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S-1/A
CHARLES & COLVARD LTD filed this Form S-1/A on 11/05/1997
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<PAGE>   1
   
    AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 5, 1997
    
                                                      REGISTRATION NO. 333-36809
================================================================================
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                             ---------------------
   
                                AMENDMENT NO. 2
    
                                       TO
 
                                    FORM S-1
                             REGISTRATION STATEMENT
                                     UNDER
                           THE SECURITIES ACT OF 1933
                             ---------------------
 
                                    C3, INC.
             (Exact name of registrant as specified in its charter)
                             ---------------------

<TABLE>
<S>                                <C>                                <C>
          NORTH CAROLINA                          3915                            56-0308470
   (State or Other Jurisdiction       (Primary Standard Industrial             (I.R.S. Employer
of Incorporation or Organization)     Classification Code Number)            Identification No.)
</TABLE>

 
                       3800 GATEWAY BOULEVARD, SUITE 310
                             MORRISVILLE, NC 27560
                                 (919) 468-0399
  (Address, Including Zip Code, and Telephone Number, Including Area Code, of
                    Registrant's Principal Executive Office)
                             ---------------------
                                 JEFF N. HUNTER
                                   PRESIDENT
                                    C3, INC.
                       3800 GATEWAY BOULEVARD, SUITE 310
                             MORRISVILLE, NC 27560
                                 (919) 468-0399
 (Name, Address, Including Zip Code, and Telephone Number, Including Area Code,
                             of Agent for Service)
 
                                   COPIES TO:

<TABLE>
<C>                                                      <C>
                   DEBORAH H. HARTZOG                                        DEBRA K. WEINER
         WOMBLE CARLYLE SANDRIDGE & RICE, PLLC                          GROVER T. WICKERSHAM, P.C.
                 2505 MERIDIAN PARKWAY                                     430 CAMBRIDGE AVENUE
                       SUITE 300                                                SUITE 100
            RESEARCH TRIANGLE PARK, NC 27713                               PALO ALTO, CA 94306
                     (919) 484-2311                                           (650) 323-6400
</TABLE>

                             ---------------------
 
    APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:  As soon as
practicable after this Registration Statement becomes effective.
 
    If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [X]
 
    If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. []
 
    If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. []
 
    If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. []
 
    If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. []
                             ---------------------
   

                        CALCULATION OF REGISTRATION FEE
    
   

<TABLE>
<CAPTION>
===============================================================================================================================
       TITLE OF EACH CLASS                                  PROPOSED MAXIMUM        PROPOSED MAXIMUM           AMOUNT OF
         OF SECURITIES TO              AMOUNT TO BE          OFFERING PRICE        AGGREGATE OFFERING         REGISTRATION
          BE REGISTERED                REGISTERED(1)          PER UNIT(2)               PRICE(2)                 FEE(3)
- -------------------------------------------------------------------------------------------------------------------------------
<S>                                 <C>                  <C>                     <C>                     <C>
Common Stock......................  3,162,500 shares              $15                 $47,437,500              $14,375.00
Representative's Warrants(4)......    275,000 shares             .0001                         28                     .01
Common Stock(5)...................    275,000 shares               18                   4,950,000                1,500.00
         Totals...................                                                    $52,387,528              $15,875.00
==============================================================================================================================
</TABLE>

    
 
   
(1) Includes 412,500 shares of Common Stock which the Underwriters have the
    option to purchase from the Company solely to cover over-allotments, if any.
    See "Underwriting."
    
   
(2) Estimated solely for purposes of calculation of the registration fee
    pursuant to Rule 457(a) under the Securities Act of 1933, as amended.
    
   
(3) A portion of the registration fee ($11,546) was paid on September 30, 1997
    in connection with the initial filing of the Registration Statement.
    
   
(4) In connection with the sale of the shares of Common Stock, the Registrant is
    granting to the Representative warrants to purchase 275,000 shares of Common
    Stock (the "Representative's Warrants").
    
   
(5) Issuable upon exercise of the Representative's Warrants.
    
                             ---------------------
    THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SECTION 8(A), MAY DETERMINE.
================================================================================

<PAGE>   2
 
     INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
     REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
     SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR
     MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT
     BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR
     THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
     SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
     UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS
     OF ANY SUCH STATE.
 
   
                 SUBJECT TO COMPLETION, DATED NOVEMBER 5, 1997
    
   
                                2,750,000 SHARES
    
 
                                [C3, INC. LOGO]
 
                                    C3, INC.
 
                                  COMMON STOCK
 
     All of the shares of Common Stock, no par value ("Common Stock"), of C3,
Inc. ("C3" or the "Company") offered hereby are being sold by the Company. Prior
to this offering, there has been no public market for the Common Stock. It is
currently estimated that the initial public offering price will be between
$12.00 and $15.00 per share. For information relating to the factors considered
in determining the initial offering price, see "Underwriting."
 
     At the request of the Company, the Underwriters have reserved approximately
100,000 of the shares of Common Stock offered by the Company hereby for sale at
the initial public offering price to directors, officers, employees and certain
individuals associated with the Company, its directors, its officers or its
employees. See "Underwriting."
 
     The Company has applied to have its Common Stock approved for quotation on
the Nasdaq National Market under the symbol "CTHR."
 
     THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" COMMENCING
ON PAGE 5 FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY
PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED HEREBY.
                             ---------------------
 
  THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
 EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
   AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
                               CRIMINAL OFFENSE.
 

