. Pro forma income tax benefit is not
presented to reflect the impact of losses incurred by the Company during its S
Corporation tax status since a valuation allowance would have been provided for
any net operating losses incurred. Accordingly, no pro forma tax benefit would
be recognized.


         Research and Development -- All research and development costs are
expensed when incurred.

         Stock Compensation -- The Company's stock option plan is accounted for
in accordance with Accounting Principles Board Opinion No. 25 ("APB 25"),
Accounting for Stock Issued to Employees. In January 1996, the Company adopted
the disclosure requirements of Statement of Financial Accounting Standards No.
123 ("FAS 123"), Accounting for Stock Based Compensation.

         Use of Estimates -- The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent 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.

         Net Loss Per Share -- In 1997, the Company adopted Statement of
Financial Accounting Standards No. 128 ("FAS 128"), Earnings Per Share. FAS 128
requires the presentation of both basic and diluted earnings per share,
regardless of materiality unless per share amounts are equal. Earnings per share
amounts for all periods presented have been restated to conform to the
requirements of FAS 128. Basic loss per share computations are based on the
weighted-average common shares outstanding. Diluted loss per share computations
include the dilutive effect, if any, of stock options and warrants using the
treasury stock method.

         Warrants to purchase 300,000 shares of common stock at $18 per share,
options outstanding at December 31, 1997 to purchase 1,176,066 shares of common
stock (exercise prices ranging from $1.88 - $15.00), and retroactive conversion
of the Series A and Series B preferred stock into common shares as of the date
of issuance were excluded from the computation of diluted loss per share because
either the options' exercise price was greater than the average market price of
the common shares or the effect of inclusion of such amounts would be
anti-dilutive to loss per share.


                                       41

<PAGE>

         Newly Issued Accounting Pronouncements -- In June 1997, Statement of
Financial Accounting Standards No. 130 ("FAS 130"), Comprehensive Income, was
issued. This Statement establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. FAS 130 is effective for
fiscal years beginning after December 15, 1997. Reclassification of financial
statements for earlier periods is required. However, this Statement does not
currently apply to the Company since it has no items of other comprehensive
income in any period presented.

3. COMMON STOCK

         On June 30, 1995, the Company issued (i) 1,465,440 shares of common
stock, no par value, to a founder for an initial capital contribution of
$50,000, (ii) 170,400 shares of common stock to other founders for consideration
of future services to be provided to the Company and (iii) 68,160 shares of
common stock to independent contractors for consideration of future services to
be provided to the Company. On April 2, 1996 the Company declared an
eight-for-one common stock split. On September 25, 1997, the Company effected a
2.13-for-1 stock split of its common stock. The effect of these stock splits are
reflected as if they had occurred at the beginning of the earliest period
presented.

         In May 1996, the Company issued 532,500 shares of common stock with net
proceeds of approximately $979,800 (net of offering costs of $20,197).

         On November 14, 1997, the Company completed an initial public offering
of 3,000,000 shares of its Common Stock with net proceeds of $41,072,982 (net of
offering costs of $3,927,018).

4. PREFERRED STOCK

         The Company has authorized 10 million shares of preferred stock, no par
value. The preferred stock may be issued from time to time in one or more
series.

         1996 Series A Preferred Stock -- The Board designated 105,000 shares of
its preferred stock as 1996 Series A preferred stock. In September 1996, the
Company issued 105,000 shares of Series A preferred stock with net proceeds of
approximately $593,000 (net of offering costs of $10,479). All of the 1996
Series A preferred stock was converted to common stock concurrent with the
initial public offering at a ratio of 2.13 common shares for each share of
preferred stock.

         1997 Series B Preferred Stock -- The Company designated 682,500 shares
of its preferred stock as 1997 Series B preferred stock. On January 3, 1997, the
Company offered a maximum of 195 units ("Units"), each consisting of 3,500
shares of its 1997 Series B preferred stock, no par value per share, at a price
of $25,725 per Unit or $7.35 per share. The preferred stock may be purchased
only by investors meeting the suitability standards prescribed by the Company.
Effective March 7, 1997, the Company completed the offering of 682,500 shares of
its 1997 Series B preferred stock with net proceeds of approximately $5 million.
All of the 1997 Series


                                       42

<PAGE>

B preferred stock was converted to common stock concurrent with the initial
public offering at a ratio of 2.13 common shares for each share of preferred
stock.


5. STOCK OPTION PLANS

         In 1996, the Company adopted the 1996 Stock Option Plan of C3, Inc.
("1996 Option Plan") under which options to acquire 777,450 common shares,
reduced by the number of options granted outside the 1996 Option Plan, may be
granted to key employees, directors and independent consultants. Under the 1996
Option Plan, both incentive and nonqualified options may be granted under terms
and conditions established by the board of directors. The exercise price for
incentive options will be the fair market value of the related common stock on
the date the option is granted. Options granted under the 1996 Option Plan
generally vest equally over a three-year period and have terms of 10 years. The
company currently has no plans to award additional options under the 1996 Option
Plan.

         In September 1997, the Company adopted the 1997 Omnibus Stock Plan of
C3, Inc. (the "1997 Omnibus Plan"). The 1997 Omnibus Plan authorizes the Company
to grant stock options, stock appreciation rights and restricted awards
(collectively, "awards") to selected employees, independent contractors and
directors of the Company and related corporations in order to promote a closer
identification of their interests with those of the Company and its
shareholders. The maximum number of shares of Common Stock for which awards may
be granted under the 1997 Omnibus Plan may be increased from time to time to a
number of shares equal to (i) 20% of the shares of common stock outstanding as
of that time less (ii) the number of shares of common stock subject to
outstanding options under the 1996 Option Plan. The number of shares reserved
for issuance under the 1997 Omnibus Plan may also be adjusted upon certain
events affecting the Company's capitalization. Options granted under the 1997
Omnibus Plan generally vest over three to five year periods and have terms of 10
years. The Board of Directors has reserved 677,979 shares for the 1997 Omnibus
Plan.


                                       43

<PAGE>

         The following is a summary of activity for the Company's two stock
option plans:

 

<TABLE>
<CAPTION>
                                                          1996 Option Plan                1997 Omnibus Plan
                                                          ----------------                -----------------
                                                                      Weighted                        Weighted
                                                       Number         Average          Number         Average
                                                         of           Exercise           of           Exercise
                                                       Shares          Price           Shares          Price
                                                       ------          -----           ------          -----
<S>                                                     <C>              <C>            <C>              <C>    
1996
         Granted                                        200,220          $ 2.37
         Exercised
         Canceled
                                                     ----------      ----------      ----------       ----------
         Outstanding at end of year                     200,220          $ 2.37
                                                     ==========      ==========      ==========       ==========

1997
         Granted                                        461,571          $ 4.64         477,000          $ 14.61
         Exercised
         Canceled
                                                     ----------      ----------      ----------       ----------
         Outstanding at end of year                     661,791          $ 3.95         477,000          $ 14.61
                                                     ==========      ==========      ==========       ==========
</TABLE>


         During 1996, the Company granted options to acquire 37,275 shares of
common stock to certain consultants. These options are immediately exercisable,
have a term of five years, and an exercise price of $1.88 per share.

         During 1995, the Company issued Cree Research, Inc. ("Cree"), a related
company (see Note 7), an option to acquire 1% of the outstanding shares of
common stock on the date of exercise at an exercise price of $500 at any time
through July 1, 1997. However, the Company retained the right to waive the $500
option fee and issue the stock at any time during the option period. The Company
issued 24,601 shares of common stock to Cree pursuant to this right on January
2, 1997. The Company has recorded compensation expense of approximately $66,000
in 1997 related to this transaction.