<TABLE>
<CAPTION>
==================================================================================================================
                                                PRICE TO               UNDERWRITING             PROCEEDS TO
                                                 PUBLIC                DISCOUNT(1)               COMPANY(2)
- ------------------------------------------------------------------------------------------------------------------
<S>                                     <C>                      <C>                      <C>
Per Share..............................            $                        $                        $
- ------------------------------------------------------------------------------------------------------------------
Total(3)...............................            $                        $                        $
==================================================================================================================
</TABLE>

 
   
(1) Excludes a non-accountable expense allowance payable to Paulson Investment
    Company, Inc., the representative (the "Representative") of the several
    underwriters named herein (the "Underwriters"), equal to 1% of the total
    price to the public of the shares being offered hereby. The Company has
    agreed to issue to the Representative warrants (the "Representative's
    Warrants") to purchase up to 275,000 shares of Common Stock for $
    per share (120% of the initial public offering price of the shares offered
    hereby). The Company has agreed to indemnify the Underwriters against
    certain liabilities, including liabilities under the Securities Act of 1933,
    as amended (the "Securities Act"). See "Underwriting."
    
   
(2) Before deducting expenses payable by the Company estimated at $1,000,000,
    including the Representative's non-accountable expense allowance.
    
   
(3) The Company has granted the Underwriters a 45-day option to purchase up to
    412,500 additional shares of Common Stock on the same terms as set forth
    above solely to cover over-allotments, if any (the "Over-allotment Option").
    If the Over-allotment Option is exercised in full, the Price to Public,
    Underwriting Discount and the Proceeds to Company will be $          ,
    $          and $          , respectively. See "Underwriting."
    
                             ---------------------
 
     The shares of Common Stock are offered by the several Underwriters, subject
to receipt and acceptance by them, to prior sale and to their right to reject
orders in whole or in part. It is expected that delivery of certificates for the
shares will be made against payment therefor in New York City on or about
            , 1997.
                             ---------------------
 
                        PAULSON INVESTMENT COMPANY, INC.
 
               THE DATE OF THIS PROSPECTUS IS             , 1997.

<PAGE>   3
 
                 DESCRIPTION OF FOLDOUT FACING FRONT COVER PAGE
 
     The background of this graphic consists of a photograph of grayish brown
slate taken at close range. In the upper left hand corner, in three lines and
white lettering, are the words "THE HARDNESS, THE BRILLIANCE, THE FIRE YOU
EXPECT . . .", and in the bottom right hand corner are the words, in two lines
and white lettering, ". . . FROM AN UNEXPECTED NEW SOURCE." Scattered across the
mid-range of the graphic are eight loose lab-created moissanite gemstones, all
produced by the Company. Beneath this picture are the words "A sample of the
Company's promotional materials." Beneath this caption appears the Company's
name in its trademark stylized name logo, consisting of a large capital C,
similarly sized 3, with a geometric diamond shape to the right of, and
intersecting, the numeral "3". In the logo, the word "Inc." appears to the right
of the geometric diamond shape.
 
                 DESCRIPTION OF INSIDE FRONT COVER PAGE FOLDOUT
 
     The inside front cover page foldout consists of a large single photograph.
The background of this graphic consists of a photograph of grayish brown slate
taken at close range. In the top middle of the graphic appears the Company's
trademark stylized moissanite gemstones logo. The logo consists of a black box
in which the word "MOISSANITE" appears in large silver capital letters,
traversed by an orange arc ending with a burst of light rays at the bottom right
corner of the box. The logo also includes the word "GEMSTONES" appearing
underneath the box in white capital letters approximately one-third of the size
of the letters used in "MOISSANITE." Underneath this logo are the words "CREATED
BY" in white capital letters approximately two-thirds of the size of the letters
used in "GEMSTONES" and the Company's stylized name logo, as described above.
Throughout the mid range of this page appear pictures of the Company's
lab-created gemstones. The photograph features a total of 13 loose lab-created
gemstones, one of which is held by jeweler's tweezers, and a total of 8
lab-created gemstones set in the following jewelry: two pairs of earrings, two
pendant necklaces, and one ring. In the bottom middle of this graphic appear the
following words in white lettering: "This jewelry features samples of the
Company's lab-created moissanite gemstones set in gold, silver or platinum. The
Company plans to distribute loose gemstones."



<PAGE>   4
 
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK OFFERED
HEREBY, INCLUDING THE ENTRY OF STABILIZING BIDS, SYNDICATE COVERING TRANSACTIONS
OR THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE
"UNDERWRITING."
 
C3(TM), THE STYLIZED C3, INC. LOGO, THE STYLIZED LOGO FOR "MOISSANITE" AND THE
STYLIZED LOGO FOR "MOISSANITE GEMSTONES" ARE TRADEMARKS OF THE COMPANY. THIS
PROSPECTUS MAY CONTAIN CERTAIN OTHER TRADEMARKS AND SERVICE MARKS OF OTHER
PARTIES.

<PAGE>   5
 

                               PROSPECTUS SUMMARY
 
   
     The following summary is qualified in its entirety by the more detailed
information and the Financial Statements and Notes thereto appearing elsewhere
in this Prospectus. Unless otherwise indicated, information in this Prospectus
(i) reflects the automatic conversion of all outstanding shares of 1996 Series A
Preferred Stock, no par value ("Series A Preferred Stock"), and 1997 Series B
Preferred Stock, no par value ("Series B Preferred Stock"), into an aggregate of
1,677,375 shares of Common Stock upon consummation of this offering; (ii)
reflects a 2.13-for-1 stock split effected in September 1997; and (iii) assumes
no exercise of the Over-allotment Option. See "Underwriting."
    
 

                                  THE COMPANY
 
     The Company is finalizing the development of, and intends to begin
marketing during the first half of 1998, colorless lab-created moissanite
gemstones which it will sell as a substitute for diamond in the jewelry market.
The physical properties of lab-created moissanite gemstones more closely match
those of diamond than any other known gemstone material. The Company believes
that its products are superior to other commercially available diamond
substitutes and intends to position its gemstone products as the ideal
substitute for diamond. The Company believes that its products will be
attractive to working women who desire an affordable alternative to diamond and
to middle and upper-income women who desire affordable "everyday" or "security"
jewelry.
 
     Moissanite, also known by its chemical name, silicon carbide ("SiC"), is a
rare, naturally occurring mineral found primarily in meteorites. Moissanite and
diamond are both carbon-based minerals; moissanite is composed of silicon and
carbon while diamond is composed of carbon.
 
     The Company's lab-created moissanite gemstones are made from crystals of
SiC grown by Cree Research, Inc. ("Cree") using patented and proprietary
technology. Cree has an exclusive license to the patent related to a process for
growing large single crystals of SiC. To the Company's knowledge, there are no
producers of SiC other than Cree that could supply lab-grown SiC crystals in
colors, sizes or volumes suitable for use as a diamond substitute. The Company
has undertaken a significant development program with Cree to develop a fully
repeatable process to grow SiC crystals in the desired diamond color grades and
sizes. The Company has certain exclusive licenses and supply rights with Cree
for SiC materials to be used for gemstone applications. In addition, the Company
has 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. As a result, the Company believes that
its lab-created moissanite gemstones are proprietary products and that there are
technological barriers to prevent other competitors from developing or marketing
lab-created moissanite gemstones at affordable prices.
 
   
     The Company currently intends to sell only loose lab-created gemstones,
rather than finished jewelry products, in round brilliant cuts of approximately
 1/2 to 1 carat in colors and clarities comparable to those commonly used in
diamond jewelry. The Company plans to begin delivery of its products in the
first half of 1998 in selected cities in the United States and the Pacific Rim.
The Company believes that these market areas represent a significant portion of
the worldwide jewelry market and that consumers in these markets are relatively
accepting of diamond substitutes. The Company intends to grant to select retail
jewelry chains and high volume independent retail jewelry stores in certain U.S.
cities the right to be the exclusive retail store selling lab-created moissanite
gemstones within a limited geographic territory. The Company is also exploring
distribution arrangements for the Pacific Rim.
    
 
     The Company believes that neither visual inspection by jewelers who are not
trained gemologists nor commonly used test instruments reliably distinguish its
products from diamond. The Company recently began production of a
moissanite/diamond test instrument that distinguishes lab-created moissanite
gemstones from diamonds in the colors and clarities most commonly sold by retail
jewelers. The Company plans to introduce this new test instrument for sale to
jewelers, gemologists and pawnbrokers during the first half of 1998.
 
     The Company was incorporated as a North Carolina corporation in June 1995.
The Company's principal executive offices are located at 3800 Gateway Boulevard,
Suite 310, Morrisville, North Carolina 27560, and its telephone number is (919)
468-0399.
                                        3

<PAGE>   6
 
                                  THE OFFERING
 
   
Common Stock offered..................     2,750,000 shares
    
 
   
Common Stock outstanding after the
offering..............................     6,688,476 shares(1)
    
 
Use of proceeds.......................     For product development, acquisition
                                           of manufacturing equipment, sales and
                                           marketing, working capital and other
                                           general corporate purposes. See "Use
                                           of Proceeds."
 
Proposed Nasdaq National Market
symbol................................     CTHR
- ---------------
 
   
(1) Excludes 1,009,066 shares of Common Stock issuable upon the exercise of
    stock options outstanding at November 3, 1997. See "Dilution,"
    "Management -- Stock Option Plans" and "Description of Capital Stock."
    
 
                               SUMMARY FINANCIAL DATA
   
                                      C3, INC.
    
   
                        (A COMPANY IN THE DEVELOPMENT STAGE)
    
 
   

<TABLE>
<CAPTION>
                                                                CUMULATIVE                             CUMULATIVE
                                 PERIOD FROM                     FOR THE                                 FOR THE
                                  INCEPTION                       PERIOD                                 PERIOD
                                  (JUNE 28,                      JUNE 28,                               JUNE 28,
                                    1995)                          1995         NINE MONTHS ENDED         1995
                                      TO         YEAR ENDED         TO            SEPTEMBER 30,            TO
                                 DECEMBER 31,   DECEMBER 31,   DECEMBER 31,   ---------------------   SEPTEMBER 30,
                                     1995           1996           1996         1996        1997          1997
                                 ------------   ------------   ------------   --------   ----------   -------------
<S>                              <C>            <C>            <C>            <C>        <C>          <C>
STATEMENT OF OPERATIONS DATA:
Revenues.......................         --              --             --           --           --            --
Operating expenses:
  Marketing and sales..........    $10,313        $ 47,019       $ 57,332     $  8,567   $  233,397    $  290,729
  General and
    administrative(1)..........     10,024         131,097        141,121       62,456      660,993       802,114
  Research and development.....      6,052         236,047        242,099      134,598    1,029,918     1,272,017
  Depreciation and
    amortization...............        798           3,618          4,416        2,180       14,668        19,084
                                   -------        --------       --------     --------   ----------    ----------
Operating loss.................     27,187         417,781        444,968      207,801    1,938,976     2,383,944
Interest income, net...........         --         (35,173)       (35,173)     (17,530)    (184,407)     (219,580)
                                   -------        --------       --------     --------   ----------    ----------
Net loss.......................    $27,187        $382,608       $409,795     $190,271   $1,754,569    $2,164,364
                                   =======        ========       ========     ========   ==========    ==========
Pro forma net loss per share...                   $   0.14       $   0.16                $     0.41    $     0.71
                                                  ========       ========                ==========    ==========
Shares used in computing pro
  forma net loss per
  share(2).....................                  2,652,250      2,487,128                 4,279,498     3,063,247
</TABLE>