                                       44

<PAGE>

         The following summarizes information about stock options outstanding at
December 31, 1997:



<TABLE>
<CAPTION>
                                                              Weighted-Average
                                  Number of Shares         Remaining Contractual         Weighted-Average
Range of Exercise Prices            Outstanding                 Life (Years)              Exercise Price
- ------------------------            -----------                 ------------              --------------
       <S>                           <C>                            <C>                       <C>    
       $ 1.88 - 2.70                   237,495                      7.22                      $ 2.37
         3.45 - 7.62                   461,571                      9.00                        4.64
        13.88 - 15.00                  477,000                      9.00                       14.61
                                     ---------
                                     1,176,066
                                     =========
</TABLE>


         At December 31, 1997, options were exercisable for 446,235 shares
(weighted-average exercise price of $3.81 per share) and 47,350 shares
(weighted-average exercise price of $15 per share) under the 1996 Option Plan
and 1997 Omnibus Plan, respectively.

         During 1997, in accordance with APB 25, the Company recorded
compensation expense of approximately $1,633,000 relating to stock options
granted with exercise prices less than market value. Had compensation cost for
stock options granted in 1996 and 1997 been determined consistent with FAS 123
rather than APB 25, the Company's pro forma net loss for 1997 and 1996 would
have been approximately $5,561,000 and $404,000 respectively. Pro forma basic
and diluted net loss per share for 1997 and 1996 would have been $1.95 per share
and $.20 per share, respectively. The fair value of each option grant is
estimated on the date of grant using the minimum value method with the following
assumptions:


                                                  1997                    1996
                                                  ----                    ----
Weighted-average grant date fair value           $10.28                  $4.88
Weighted-average expected lives (years)           3.04                    1.80
Risk-free interest rate                           5.50%                  6.00%
Dividend yield                                     0%                      0%

         In connection with the Company's initial public offering on November
14, 1997, the Company granted the underwriters options to purchase 450,000
shares of common stock at $15 per share solely to cover over-allotments in the
sale of common stock in the offering. The options had an exercise term of 45
days and expired as of December 31, 1997. Also in connection with the offering,
the Company issued warrants to the underwriter to purchase 300,000 shares of
common stock at a price of $18 per share. The warrants are exercisable for a
period of four years beginning November 14,1998.


                                       45

<PAGE>

6. INCOME TAXES

         The Company accounts for income taxes under the liability method in
accordance with FAS 109. Under the liability method, deferred income taxes are
recognized for the tax consequences of "temporary differences" by applying
enacted statutory tax rates applicable to future years to differences between
the financial statement carrying amounts and the tax bases of existing assets
and liabilities.

Significant components of the Company's deferred tax assets and liabilities are
as follows:

                                                        December 31,
                                             --------------------------------
                                                1997                  1996
                                             -----------          -----------

Federal and state loss carryforwards         $ 1,319,000          $    57,600
Depreciation .......................              (9,000)                  --
                                             -----------          -----------
Total deferred tax assets ..........           1,310,000               57,600
Less valuation allowance ...........          (1,310,000)             (57,600)
                                             -----------          -----------
Net deferred tax assets ............         $        --          $        --
                                             ===========          ===========

         A reconciliation between anticipated income taxes, computed at the
statutory federal income tax rate applied to pretax accounting income, and the
income taxes included in the statements of operations follows:



<TABLE>
<CAPTION>
                                                                    1997                 1996                1995
<S>                                                             <C>                  <C>                  <C>
Anticipated income tax benefit at the statutory federal
rate ..................................................         $(1,673,400)         $   (40,600)         $    (9,250)
State income tax benefit, net of federal tax effect ...            (252,000)              (6,300)              (1,450)
Compensation expense -- stock options..................             640,000                   --                   --
Other .................................................              33,000                   --                   --
Increase in valuation allowance .......................           1,252,400               46,900               10,700
                                                                -----------          -----------          -----------

Income tax (benefit) expense ..........................         $        --          $        --          $        --
                                                                ===========          ===========          ===========
</TABLE>


         At December 31, 1997, the Company has operating and economic loss
carryforwards of approximately $3,373,000 expiring through 2012, which can be
offset against future federal and state taxable income. In accordance with
Section 382 of the Internal Revenue Code of 1986, as amended, a change in equity
ownership of greater than 50% of the Company within a three-year period results
in an annual limitation on the Company's ability to utilize its NOL
carryforwards that were created during tax periods prior to the change in
ownership. As a result of the Company's



                                       46

<PAGE>

private equity offerings to date and certain shareholder transactions, the
utilization of the Company's NOL carryforwards has become limited.

7. COMMITMENTS

         Operating Lease -- In August 1997, the Company entered into an
agreement to lease approximately 12,700 square feet of mixed use space from an
unaffiliated third party at a base cost of approximately $9,800 per month, plus
contingent rentals based on the Company's proportionate share of the lessor's
operating costs, as defined in the lease agreement. The lease expires August 31,
2004. The Company may cancel the lease effective as of the last day of the
thirty-eighth month by delivering to the lessor written notice nine months prior
to the cancellation date and by paying a cancellation fee of $66,300. The lease
provides for escalations of the base rent throughout the lease term, up to
$11,706 at November 1, 2003. The future minimum lease payments, including the
$66,300 cancellation fee, are as follows: $118,800 in 1998, $122,400 in 1999,
$170,925 in 2000, totaling $412,125.

         Rental expense incurred for operating leases and leases whose terms are
less than one year in duration, during 1997 was approximately $69,000. There was
no rental expense prior to 1997.

         Purchase Commitment -- On June 6, 1997, the Company entered into an
Amended and Restated Exclusive Supply Agreement ("Supply Agreement") and a
Development Agreement with Cree, a related company. The Supply Agreement has an
initial term of ten years which may be extended for an additional ten years by
either party if the Company orders in any 36-month period SiC crystals with an
aggregate purchase price in excess of $1 million. The Company expects to meet
this order threshold and to extend the term of the Supply Agreement. In
connection with the Supply Agreement, the Company has committed to purchase a
minimum of 50% (by dollar volume) of its requirements for SiC crystals from
Cree. If the Company's orders require Cree to expand beyond specified production
levels, the Company must commit to purchase certain minimum quantities. The
Company is totally dependent on Cree to supply SiC crystals for its production
process. If the Company is unable to obtain SiC crystals from Cree, its
operations would be adversely affected.

         The Development Agreement provides for a five-year development effort
by Cree to produce a fully repeatable process for producing SiC crystals meeting
certain target specifications. If Cree is successful in meeting the development
milestones set forth in the Development Agreement, the Company will be obligated
to pay Cree approximately $12 million over the five-year term of the Development
Agreement.

         During 1997, 1996 and 1995, the Company made purchases from Cree of
approximately $2,022,700, $189,600 and $13,500, respectively, for SiC materials
and research and development costs.


                                       47

<PAGE>

8. RELATED PARTIES

         During 1995 and 1996, a significant shareholder of the Company loaned
an aggregate of $60,000 to the Company for working capital needs. In addition,
during 1996 an officer and director loaned the Company $3,000. Amounts
outstanding on these loans at December 31, 1995 totaled $10,100 and were paid in
full during 1996.

9. SUBSEQUENT EVENT

         On January 8, 1998, the Company entered into a supplemental development
agreement with Cree. The agreement accelerates the timetable for Cree to develop
larger crystals for C3 to use for its gemstones, calling for Cree to develop a
fully repeatable process for producing larger-diameter silicon carbide crystals
that meet color and other specifications during 1998 in contrast to the existing
agreement which targeted mid-1999 delivery dates for the larger-diameter
crystals. The agreement provides for additional payments to Cree by C3 of up to
$2.3 million during a 12-month period.


                                       48

<PAGE>


Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
        ACCOUNTING AND FINANCIAL DISCLOSURE.

         Not Applicable.



                                    PART III


Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

         Information required by this Item will be contained in the Registrant's
definitive proxy statement relating to its Annual Meeting of Shareholders to be
held on June 23, 1998 under the captions "Board of Directors" and "Section 16(a)
Beneficial Ownership Reporting Compliance" which are incorporated by reference
herein.


Item 11. EXECUTIVE COMPENSATION.

         Information required by this Item will be contained in the Registrant's
definitive proxy statement relating to its Annual Meeting of Shareholders to be
held on June 23, 1998 under the caption "Executive Compensation" which is
incorporated by reference herein.


Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
         MANAGEMENT.

         Information required by this Item will be contained in the Registrant's
definitive proxy statement relating to its Annual Meeting of Shareholders to be
held on June 23, 1998 under the caption "Security Ownership of Management and
Certain Beneficial Owners" which is incorporated by reference herein.


Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

         Information required by this Item will be contained in the Registrant's
definitive proxy statement relating to its Annual Meeting of Shareholders to be
held on June 23, 1998 under the caption "Certain Transactions" which is
incorporated by reference herein.



                                       49

<PAGE>


                                     PART IV


Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
         FORM 8-K.

(a)      Filed Documents.

         (1)      Financial Statements.

                  The following financial statements of C3, Inc. are included in

                  Item 8 of this Annual Report on Form 10-K.

                  (i)      Independent Auditors' Report
                  (ii)     Balance Sheets as of December 31, 1997 and 1996
                  (iii)    Statements of Operations for the years ended December
                           31, 1997 and 1996, the seven-month period ended
                           December 31, 1995, and for the period June 28, 1995
                           to December 31, 1997
                  (iv)     Statements of Shareholders' Equity for the
                           seven-month period ended December 31, 1995 and for
                           the years ended December 31, 1996 and 1997
                  (v)      Statements of Cash Flows for the years ended December
                           31, 1997 and 1996, the seven-month period ended
                           December 31, 1995, and for the period June 28, 1995
                           to December 31, 1997

         (2)      Financial Statement Schedules.

                  No financial statement schedules are filed with this Annual
                  Report on Form 10-K due to the absence of the conditions under
                  which they are required or because the required information is
                  included within the financial statements or the notes thereto
                  included in Item 8.

         (3)      Exhibits.

                  A list of the exhibits required by Item 601 of Regulation S-K
                  is set forth in the response to Item 14(c) of this Annual
                  Report on Form 10-K.

(b)      Current Reports on Form 8-K.

         The Registrant did not file any Current Reports on Form 8-K during the
         last fiscal quarter of the period covered by this Annual Report on Form
         10-K.

(c)      Exhibits.

         The following exhibits are filed as part of, or incorporated by
         reference into, this Annual Report on Form 10-K.


                                       50

<PAGE>

Exhibit
Number                                   Description
- ------                                   -----------

3.1            Amended and Restated Articles of Incorporation of C3, Inc. which
               is hereby incorporated by reference to Exhibit 3.1 to the
               Registration Statement on Form S-1 of C3, Inc. (File No.
               333-36809).

3.2            Amended and Restated Bylaws of C3, Inc. which is hereby
               incorporated by reference to Exhibit 3.2 to the Registration
               Statement on Form S-1 of C3, Inc. (File No. 333- 36809).

4.1            Specimen Certificate of Common Stock which is hereby incorporated
               by reference to Exhibit 4.1 to the Registration Statement on Form
               S-1 of C3, Inc. (File No. 333- 36809).

4.2            Form of Representative's Warrant which is hereby incorporated by
               reference to Exhibit 4.2 to the Registration Statement on Form
               S-1 of C3, Inc. (File No. 333- 36809).

10.1           Consulting Agreement, dated May 1, 1997, between Kurt Nassau and
               C3, Inc. which is hereby incorporated by reference to Exhibit
               10.1 to the Registration Statement on Form S-1 of C3, Inc. (File
               No. 333-36809).+

10.2           Letter Agreement, dated May 17, 1997, between Kurt Nassau and C3,
               Inc. which is hereby incorporated by reference to Exhibit 10.2 to
               the Registration Statement on Form S-1 of C3, Inc. (File No.
               333-36809).+

10.3           Letter Agreement, dated February 17, 1997, between Howard Rubin
               and C3, Inc. which is hereby incorporated by reference to Exhibit
               10.3 to the Registration Statement on Form S-1 of C3, Inc. (File
               No. 333-36809).+

10.4           Independent Contractor Agreement, dated May 1, 1997, between
               Paula K. Berardinelli and C3, Inc. which is hereby incorporated
               by reference to Exhibit 10.4 to the Registration Statement on
               Form S-1 of C3, Inc. (File No. 333-36809).+

10.5           Independent Contractor Agreement, dated September 3, 1997,
               between C. Eric Hunter and C3, Inc. which is hereby incorporated
               by reference to Exhibit 10.5 to the Registration Statement on
               Form S-1 of C3, Inc. (File No. 333-36809).

10.6           Independent Contractor Agreement dated July 10, 1997 between
               Ollin B. Sykes and C3, Inc. which is hereby incorporated by
               reference to Exhibit 10.6 to the Registration Statement on Form
               S-1 of C3, Inc. (File No. 333-36809).+

10.7           Employment Agreement, dated June 1, 1997, between Jeff N. Hunter
               and C3, Inc. which is hereby incorporated by reference to Exhibit
               10.7 to the Registration Statement on Form S-1 of C3, Inc. (File
               No. 333-36809).+


                                       51

<PAGE>

Exhibit
Number                                   Description
- ------                                   -----------

10.8           Employment Agreement, dated July 30, 1997, between Mark W. Hahn
               and C3, Inc. which is hereby incorporated by reference to Exhibit
               10.8 to the Registration Statement on Form S-1 of C3, Inc. (File
               No. 333-36809).+

10.9           Employment Agreement, dated September 15, 1997, between Martin J.
               DeRoy and C3, Inc. which is hereby incorporated by reference to
               Exhibit 10.9 to the Registration Statement on Form S-1 of C3,
               Inc. (File No. 333-36809).+

10.10          Employment Agreement, dated March 1, 1997, between Thomas G.
               Coleman and C3, Inc. which is hereby incorporated by reference to
               Exhibit 10.10 to the Registration Statement on Form S-1 of C3,
               Inc. (File No. 333-36809).+

10.11          Amended and Restated Exclusive Supply Agreement, dated June 6,
               1997, between Cree Research, Inc. and C3, Inc. which is hereby
               incorporated by reference to Exhibit 10.11 to the Registration
               Statement on Form S-1 of C3, Inc. (File No. 333-36809).*

10.12          Development Agreement, dated as of June 6, 1997, between Cree
               Research, Inc. and C3, Inc. which is hereby incorporated by
               reference to Exhibit 10.12 to the Registration Statement on Form
               S-1 of C3, Inc. (File No. 333-36809).*

10.13          Letter Agreement, dated July 14, 1997, between Cree Research,
               Inc. and C3, Inc. which is hereby incorporated by reference to
               Exhibit 10.13 to the Registration Statement on Form S-1 of C3,
               Inc. (File No. 333-36809).*

10.14          Letter Agreement, dated January 31, 1996, between Cree Research,
               Inc. and C3, Inc. which is hereby incorporated by reference to
               Exhibit 10.14 to the Registration Statement on Form S-1 of C3,
               Inc. (File No. 333-36809).*

10.15          1996 Stock Option Plan of C3, Inc. (as amended October 27, 1997)
               which is hereby incorporated by reference to Exhibit 10.15 to the
               Registration Statement on Form S-1 of C3, Inc. (File No.
               333-36809).+

10.16          1997 Omnibus Stock Plan of C3, Inc. which is hereby incorporated
               by reference to Exhibit 10.16 to the Registration Statement on
               Form S-1 of C3, Inc. (File No. 333- 36809).+

10.17          Restricted Stock Agreement, dated June 30, 1995, between Jeff N.
               Hunter and Paula K. Berardinelli and C3, Inc. which is hereby
               incorporated by reference to Exhibit 10.17 to the Registration
               Statement on Form S-1 of C3, Inc. (File No. 333-36809).+

10.18          Shareholders Agreement, dated March 18, 1997, between General
               Electric Pension Trust, C. Eric Hunter and C3, Inc. which is
               hereby incorporated by reference to Exhibit 10.18 to the
               Registration Statement on Form S-1 of C3, Inc. (File No. 333-
               36809).