    
 
   

<TABLE>
<CAPTION>
                                                                  SEPTEMBER 30, 1997
                                                              ---------------------------
                                                                ACTUAL     AS ADJUSTED(3)
                                                              ----------   --------------
<S>                                                           <C>          <C>
BALANCE SHEET DATA:
Cash and equivalents........................................  $4,737,864    $31,737,864
Working capital.............................................   4,405,234     31,405,234
Total assets................................................   5,085,048     33,985,048
Shareholders' equity........................................   4,615,086     38,415,086
</TABLE>

    
 
- ---------------
 
   
(1) For the nine months ended September 30, 1997, includes $66,000 of
    compensation expense related to the issuance of Common Stock to Cree
    pursuant to a stock option agreement and $109,000 of compensation expense
    related to the issuance of other stock options. See "Management's Discussion
    and Analysis of Financial Condition and Results of Operations" and Notes 5
    and 10 of Notes to Financial Statements.
    
   
(2) The calculation of shares for all periods reflects a 2.13-for-1 stock split
    effected in September 1997 and the automatic conversion of the Series A
    Preferred Stock and Series B Preferred Stock to be effected upon completion
    of this Offering. See Notes 2 and 9 of Notes to Financial Statements.
    
   
(3) Adjusted to give effect to the sale by the Company of 2,750,000 shares of
    Common Stock offered hereby at an assumed initial public offering price of
    $13.50 per share, after deducting the underwriting discount and estimated
    offering expenses and the application of net proceeds therefrom. See "Use of
    Proceeds." The Company is reserving $15.9 million from the net proceeds of
    the offering (currently shown as cash) to fund the acquisition of additional
    crystal growth systems from Cree in the event that Cree elects to require
    the Company to purchase systems anticipated to be required to support the
    Company's business. See "Management's Discussion and Analysis of Financial
    Condition and Results of Operations -- Liquidity and Capital Resources" and
    "Business -- Manufacturing."
    
                                        4

<PAGE>   7
 

                                  RISK FACTORS
 
     An investment in the shares of Common Stock being offered hereby involves a
high degree of risk. In addition to the other information set forth in this
Prospectus, the following risk factors should be considered carefully in
evaluating the Company and its business before purchasing any of the shares of
Common Stock offered hereby. This Prospectus contains certain forward-looking
statements that involve risks and uncertainties, such as statements of the
Company's plans, objectives, expectations and intentions. The cautionary
statements made in this Prospectus should be read as being applicable to all
related forward-looking statements wherever they appear in this Prospectus. The
Company's actual results could differ materially from those discussed in this
Prospectus. Factors that could cause or contribute to such differences include
those discussed below, as well as those discussed elsewhere in this Prospectus.
 
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 revenue-producing business activities and
does not anticipate having product sales until at least the first half of 1998.
Accordingly, the Company has no operating history upon which an evaluation of
the Company and its prospects can be based. To date, the Company's principal
activities have been to develop a process for the production of colorless
lab-created moissanite gemstones and the infrastructure to support the rapid
commercialization of those products. The Company's business is 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. To
address these risks, the Company must, among other things, respond to
competitive developments, attract and motivate qualified personnel, develop
market acceptance for its products, establish effective distribution channels,
effectively manage any growth that may occur and continue to upgrade its
technologies and successfully commercialize products incorporating such
technologies. See "Business" and "Management."
    
 
NEED FOR FURTHER PRODUCT DEVELOPMENT
 
     Although the Company has produced small quantities of colorless lab-created
moissanite gemstones, the Company and its supplier of SiC crystals, Cree
Research Inc. ("Cree"), have 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. The Company intends to market lab-created gemstones in
the comparable diamond color grade range, according to the standards generally
accepted by the diamond industry for color using pregraded master color stones
("comparable diamond color grade"), of "G" through "J", but Cree has not yet
consistently achieved production of SiC crystals in this color range. The
Company's development agreement with Cree establishes milestones for developing
a fully repeatable process that will consistently grow SiC crystals in the
desired color grades, sizes and volumes. 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. See "Business --
Dependence on Cree and Cree Technology" and "-- Products."
 
RELIANCE ON CREE RESEARCH, INC.
 
     The Company is dependent on a single source, Cree, for development and
supply of SiC crystals. Cree has certain patents and other 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 suitable for use as lab-created
gemstones is concentrated entirely with Cree and is dependent on Cree's
expertise in SiC technology.
 