                                       52

<PAGE>

Exhibit
Number                                   Description
- ------                                   -----------

10.19          Registrations Rights Agreement, dated March 18, 1997, between
               General Electric Pension Trust and C3, Inc. which is hereby
               incorporated by reference to Exhibit 10.19 to the Registration
               Statement on Form S-1 of C3, Inc. (File No. 333-36809).

10.20          Agreement, dated September 24, 1997, between John M. Bachman,
               Inc. and C3, Inc. which is hereby incorporated by reference to
               Exhibit 10.20 to the Registration Statement on Form S-1 of C3,
               Inc. (File No. 333-36809).*

10.21          Agreement, dated September 12, 1997, between QMD, Inc. and C3,
               Inc. which is hereby incorporated by reference to Exhibit 10.21
               to the Registration Statement on Form S-1 of C3, Inc. (File No.
               333-36809).*

10.22          1997 Declaration of Amendment to 1997 Omnibus Stock Plan of C3,
               Inc. which is hereby incorporated by reference to Exhibit 99.3 to
               the Registration Statement on Form S-8 of C3, Inc. (File No.
               333-43613).+

10.23          Supplemental Development Agreement, dated January 8, 1998,
               between Cree Research, Inc. and C3, Inc.*

10.24          Letter Agreement, dated January 8, 1998, between Cree Research,
               Inc. and C3, Inc.*

23.1           Consent of Deloitte & Touche LLP

27.1           Financial Data Schedule - Fiscal year ended December 31, 1997.

27.2           Financial Data Schedule - Fiscal year ended December 31, 1996.

27.3           Financial Data Schedule 6 months ended June 30, 1997 and 9 months
               ended September 30, 1997.


* The registrant has requested that certain portions of this exhibit be given
confidential treatment.

+ Denotes a management contract or compensatory plan or arrangement.

(d)      Financial Statement Schedules.

         No financial statement schedules are filed with this Annual Report on
         Form 10-K due to the absence of the conditions under which they are
         required or because the required information is included within the
         financial statements or the notes thereto included in Item 8.



                                       53

<PAGE>


                                   SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) 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.

C3, Inc.

By:/s/ Jeff N. Hunter                                     Date: 03/31/98
   ----------------------------                                ----------------
       Jeff N. Hunter
       President

         Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.


By:/s/   Jeff N. Hunter                                   Date: 03/31/98
   ----------------------------                                ----------------
         Jeff N. Hunter
         President, Chairman of the Board and Director
         (principal executive officer)

By:/s/   Mark W. Hahn                                     Date: 03/31/98
   ----------------------------                                ----------------
         Mark W. Hahn
         Chief Financial Officer
         (principal financial and accounting officer)

By:/s/   Kurt Leutzinger                                  Date: 03/30/98
   ----------------------------                                ----------------
         Kurt Leutzinger
         Director

By:/s/   Kurt Nassau                                      Date: 03/30/98
   ----------------------------                                ----------------
         Kurt Nassau
         Director

By:/s/   Howard Rubin                                     Date: 03/30/98
   ----------------------------                                ----------------
         Howard Rubin
         Director

By: /s/  Frederick A. Russ                                Date: 03/31/98
    ----------------------------                               ----------------
         Frederick A. Russ
         Director


                                       54

<PAGE>

By: /s/  David B. Stewart                                 Date: 03/31/98
    ----------------------------                               ----------------
         David B. Stewart
         Director

By: /s/  Ollin B. Sykes                                   Date: 03/30/98
    ----------------------------                               ----------------
         Ollin B. Sykes
         Director


                                       55

<PAGE>


                                  EXHIBIT INDEX
                                       TO
                           ANNUAL REPORT ON FORM 10-K
                                       OF
                                    C3, INC.



Exhibit
Number                                       Description
- ------                                       -----------

3.1            Amended and Restated Articles of Incorporation of C3, Inc. which
               is hereby incorporated by reference to Exhibit 3.1 to the
               Registration Statement on Form S-1 of C3, Inc. (File No.
               333-36809).

3.2            Amended and Restated Bylaws of C3, Inc. which is hereby
               incorporated by reference to Exhibit 3.2 to the Registration
               Statement on Form S-1 of C3, Inc. (File No. 333- 36809).

4.1            Specimen Certificate of Common Stock which is hereby incorporated
               by reference to Exhibit 4.1 to the Registration Statement on Form
               S-1 of C3, Inc. (File No. 333- 36809).

4.2            Form of Representative's Warrant which is hereby incorporated by
               reference to Exhibit 4.2 to the Registration Statement on Form
               S-1 of C3, Inc. (File No. 333- 36809).

10.1           Consulting Agreement, dated May 1, 1997, between Kurt Nassau and
               C3, Inc. which is hereby incorporated by reference to Exhibit
               10.1 to the Registration Statement on Form S-1 of C3, Inc. (File
               No. 333-36809).

10.2           Letter Agreement, dated May 17, 1997, between Kurt Nassau and C3,
               Inc. which is hereby incorporated by reference to Exhibit 10.2 to
               the Registration Statement on Form S-1 of C3, Inc. (File No.
               333-36809).

10.3           Letter Agreement, dated February 17, 1997, between Howard Rubin
               and C3, Inc. which is hereby incorporated by reference to Exhibit
               10.3 to the Registration Statement on Form S-1 of C3, Inc. (File
               No. 333-36809).

10.4           Independent Contractor Agreement, dated May 1, 1997, between
               Paula K. Berardinelli and C3, Inc. which is hereby incorporated
               by reference to Exhibit 10.4 to the Registration Statement on
               Form S-1 of C3, Inc. (File No. 333-36809).

10.5           Independent Contractor Agreement, dated September 3, 1997,
               between C. Eric Hunter and C3, Inc. which is hereby incorporated
               by reference to Exhibit 10.5 to the Registration Statement on
               Form S-1 of C3, Inc. (File No. 333-36809).


                                       56

<PAGE>

Exhibit
Number                                       Description
- ------                                       -----------

10.6           Independent Contractor Agreement dated July 10, 1997 between
               Ollin B. Sykes and C3, Inc. which is hereby incorporated by
               reference to Exhibit 10.6 to the Registration Statement on Form
               S-1 of C3, Inc. (File No. 333-36809).

10.7           Employment Agreement, dated June 1, 1997, between Jeff N. Hunter
               and C3, Inc. which is hereby incorporated by reference to Exhibit
               10.7 to the Registration Statement on Form S-1 of C3, Inc. (File
               No. 333-36809).

10.8           Employment Agreement, dated July 30, 1997, between Mark W. Hahn
               and C3, Inc. which is hereby incorporated by reference to Exhibit
               10.8 to the Registration Statement on Form S-1 of C3, Inc. (File
               No. 333-36809).

10.9           Employment Agreement, dated September 15, 1997, between Martin J.
               DeRoy and C3, Inc. which is hereby incorporated by reference to
               Exhibit 10.9 to the Registration Statement on Form S-1 of C3,
               Inc. (File No. 333-36809).

10.10          Employment Agreement, dated March 1, 1997, between Thomas G.
               Coleman and C3, Inc. which is hereby incorporated by reference to
               Exhibit 10.10 to the Registration Statement on Form S-1 of C3,
               Inc. (File No. 333-36809).

10.11          Amended and Restated Exclusive Supply Agreement, dated June 6,
               1997, between Cree Research, Inc. and C3, Inc. which is hereby
               incorporated by reference to Exhibit 10.11 to the Registration
               Statement on Form S-1 of C3, Inc. (File No. 333-36809).

10.12          Development Agreement, dated as of June 6, 1997, between Cree
               Research, Inc. and C3, Inc. which is hereby incorporated by
               reference to Exhibit 10.12 to the Registration Statement on Form
               S-1 of C3, Inc. (File No. 333-36809).

10.13          Letter Agreement, dated July 14, 1997, between Cree Research,
               Inc. and C3, Inc. which is hereby incorporated by reference to
               Exhibit 10.13 to the Registration Statement on Form S-1 of C3,
               Inc. (File No. 333-36809).

10.14          Letter Agreement, dated January 31, 1996, between Cree Research,
               Inc. and C3, Inc. which is hereby incorporated by reference to
               Exhibit 10.14 to the Registration Statement on Form S-1 of C3,
               Inc. (File No. 333-36809).

10.15          1996 Stock Option Plan of C3, Inc. (as amended October 27, 1997)
               which is hereby incorporated by reference to Exhibit 10.15 to the
               Registration Statement on Form S-1 of C3, Inc. (File No.
               333-36809).

10.16          1997 Omnibus Stock Plan of C3, Inc. which is hereby incorporated
               by reference to Exhibit 10.16 to the Registration Statement on
               Form S-1 of C3, Inc. (File No. 333- 36809).


                                       57

<PAGE>

Exhibit
Number                                       Description
- ------                                       -----------

10.17          Restricted Stock Agreement, dated June 30, 1995, between Jeff N.
               Hunter and Paula K. Berardinelli and C3, Inc. which is hereby
               incorporated by reference to Exhibit 10.17 to the Registration
               Statement on Form S-1 of C3, Inc. (File No. 333-36809).

10.18          Shareholders Agreement, dated March 18, 1997, between General
               Electric Pension Trust, C. Eric Hunter and C3, Inc. which is
               hereby incorporated by reference to Exhibit 10.18 to the
               Registration Statement on Form S-1 of C3, Inc. (File No. 333-
               36809).

10.19          Registrations Rights Agreement, dated March 18, 1997, between
               General Electric Pension Trust and C3, Inc. which is hereby
               incorporated by reference to Exhibit 10.19 to the Registration
               Statement on Form S-1 of C3, Inc. (File No. 333-36809).

10.20          Agreement, dated September 24, 1997, between John M. Bachman,
               Inc. and C3, Inc. which is hereby incorporated by reference to
               Exhibit 10.20 to the Registration Statement on Form S-1 of C3,
               Inc. (File No. 333-36809).

10.21          Agreement, dated September 12, 1997, between QMD, Inc. and C3,
               Inc. which is hereby incorporated by reference to Exhibit 10.21
               to the Registration Statement on Form S-1 of C3, Inc. (File No.
               333-36809).

10.22          1997 Declaration of Amendment to 1997 Omnibus Stock Plan of C3,
               Inc. which is hereby incorporated by reference to Exhibit 99.3 to
               the Registration Statement on Form S-8 of C3, Inc. (File No.
               333-43613).

10.23          Supplemental Development Agreement, dated January 8, 1998,
               between Cree Research, Inc. and C3, Inc.

10.24          Letter Agreement, dated January 8, 1998, between Cree Research,
               Inc. and C3, Inc.

23.1           Consent of Deloitte & Touche LLP

27.1           Financial Data Schedule - Fiscal year ended December 31, 1997.

27.2           Financial Data Schedule - Fiscal year ended December 31, 1996.

27.3           Financial Data Schedule - 6 months ended June 30, 1997 and 9
               months ended September 30, 1997.



                                       58





                                                                   EXHIBIT 10.23

       THE REGISTRANT HAS REQUESTED THAT CERTAIN PORTIONS OF THIS EXHIBIT
         BE GIVEN CONFIDENTIAL TREATMENT. AN UNREDACTED VERSION OF THIS
                   EXHIBIT HAS BEEN FILED WITH THE COMMISSION.




                       SUPPLEMENTAL DEVELOPMENT AGREEMENT
                              DATED JANUARY 8, 1998
                    BETWEEN CREE RESEARCH, INC. AND C3, INC.



<PAGE>

         REDACTED -- OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH THE
                   COMMISSION AND IS DENOTED HEREIN BY *****.

                       SUPPLEMENTAL DEVELOPMENT AGREEMENT

         This SUPPLEMENTAL DEVELOPMENT AGREEMENT (the "Agreement") is entered
into effective as of the 8th day of January, 1998 by and between Cree Research,
Inc. ("Cree") and C3, Inc. ("C3").

                                R E C I T A L S:

         WHEREAS, Cree and C3 are parties to an Amended and Restated Exclusive
Supply Agreement dated June 6, 1997 (the "Supply Agreement") wherein Cree and C3
agree, inter alia, for Cree to supply C3 certain silicon carbide ("SiC")
material and C3 agrees to purchase certain SiC material as provided therein; and

         WHEREAS, Cree and C3 are also parties to a Development Agreement dated
June 6, 1997 (the "Principal Development Agreement") wherein Cree agrees to
perform certain research and development activities directed to improving the
colorless material available for purchase under the Supply Agreement; and

         WHEREAS, Cree
 and C3 desire to enter into an additional agreement
whereby Cree shall perform certain research and development activities directed
more specifically to accelerating improvements in the volume of SiC material
available for purchase under the Supply Agreement;

         WHEREAS, Cree and C3, in entering into this Agreement, desire to
improve and expand upon their relationship and intend to work together
cooperatively with the objective of developing, as promptly as practicable, both
the market for and commercially viable means of manufacturing colorless silicon
carbide material suitable for gemstones; and

         NOW, THEREFORE, the parties hereto, in consideration of the foregoing
premises and the covenants and undertakings herein contained, mutually agree as
follows:

         1.       Duties of Cree

                  1.1 Cree agrees to use its best commercially reasonable
efforts to develop a repeatable process, as defined in Section 1.2 (the
"Repeatable Process"), for producing SiC boules which meet the specifications
provided in Section 1.3 (the "Specifications"). The effort under this Agreement
will be focused on meeting the Volume Specifications provided in Section 1.3 and
incorporating improvements for achieving the Color Specifications from the
program under the Principal Development Agreement.

                  1.2 The process for producing SiC boules shall be considered a
"Repeatable Process" when ***** crystal grower can produce, in a period of 30
days, at least ***** SiC boules that meet the Specifications.



<PAGE>

         REDACTED -- OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH THE
                   COMMISSION AND IS DENOTED HEREIN BY *****.