                                        5

<PAGE>   8
 
     Under the Company's Amended and Restated Exclusive Supply Agreement with
Cree dated June 6, 1997 (the "Exclusive Supply Agreement"), 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 believes that no
other SiC producer could supply crystals in the colors, sizes and volumes needed
for the Company's products. Therefore, the Company is, and expects for the
forseeable future to be, entirely dependent on Cree as its 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 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. The Company
believes that the test instrument may be important to building market acceptance
of the Company's lab-created gemstones. See "Business -- Manufacturing." 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.
 
     Thus, the Company is dependent on Cree's ability to protect its patents and
other proprietary rights concerning the growth of SiC crystals, on Cree's
technological capabilities for the further development needed to deliver SiC
crystals acceptable to the Company, on Cree consistently producing and
delivering volumes of SiC crystals as and when needed by the Company and on
Cree's ability to supply the Company with components for its test instrument,
all of which are beyond the Company's control. Cree's failure to protect its
patents or other proprietary rights, 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 or cessation of the Company's business. See
"Business -- Dependence on Cree and Cree Technology."
 
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.
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. The Company's future
financial performance will depend upon consumer acceptance of the Company's
lab-created gemstones as a realistic and affordable substitute for diamond,
which may be impacted by (i) the jewelers' acceptance of lab-created gemstones
as a diamond substitute, (ii) the willingness of retail jewelers to purchase
loose stones and undertake setting of the loose stones, (iii) the ability of
retail jewelers to select jewelry settings that encourage consumer acceptance of
and demand for the Company's lab-created gemstones and (iv) the ability of
retail jewelers to set loose lab-created gemstones in jewelry with high quality
workmanship. The Company has not conducted extensive market tests to predict
retail jeweler or consumer reaction to its products.
 
                                        6

<PAGE>   9
 
     Because no market now exists for lab-created moissanite gemstones, it is
difficult to predict the future growth rate, if any, and the size of the market
for the Company's products. In order to build inventory to meet anticipated
future demand, the Company expects to place orders with Cree 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 -- Dependence on Cree and Cree Technology" and "-- Distribution,
Marketing and Sales."
 
UNDEVELOPED DISTRIBUTION CHANNELS
 
   
     The Company currently plans to sell its products initially in selected
cities in the United States and the Pacific Rim. Although most loose gemstones
are sold to wholesalers or jewelry manufacturers, the Company initially intends
to sell its gemstones directly to retail jewelry chains and high-volume
independent retail jewelry stores in certain U.S. cities pursuant to agreements
in which the Company will grant the right to be the exclusive retail store
selling lab-created moissanite gemstones within a limited geographic territory.
In addition, the Company is exploring distribution arrangements in the Pacific
Rim. The Company must enter into distribution agreements with and will be
dependent upon a number of third parties for sales of its lab-created moissanite
gemstones to consumers. The Company has not yet entered into distribution
agreements with any retail jewelers or other distributors. There can be no
assurance that the Company will be able to enter into distribution agreements
with retail jewelers or other distributors, that its strategy of eliminating
dependence on gemstone wholesalers and jewelry manufacturers will prove to be
successful, or that jewelers or other distributors will devote the efforts
needed for successful distribution of the Company's products. The inability of
the Company to enter into favorable arrangements with retail jewelers or other
distributors or to achieve desired distribution of its lab-created moissanite
gemstones would have a material adverse effect on the Company's business,
operating results and financial condition. See "Business -- Product
Distribution."
    
 
DEPENDENCE ON INTELLECTUAL PROPERTY
 
     The Company is heavily dependent upon Cree's technology for SiC crystals
and is dependent upon its own technology for the production of lab-created
gemstones from SiC crystals. Cree is exclusively licensed to use the 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 pending for a process for growing colorless SiC. However, there can be no
assurance that any patents issued to or licensed by Cree will provide any
significant commercial protection to Cree or to the Company, that Cree will have
sufficient resources to prosecute its 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. See "Business -- Dependence on Cree and
Cree Technology."
 
     The Company has certain patent applications pending for lab-created
moissanite gemstones and also has an application pending on its
moissanite/diamond test instrument. Although one of the Company's pending patent
applications for lab-created moissanite gemstones has been rejected by the
United States Patent and Trademark Office (the "PTO") in its initial office
action, the Company intends to vigorously prosecute its patent applications.
There can be no assurance that any patent will be granted or that a patent, if
granted, will have any commercial or competitive value. See
"Business -- Intellectual Property of the Company."
 
     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 of SiC or colorless SiC crystals
in a manner that does not infringe patents owned or licensed by Cree or the
Company. In addition, existing
 
                                        7

<PAGE>   10
 
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 Cree or the Company.
 
     The Company regards certain of its technology as critical to its business
and attempts to protect such technology under copyright and trade secret laws
and through the use of employee, customer and business partner confidentiality
agreements. Such measures, however, afford only limited protection, and the
Company may not be able to maintain the confidentiality of its technology.
 
     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 significant 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 and manufacture components for and assemble its
moissanite/diamond test instrument. 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, there can be no assurance that the Company will be
successful in identifying component manufacturers and assemblers for its
moissanite/diamond test instrument. 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 planned
products face competition from established producers and sellers of diamonds,
synthetic gemstones and diamond simulants such as synthetic cubic zirconia. In
addition, other companies could seek to introduce synthetic diamonds or other
competing products or to develop competing processes for production of
lab-created moissanite gemstones. 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 reduce demand for the Company's products, which would have a
material adverse effect on the Company's business, operating results and
financial condition. Further, 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."
 