                  1.3 As used in this Agreement, the term "Specifications" shall
mean the applicable specifications set out in the Specifications and Timetable
Chart below for SiC boules. The Specifications consist of "Volume
Specifications" and "Color Specifications." The Volume Specifications are
expressed in terms of the diameter and height of each boule, but any equivalent
volume is acceptable. The Color Specifications require that a specified
percentage (the "Percentage") of the volume of SiC material required by the
Volume Specifications is in the comparable diamond color grade range of GHIJ,
with no less than ***** in the GH range, or better, according to the standards
generally accepted by the diamond industry for color using pregraded master
color stones. While the specifications do not require the absence of inclusions,
blemishes or other defects affecting clarity, Cree shall use its best
commercially reasonable efforts to minimize such defects since such defects can
have an impact on the final color grade. The Percentage shall be measured by
observation on the a-axis through "windows" ground onto two sides of the boule.
The parties acknowledge that initially C3 shall promptly provide feedback to
Cree concerning the Percentage, but the parties shall cooperate to develop a
mutually acceptable testing procedure for Cree to determine the Percentage prior
to delivery of the SiC boules to C3. The Specifications change over time, as the
Date column indicates.

                       Specifications and Timetable Chart

 Date                  Diameter             Height           %G-J Grade
 ----                  --------             ------           ----------
 *****/1998             *****               *****              *****
 *****/1998             *****               *****              *****

If, pursuant to Section 1.7, the polytype used in the development work is
changed to the ***** polytype at C3's written request or with its written
consent, (i) the *****, 1998 date shown above will be extended by ***** if the
change is effective on or before *****, 1998, and by ***** if the change is
effective after *****, 1998; and (ii) Cree will no longer be obligated to
attempt to achieve the *****, 1998 Specifications by that date but will continue
to use its best commercially reasonable efforts to work toward such
Specifications during the remainder of the term of this Agreement. For each of
the Specifications above, Cree will provide prompt notice to C3 when Cree has
developed a Repeatable Process for producing boules meeting such specifications.

                  1.4 In seeking to achieve the Specifications, Cree will use
its best commercially reasonable efforts to incorporate color-related and other
improvements developed in the work conducted under the Principal Development
Agreement into the work being conducted under this Agreement within ***** after
such improvements are made under the Principal Development Agreement, subject to
such delays as may result from lead times required to obtain necessary equipment
or services from third parties and other similar circumstances.

                                        3


<PAGE>


         REDACTED -- OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH THE
                   COMMISSION AND IS DENOTED HEREIN BY *****.


                  1.5 In performing development services under this Agreement,
Cree will assign to the work such Cree personnel, for such amounts of time, as
may be mutually agreed upon in writing by Cree and C3 from time to time. Cree
reserves the right to alter such assignments upon written notice to C3.

                  1.6 Cree agrees to report to C3 the progress of the
development services provided pursuant to this Agreement at monthly progress
meetings. Cree further agrees to keep C3's President informed of significant
developments on a weekly basis. Any "Confidential Information" provided by Cree
to C3 at such meetings or otherwise under this Agreement shall be subject to the
terms of Section 5 of the Supply Agreement. Nothing herein shall obligate Cree
to disclose to C3 any Confidential Information regarding Cree's processes for
SiC growth.

                  1.7 Development work under this Agreement will initially be
directed to the production of boules meeting the Specifications that are
composed of the ***** polytype of SiC. If requested by C3 in writing,
development work shall be redirected to the production of boules meeting the
Specifications that are composed of the ***** polytype of SiC, except that Cree
shall not be required to change polytypes if it has achieved the then applicable
specifications using the ***** polytype under the Principal Development
Agreement. Unless otherwise mutually agreed, the change in polytype will be
effective on the first day of the month following Cree's receipt of C3's
request, provided the request is received at least 14 days in advance. Cree
reserves the right to change the polytype used in the development work to *****,
if it reasonably determines the change is necessary or desirable to achieve the
Specifications, and shall advise C3 of the change in writing at least 7 days in
advance.

                  1.8 If prior to *****, 1998 (or such later date as may be
applicable under Section 1.3 in the event of a change in SiC polytype) Cree does
not develop a Repeatable Process for producing SiC boules that meet both the
Volume Specifications and Color Specifications shown in Section 1.3 for *****,
1998, then Cree and C3 shall consult on appropriate development goals for the
remainder of the term of this Agreement and shall in good faith endeavor to
reach a mutual agreement on the work to be conducted thereafter.

                  1.9 All SiC boules produced pursuant to this Agreement,
including SiC boules that do not meet the Specifications but excluding seed
boules, shall be the property of C3; provided that the seeds from all SiC boules
produced shall remain the property of Cree and shall be removed and retained by
Cree. Cree shall in any event deliver to C3 each month SiC material having a
minimum volume of ***** and a minimum height of *****. Cree shall identify each
boule delivered to C3 both by the crystal growth system in which it was grown
and with the date it was produced. Crystal growth systems used in the
development activities shall not be

                                       4


<PAGE>

considered as "in use for production" for purposes of the Supply Agreement. All
SiC boules delivered hereunder will

         REDACTED -- OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH THE
                   COMMISSION AND IS DENOTED HEREIN BY *****.

be supplied "AS IS." EXCEPT AS PROVIDED ABOVE IN THIS PARAGRAPH WITH RESPECT TO
IDENTIFICATION OF BOULES, CREE MAKES NO WARRANTY OF ANY KIND WITH RESPECT TO ANY
MATERIAL SUPPLIED HEREUNDER AND DISCLAIMS ANY IMPLIED WARRANTIES, INCLUDING ANY
WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR
NONINFRINGEMENT OF PATENT OR SIMILAR RIGHTS.

                  1.10 Cree will use all commercially reasonable efforts to
reduce costs of the development services performed under this Agreement.

                  1.11 Cree is not obligated to contribute resources to the
development services performed under this Agreement beyond those funded by C3,
as provided in Section 2.1.

                  1.12 Cree provides no assurances that the development services
performed under this Agreement will be successful.

         2.       Duties of C3

                  2.1 Subject to Sections 2.2 and 2.3, C3 shall pay to Cree each
month a development fee equal to the sum of:

                           (i) The costs of materials and equipment used in the
         development activities undertaken pursuant to this Agreement (including
         the costs of operating such equipment; with such costs calculated in
         the same manner as "loaded manufacturing costs," but without reduction
         for boules that do not meet the "minimum specifications," as provided
         in the Supply Agreement);

                           (ii) An amount equal to a ***** gross margin of the
         costs described in Section 2.1(i); and

                           (iii) All research and development labor costs and
         outside services costs directly incurred by Cree in providing
         development services pursuant to this Agreement; provided, that these
         costs shall be charged to C3 on the same basis as Cree charges similar
         costs in providing research services pursuant to contracts between Cree
         and the U.S. government, using allocations, conditions and calculations
         no less favorable to C3 than those available under any such contract of
         Cree (it being understood that reductions in costs from cost-sharing
         shall not be applicable and that such costs include

                                       5


<PAGE>

         certain overhead allocations).

             REDACTED -- OMITTED MATERIAL HAS BEEN FILED SEPARATELY
                  WITH THE COMMISSION AND IS DENOTED BY *****

                  2.2 Subject to Section 2.3 and notwithstanding Section 2.1, C3
shall pay to Cree each month this Agreement continues in effect a development
fee equal to the lesser of:

                           (i)  The fee calculated pursuant to Section 2.1; or

                           (ii) The total development budget for the appropriate
         month set forth in Exhibit A.

                  2.3 If the fee calculated pursuant to Section 2.1 is less than
the total development budget for the appropriate month set forth in the proposal
in Exhibit A, the difference will be carried forward and applied to the
development budget for subsequent months.

                  2.4 If, prior to *****, 1998, Cree has developed a Repeatable
Process for producing SiC boules that meet both the Volume Specifications and
Color Specifications shown in Section 1.3 for *****, 1998, C3 shall pay Cree
the sum of five hundred thousand dollars ($500,000.00) in addition to all other
amounts due under this Agreement. If, prior to *****, 1998, Cree has developed a
Repeatable Process for producing SiC boules that meet both the Volume
Specifications and Color Specifications shown in Section 1.3 for *****, 1998, C3
shall pay Cree the sum of five hundred thousand dollars ($500,000.00) in
addition to all other amounts due under this Agreement.

                  2.5 Cree shall invoice amounts due from C3 under this
Agreement, and such invoices shall be due and payable within thirty days.

                  2.6 C3 shall have the right, at its expense, to have an
independent public accounting firm reasonably acceptable to Cree audit Cree's
costs described in Sections 2.1(i) and 2.1(iii) (the "Audited Costs"). The audit
shall be conducted during normal business hours and upon reasonable prior
notice. The accounting firm conducting the audit shall be required to enter into
a mutually acceptable nondisclosure agreement with Cree under which such firm
will be obligated not to disclose any information obtained during the course of
the audit, except that it may disclose to C3 its analysis of the correctness of
the Audited Costs as calculated by Cree. The audit right under this paragraph
may be exercised not more than once during any fiscal year of Cree and only with
respect to costs applicable to the year preceding the request for an audit. Cree
shall provide reasonable assistance to the public accounting firm including, but
not limited to, providing a schedule of the Audited Costs (which shall provide
reasonable detail as to the calculation of the Audited Costs, including but not
limited to hours charged by person at billing rates applicable to each, total
material costs, equipment charges and overhead charges, however such schedule
shall not divulge any proprietary or confidential information of Cree),
supporting analyses and any supporting source documentation reasonably required
by the public accounting firm. Such accounting firm will audit and report to C3
on the schedule of Audited Costs, but will not divulge to C3 any proprietary or
confidential information (including but not limited to

                                       6


<PAGE>

supporting schedules and source documents) disclosed during the audit process.

             REDACTED -- OMITTED MATERIAL HAS BEEN FILED SEPARATELY
                  WITH THE COMMISSION AND IS DENOTED BY *****


         3.       Terms and Termination

                  3.1 Unless earlier terminated pursuant to Section 3.2 or
Section 5.6, or unless extended by the mutual consent of the parties hereto,
this Agreement shall terminate on December 31, 1998.

                  3.2 C3 shall have the option to terminate this Agreement, upon
written notice given thirty days prior to the effective date of the termination,
if Cree does not develop by *****, 1998 (or such later date as may be applicable
under Section 1.3 in the event of a change in SiC polytype) a Repeatable Process
for producing SiC boules that meet the Volume Specifications shown in Section
1.3 for *****, 1998; provided, that such termination option, if not sooner
exercised by C3, shall expire at 11:59 p.m. eastern daylight savings time on the
tenth day following the termination of the deadline for establishing the
Repeatable Process. If C3 exercises its option to terminate this Agreement
pursuant to this Section 3.2, Cree shall not be entitled to payment for any work
done or any expenses incurred during the period from the time C3's option to
terminate became exercisable to the time such option is exercised.

         4.       Intellectual Property

                  4.1 All inventions developed by Cree personnel in performing
work under this Agreement shall be the sole property of Cree.

                  4.2 Except for the inventions related to the bulk growth of
silicon carbide or gallium nitride, C3 shall have a perpetual, irrevocable,
royalty-free, exclusive (including exclusive of Cree) license to use,
manufacture, sell and otherwise practice (including the right to sublicense) all
inventions developed by Cree pursuant to this Agreement for all gemstone
applications and applications for gemological instrumentation; provided that
Cree shall have the right to use and practice the invention to manufacture or
process material for C3 for the licensed applications. References in this
Agreement to "gemstones" are understood to mean "gems" (and vice versa).

         5.       General

                  5.1 This Agreement shall not be amended, modified or altered
except pursuant to a document signed by both parties.

                  5.2 This Agreement is made in and shall be construed in
accordance with and governed by the laws of the State of North Carolina.

                  5.3 This Agreement shall inure to the benefit of and be
binding upon the

                                       7


<PAGE>

parties and their respective successors and permitted assigns.

                  5.4 The invalidity or unenforceability of any particular
provision of this Agreement shall not affect the other provisions hereof, and
this Agreement shall be construed in all respects as if such invalid or
unenforceable provisions were omitted.

                  5.5 This Agreement may not be assigned by either party without
the other party's prior written consent, which consent shall not be unreasonably
withheld except that either party may, in its sole discretion, withhold consent
to assignment of this Agreement to anyone other than a permitted assignee of all
rights under the Supply Agreement. Any attempted assignment in violation of this
Section 5.5 is void and shall constitute a breach of this Agreement.

                  5.6 In the event of a material breach by either party of any
obligation under this Agreement to the other party, the other party may
terminate this Agreement upon written notice if the breach is not cured within
thirty (30) days after giving written notice to the party in breach, setting out
the nature of the breach in reasonable detail; provided, however, that no cure
period shall apply to a termination pursuant to the terms of the Agreement by C3
pursuant to Section 3.2 (it being understood that the grounds for termination
specified in Section 3.2 do not constitute a breach) or in the event of a
material breach by a party that has breached this Agreement and been given
notice of similar material breaches on two prior occasions. In addition, this
Agreement shall automatically terminate upon any termination of the Supply
Agreement under Section 3.3 thereof.

                  5.7 Neither party shall issue any press release nor otherwise
make any public announcement concerning this Agreement without the prior consent
of the other party, except as may be required by law. The parties further agree
that the terms of this Agreement shall be treated as Confidential Information of
each other subject to Section 5 of the Supply Agreement; provided, however that
either party may, upon notice to the other, make such public disclosures
regarding this Agreement as in the opinion of counsel for such party are
required by applicable securities laws or regulations or other applicable law.
Neither party shall use the name of the other party in any advertising,
marketing or similar material without the other party's prior written consent.

                  5.8 The parties acknowledge and agree that in the event of a
breach of the Agreement, in addition to any other rights and remedies available
to it at law or otherwise, the parties shall be entitled to seek equitable
relief in the form of a temporary restraining order ("TRO") from any court of
competent jurisdiction; provided however, that in the event a TRO is obtained,
the parties shall request that any hearing on the merits of the dispute shall be
stayed pending arbitration of the dispute as provided in this Section 5.8. In
the event a party seeks a TRO or in the event of any other controversy or claim
(including, without limitation, any claim based on negligence,
misrepresentation, strict liability or other basis) arising out of or relating
to this Agreement or its performance or breach, a party shall give the other
party notice of the

                                       8


<PAGE>

dispute, setting out the circumstance in reasonable detail, and requesting a
meeting of the representatives of the parties to attempt to resolve the dispute
or to reduce the scope of the issues subject to dispute. The chief executive
officers of the parties, and such other representatives as each may desire to
have attend, shall meet at a mutually agreeable time within five business days
from the date the meeting request was received and shall hold such meeting at
the offices of the party not requesting the same, or at some mutually agreeable
alternative location. In the event the parties do not resolve the dispute at
such meeting, or any mutually agreed upon adjournment thereof, the dispute shall
be settled exclusively by arbitration in the City of Raleigh, North Carolina
pursuant to the expedited procedures of the Commercial Arbitration Rules of the
American Arbitration Association (other than notice requirements which shall be
as provided in Section 5.9 below and the expedited procedures for selection of
arbitrators which shall be as provided in Sections 14 and 15 of such Rules).
There shall be three arbitrators, one selected by each of C3 and Cree and a
third selected by the arbitrators selected by the parties. The arbitrators shall
in no event make any damage award that contravenes Section 5.10 of this
Agreement, but shall order the losing party to pay all of the charges of the
American Arbitration Association for such arbitration and all of the prevailing
party's costs of the arbitration, including reasonable attorneys' fees. The
decision in such arbitration shall be final and binding and judgment on any
award rendered therein may be entered in any court having jurisdiction.