NEED FOR ADDITIONAL CAPITAL
 
     The Company will require substantial additional capital to continue to
develop and improve the process for growing colorless SiC crystals in the
desired colors, sizes and volumes, to fund expansion of manufacturing capacity
to meet projected growth and to fund its expansion into new markets. The
Company's future capital requirements will depend on many factors, including the
speed at which the SiC crystal growth process can be refined and improved,
market acceptance of and demand for the Company's products and the timing of the
Company's expansion into new markets. The Company currently believes that its
existing capital resources, together with the proceeds of this offering and
interest earned thereon, will satisfy its capital requirements for at least the
12 months following this offering. However, there can be no assurance that
additional financing will not be required prior to such time. Moreover, there
can be no assurance that additional equity or debt financing, if required, will
be available on acceptable terms or at all. The inability of the Company to
obtain
 
                                        8

<PAGE>   11
 
financing on acceptable terms when needed would have a material adverse effect
on the Company's business, operating results and financial condition. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
 
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 Federal Trade Commission (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 as
diamond substitutes, the Company's business, operating results and financial
condition could be materially adversely affected. See "Business -- Government
Regulation."
 
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 realistic substitute for
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 currently is experiencing a period of rapid and significant
growth, which is expected to continue over the next several years. This rapid
growth has placed and will continue to 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.
 
                                        9

<PAGE>   12
 
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,
Vice President of Marketing, Director of Technology, Director of Manufacturing
and Director of Sales. In addition, the Company intends to obtain "key man" life
insurance policies on its President and Chief Financial Officer, but each policy
is expected to provide 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. See "Management."
 
     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.
 
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 $1,754,569 for the nine months ended September 30, 1997. As of September 30,
1997, the Company had an accumulated deficit of $2,164,364. 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 some or all of 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 base estimated operating revenues and expenses. The Company's
revenues will be affected by many factors, including those discussed in "Risk
Factors." 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.
 
NO PRIOR PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK PRICE
 
     Prior to this offering, there has been no public market for the Common
Stock, and there can be no assurance that an active public market for the Common
Stock will develop or be sustained after this offering. The initial public
offering price will be determined by negotiation between the Company and the
Representative of the Underwriters. See "Underwriting."
 
     The trading price of the Common Stock could 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.
 
                                       10

<PAGE>   13
 
SUBSTANTIAL DILUTION
 
   
     Purchasers of the Common Stock offered hereby will incur immediate and
substantial dilution of approximately $8.51 per share in the pro forma net
tangible book value per share of the Common Stock from the initial public
offering price. See "Dilution."
    
 
SHARES ELIGIBLE FOR FUTURE SALE
 
   
     Sales of the Common Stock in the public market after this offering could
adversely affect the market price of the Common Stock. Following this offering,
there will be 6,688,476 shares of Common Stock outstanding, of which the
2,750,000 shares offered hereby (3,162,500 if the Over-allotment Option is
exercised in full) will be freely tradeable without restriction under the
Securities Act, except for shares acquired in this offering by "affiliates" of
the Company, as that term is defined in Rule 144 under the Securities Act. All
of the shares of Common Stock held by the officers, directors and beneficial
owners of more than five percent of the Company's Common Stock, aggregating
1,927,393 shares as of November 3, 1997, are subject to lock-up agreements and
may not be sold or otherwise transferred until one year after the date of this
Prospectus unless sooner released by the Representative in its sole discretion.
Upon expiration of the lock-up agreements, all such shares of Common Stock will
become eligible for sale in the public market, subject to the provisions of Rule
144 or Rule 701. In addition, approximately 1,921,621 shares of Common Stock
outstanding prior to this offering and not subject to lock-up agreements will
become eligible for sale in the public markets under Rule 144, 90 days after the
effective date of this offering (the date on which these shares are assumed to
be eligible for resale is February 14, 1998). Moreover, the Company intends to
file registration statements under the Securities Act covering shares of Common
Stock reserved for issuance under stock option plans.
    
 
   
     The Company has entered into an agreement under which holders of an
aggregate of 1,453,725 shares of Common Stock, which are to be issued at the
time of the offering upon the automatic conversion of the currently outstanding
Series B Preferred Stock, are entitled to cause the Company to register their
shares for sale and to participate in any future registration of securities
effected by the Company, subject to certain limitations and restrictions. See
"Shares Eligible For Future Sale" and "Description of Capital Stock --
Registration Rights."
    
 
BROAD DISCRETION OVER USE OF PROCEEDS
 
   
     The principal purpose of this offering is to increase the Company's equity
capital to fund anticipated expenses for the development, production and
marketing and sale of the Company's lab-created gemstones. The Company currently
estimates that the net proceeds of this offering will be approximately $33.8
million and that $4.4 million (representing 13.0%) of such proceeds will be
allocated to working capital and other general corporate purposes. The Company's
management will have broad discretion to reallocate the use of the proceeds and
to direct the use of working capital without any action or approval of the
Company's shareholders. See "Use of Proceeds."
    
 
ANTI-TAKEOVER AND CERTAIN OTHER PROVISIONS
 
     Certain provisions of the Company's Articles of Incorporation and Bylaws
could have the effect of making it more difficult for a third party to acquire,
or of discouraging a third party from attempting to acquire, control of the
Company or limit the price that third parties might be willing to pay in the
future for shares of the Company's Common Stock. See "Description of Capital
Stock -- Certain Anti-Takeover Provisions."
 
     Under the terms of the Exclusive Supply Agreement, the Company is
prohibited from entering into exclusive marketing or distribution agreements
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.
 
                                       11

<PAGE>   14
 

                                USE OF PROCEEDS
 
   
     The net proceeds to be received by the Company from the sale of the Common
Stock offered hereby are estimated to be approximately $33.8 million
(approximately $39.0 million if the Over-allotment Option is exercised in full),
assuming an initial public offering price of $13.50 per share and after
deducting underwriting discounts and estimated offering expenses.
    
 
   
     The Company intends to use approximately $5.5 million of the net proceeds
of this offering to fund research and development activities. Of this amount,
approximately $4.9 million will be paid to Cree under the Development Agreement
and $600,000 will be used to fund other aspects of the Company's development
efforts. The Company has reserved approximately $15.9 million of the net
proceeds of this offering to fund the acquisition of additional SiC crystal
growth systems from Cree, which the Company could be required to purchase for
use by Cree in supplying commercial production quantities of SiC crystals to the
Company. Under the Exclusive Supply Agreement, Cree has the option to require
the Company to purchase such systems from Cree at Cree's cost or to build such
systems itself and recoup its costs by incorporating the cost of the systems
into the cost of the SiC crystals purchased by the Company. See
"Business -- Dependence on Cree and Cree Technology." The Company has not
received any indication from Cree as to whether future capacity requirements
will be met at the Company's or Cree's expense. The Company also intends to use
approximately $1.9 million to purchase other equipment from unaffiliated third
parties. In addition, the Company plans to use approximately $6.1 million of the
net proceeds to fund its sales and marketing efforts.
    
 
   
     The remaining net proceeds will be used for working capital and general
corporate purposes or may be used to fund additional equipment or sales and
marketing expenses as the Company's business develops. Pending application of
the net proceeds as set forth above, the Company intends to invest the net
proceeds in short-term, investment grade debt securities. The Company reserves
the right to reallocate the use of the net proceeds of the offering to meet the
business needs of the Company, which could be required if Cree is unable to
develop a fully repeatable process for growing SiC crystals in desired colors,
sizes and volumes, if market acceptance of lab-created moissanite gemstones is
slower than anticipated or if there are unanticipated technological or other
changes within the jewelry industry. The Company currently believes that its
existing capital resources, together with the net proceeds of this offering and
interest earned thereon, will satisfy the Company's capital requirements at
least through the 12 months following this offering.
    
 

                                DIVIDEND POLICY
 
     The Company has never declared or paid any cash dividends on its capital
stock. The Company intends to retain its future earnings, if any, to fund the
development and growth of its business and, therefore, does not anticipate
paying any cash dividends in the foreseeable future. Any future decision
concerning the payment of dividends on the Common Stock will depend upon the
results of operations, financial condition and capital expenditure plans of the
Company, as well as such other factors as the Board of Directors, in its sole
discretion, may consider relevant.
 
                                       12

<PAGE>   15
 
                                    DILUTION
 
   
     As of September 30, 1997, the Company had a pro forma net tangible book
value of approximately $4.5 million or $1.14 per share of Common Stock. "Pro
forma net tangible book value" represents the amount of total tangible assets
less total liabilities divided by the number of shares of Common Stock
outstanding, after giving effect to the automatic conversion of the outstanding
shares of the Series A Preferred Stock and Series B Preferred Stock into an
aggregate of 1,677,375 shares of Common Stock. After giving effect to the sale
of 2,750,000 shares of Common Stock in this offering at an assumed initial
public offering price of $13.50 per share, and the receipt of the net proceeds
therefrom, the pro forma net tangible book value of the Company as of September
30, 1997 is approximately $33.4 million or $4.99 per share of Common Stock. This
represents an immediate dilution of $8.51 per share to new investors purchasing
shares of Common Stock offered hereby. The following table illustrates the per
share dilution:
    
 
   

<TABLE>
<S>                                                           <C>      <C>
Assumed public offering price per share.....................           $13.50
  Pro forma net tangible book value per share as of
     September 30, 1997.....................................  $1.14
  Increase in net tangible book value per share attributable
     to this offering.......................................   3.85
Pro forma net tangible book value per share after this
  offering..................................................             4.99
                                                                       ------
Dilution per share to new investors.........................           $ 8.51
                                                                       ======
</TABLE>

    
 
   
     The following table summarizes as of September 30, 1997, after giving
effect to the automatic conversion of the Series A Preferred Stock and Series B
Preferred Stock and the sale of 2,750,000 shares of Common Stock in this
offering, the number of shares of Common Stock purchased from the Company, the
total consideration paid therefor and the average price per share paid by the
existing shareholders and by the new investors purchasing shares of Common Stock
in this offering, at an assumed initial public offering price of $13.50 per
share, before deduction of the estimated underwriting discount and offering
expenses payable by the Company:
    
 
   