                  5.9 All notices under this Agreement shall be in writing and
addressed to the other party at the address shown below or to such other
addresses as the party may hereafter designate by notice under this Agreement.
All notices so addressed shall be deemed given five (5) days after mailing if
sent by certified mail, return receipt requested, postage prepaid, or when sent
via facsimile if receipt is acknowledged in writing or otherwise when actually
received.

                  5.10 In no event shall either party be liable to the other for
incidental, consequential or special loss or damages of any kind, however
caused, or any punitive damages.

         IN WITNESS WHEREOF, the parties have executed this Agreement by and
through their duly authorized representatives.

CREE RESEARCH, INC.                       C3, INC.

By:  /s/ Charles M. Swoboda               By:  /s/ Jeff N. Hunter
     Charles M. Swoboda, Vice President        Jeff N. Hunter, President
     and Chief Operating Officer


Address for Notices:                      Address for Notices:

Cree Research, Inc.                       C3, Inc.
4600 Silicon Drive                        P.O. Box 13533
Durham, North Carolina 27703              Research Triangle Park, NC 27709-3533

                                       9



<PAGE>

Attention: President                      Attention: President
Fax No.: (919) 361-5415                   Fax No.: (919) 468-0486


                                       10


<PAGE>

         REDACTED -- OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH THE
                   COMMISSION AND IS DENOTED HEREIN BY *****.

                                    EXHIBIT A

                               Development Budget



<TABLE>
<CAPTION>
          Jan-98    Feb-98   Mar-98   Apr-98   May-98  June-98  July-98  Aug-98  Sept-98   Oct-98   Nov-98  Dec-98
<S>       <C>       <C>      <C>      <C>      <C>     <C>      <C>      <C>     <C>       <C>      <C>     <C>
Total      *****    *****    *****    *****    *****   *****    *****    *****   *****     *****    *****   *****
</TABLE>



                                       11




                                                                   EXHIBIT 10.24

       THE REGISTRANT HAS REQUESTED THAT CERTAIN PORTIONS OF THIS EXHIBIT
         BE GIVEN CONFIDENTIAL TREATMENT. AN UNREDACTED VERSION OF THIS
                   EXHIBIT HAS BEEN FILED WITH THE COMMISSION.




                                LETTER AGREEMENT
                              DATED JANUARY 8, 1998
                    BETWEEN CREE RESEARCH, INC. AND C3, INC.




<PAGE>

         REDACTED -- OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH THE
                    COMMISSION AND IS DENOTED HEREIN BY *****

                                 January 8, 1998

C3, Inc.
P.O. Box 13533
Research Triangle Park, NC 27709-3533

  Re: Supplemental Development Agreement dated as of January 8, 1998 between C3,
      Inc. and Cree Research, Inc.

Gentlemen:

         This letter confirms the following understandings reached between C3,
Inc. ("C3") and Cree Research, Inc. ("Cree") in connection with the execution of
the Supplemental Development Agreement referenced above:

         1. Cree shall assign ***** to the work to be performed pursuant to the
Supplemental Development Agreement, with ***** to devote, on average during the
term of the agreement, approximately 50% of his effort to the program.

         2. Cree shall assign ***** and ***** to the work to be performed
pursuant to the Supplemental Development Agreement, with ***** and ***** to
devote, on average during the term of the agreement, a combined total of
approximately 25% of the effort of one person to the program.

         3. Cree
 shall assign a crystal growth scientist and process technician
to the work to be performed pursuant to the Supplemental Development Agreement,
with such personnel to devote their full-time efforts to the program under the
direction of *****.

         4. The assignment of individuals named above is subject to the
condition that such individual continue in Cree's employment.

         5. The contents of this letter shall be considered "Confidential
Information" of each party subject to the provisions of Section 5 of the Supply
Agreement.

         If you agree that the foregoing accurately states our understanding
regarding the subject matter addressed above, please indicate your agreement on
behalf of C3 by signing below.

                                       Very truly yours,

                                       CREE RESEARCH, INC.

                                       By:      /s/ Charles M. Swoboda
                                              Charles M. Swoboda, Vice President
                                              and Chief Operating Officer
Agreed:

C3, INC.

By:    /s/ Jeff N. Hunter
       Jeff N. Hunter, President





                                                                    Exhibit 23.1

INDEPENDENT AUDITORS' CONSENT

We consent to the incorporation by reference in Registration Statement No.
333-43613 of C3, Inc. on Form S-8 of our report dated February 26, 1998,
appearing in this Annual Report on Form 10-K of C3, Inc. for the year ended
December 31, 1997.

/s/ Deloitte & Touche LLP
Deloitte & Touche LLP

Raleigh, North Carolina
March 28, 1998







<TABLE> <S> <C>

<ARTICLE> 5
       
<S>                             <C>
<PERIOD-TYPE>                   YEAR
<FISCAL-YEAR-END>                          DEC-31-1997
<PERIOD-END>                               DEC-31-1997
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<SECURITIES>                                         0
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<INVENTORY>                                    278,602
<CURRENT-ASSETS>                            44,514,213
<PP&E>                                         214,990
<DEPRECIATION>                                  21,720
<TOTAL-ASSETS>                              44,873,089
<CURRENT-LIABILITIES>                          826,808
<BONDS>                                              0
<PREFERRED-MANDATORY>                                0
<PREFERRED>                                          0
<COMMON>                                    47,743,431
<OTHER-SE>                                 (3,697,150)
<TOTAL-LIABILITY-AND-EQUITY>                44,873,089
<SALES>                                              0
<TOTAL-REVENUES>                                     0
<CGS>                                                0
<TOTAL-COSTS>                                        0
<OTHER-EXPENSES>                             2,672,545
<LOSS-PROVISION>                                     0
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<INCOME-PRETAX>                            (4,920,159)
<INCOME-TAX>                                         0
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<DISCONTINUED>                                       0
<EXTRAORDINARY>                                      0
<CHANGES>                                            0
<NET-INCOME>                               (4,920,159)
<EPS-PRIMARY>                                   (.173)
<EPS-DILUTED>                                   (.173)
        

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<TABLE> <S> <C>

<ARTICLE> 5
       
<S>                             <C>
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<FISCAL-YEAR-END>                          DEC-31-1996
<PERIOD-END>                               DEC-01-1996
<CASH>                                       1,167,458
<SECURITIES>                                         0
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<PP&E>                                          14,081
<DEPRECIATION>                                   2,352
<TOTAL-ASSETS>                               1,226,134
<CURRENT-LIABILITIES>                           12,855
<BONDS>                                              0
<PREFERRED-MANDATORY>                                0
<PREFERRED>                                    593,271
<COMMON>                                     1,029,803
<OTHER-SE>                                   (409,795)
<TOTAL-LIABILITY-AND-EQUITY>                 1,226,134
<SALES>                                              0
<TOTAL-REVENUES>                                     0
<CGS>                                                0
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<CHANGES>                                            0
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<EPS-PRIMARY>                                    (.19)
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<TABLE> <S> <C>

<ARTICLE> 5
       
<S>                             <C>                     <C>
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<PERIOD-END>                               JUN-30-1997             SEP-30-1997
<CASH>                                       5,538,099               4,737,864
<SECURITIES>                                         0                       0
<RECEIVABLES>                                        0                       0
<ALLOWANCES>                                         0                       0
<INVENTORY>                                          0                  17,911
<CURRENT-ASSETS>                             5,538,099               4,875,196
<PP&E>                                          53,955                  94,380
<DEPRECIATION>                                       0                       0
<TOTAL-ASSETS>                               5,661,920               5,085,048
<CURRENT-LIABILITIES>                          109,874                 469,962
<BONDS>                                              0                       0
<PREFERRED-MANDATORY>                                0                       0
<PREFERRED>                                  5,574,647               5,574,647
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