<TABLE>
<CAPTION>
                                  SHARES PURCHASED       TOTAL CONSIDERATION       AVERAGE
                                --------------------    ----------------------      PRICE
                                 NUMBER      PERCENT      AMOUNT       PERCENT    PER SHARE
                                ---------    -------    -----------    -------    ---------
<S>                             <C>          <C>        <C>            <C>        <C>
Existing shareholders.........  3,938,476     58.9%     $ 6,670,125     15.2%      $ 1.69
New investors.................  2,750,000     41.1       37,125,000     84.8        13.50
                                ---------     ----      -----------     ----
          Total...............  6,688,476      100%     $43,795,125      100%
                                =========     ====      ===========     ====
</TABLE>

    
 
   
     The foregoing tables assume no exercise of the Over-allotment Option and no
exercise of outstanding stock options to purchase Common Stock. There are (i)
661,791 shares of Common Stock issuable upon the exercise of options granted
under the 1996 Option Plan exercisable at a weighted average price of
approximately $3.95 per share and (ii) 37,275 shares of Common Stock issuable
upon the exercise of options granted to certain independent contractors at an
exercise price of approximately $1.88 per share. To the extent that any of these
options are exercised in the future, there will be further substantial dilution
to new investors. See "Management -- Stock Option Plans."
    
 
                                       13

<PAGE>   16
 

                                 CAPITALIZATION
 
   
     The following table sets forth the capitalization of the Company as of
September 30, 1997 on an actual and pro forma basis. The pro forma
capitalization gives effect to the automatic conversion of the Series A
Preferred Stock and Series B Preferred Stock into an aggregate of 1,677,375
shares of Common Stock, an amendment to the Company's articles of incorporation
effected in October 1997 and the sale of 2,750,000 shares of Common Stock in
this offering at an assumed initial public offering price of $13.50 and the
application of the estimated net proceeds therefrom. See "Use of Proceeds." This
information should be read in conjunction with the Company's Financial
Statements and the Notes thereto appearing in this Prospectus.
    
 
   

<TABLE>
<CAPTION>
                                                                  SEPTEMBER 30, 1997
                                                              --------------------------
                                                                ACTUAL        PRO FORMA
                                                              -----------    -----------
<S>                                                           <C>            <C>
Shareholders' equity:
  1996 Series A Preferred Stock, no par value; 105,000
     shares authorized, 105,000 shares issued and
     outstanding, actual; none authorized or issued and
     outstanding, pro forma(1)..............................  $   593,271    $        --
  1997 Series B Preferred Stock, no par value; 682,500
     shares authorized, 682,500 shares issued and
     outstanding, actual; none authorized or issued and
     outstanding, pro forma(1)..............................    4,981,376             --
  Preferred Stock, no par value; 4,212,500 shares
     authorized, none issued and outstanding, actual;
     10,000,000 authorized, none issued and outstanding, pro
     forma..................................................           --             --
  Common Stock, no par value; 10,000,000 shares authorized,
     2,261,101 issued and outstanding, actual; 50,000,000
     shares authorized, 6,688,476 issued and outstanding,
     pro forma(1)(2)........................................    1,095,803     40,470,450
  Additional paid-in capital -- stock options...............      109,000        109,000
  Deficit accumulated during the development stage..........   (2,164,364)    (2,164,364)
                                                              -----------    -----------
          Total shareholders' equity(2).....................    4,615,086     38,415,086
                                                              -----------    -----------
               Total capitalization.........................  $ 4,615,086    $38,415,086
                                                              ===========    ===========
</TABLE>

    
 
- ---------------
 
   
(1) Net of related offering expenses. Under the Company's articles of
    incorporation, shares of 1996 Series A Preferred Stock and shares of 1997
    Series B Preferred Stock will automatically convert into shares of Common
    Stock upon consummation of this offering.
    
(2) Excludes (i) 37,275 shares of Common Stock issuable upon the exercise of
    stock options granted to certain independent consultants with an exercise
    price of approximately $1.88 per share, (ii) 661,791 shares of Common Stock
    issuable upon the exercise of stock options granted under the 1996 Option
    Plan with a weighted average exercise price of approximately $3.95 per share
    and (iii) 310,000 shares of Common Stock issuable upon the exercise of stock
    options granted under the 1997 Omnibus Plan with an exercise price equal to
    the initial public offering price of the shares of Common Stock offered
    hereby.
 
                                       14

<PAGE>   17
 
                            SELECTED FINANCIAL DATA
 
   
     The following selected statement of operations data for the period from
inception through December 31, 1995 and for the year ended December 31, 1996 and
the selected balance sheet data at December 31, 1995 and December 31, 1996 have
been derived from, and are qualified by reference to, the Company's financial
statements included elsewhere in this Prospectus, which have been audited by
Deloitte & Touche LLP, independent auditors. The selected statements of
operations data for the nine month periods ended September 30, 1996 and
September 30, 1997 and the selected balance sheet data at September 30, 1997
have been derived from the Company's unaudited financial statements included
elsewhere in this Prospectus. In the opinion of management of the Company, such
unaudited financial statements have been prepared on a basis consistent with the
audited financial information and include all adjustments, consisting of normal
recurring accruals, necessary for a fair presentation of the results of such
periods. The results of operations for the nine month period ended September 30,
1997 are not necessarily indicative of the results of operations for the year
ending December 31, 1997. The selected financial data set forth below should be
read in conjunction with the "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Financial Statements and Notes
thereto included elsewhere in this Prospectus.
    
 
   
                                    C3, INC.
    
   
                      (A COMPANY IN THE DEVELOPMENT STAGE)
    
 
   

<TABLE>
<CAPTION>
                                                                CUMULATIVE                             CUMULATIVE
                                 PERIOD FROM                     FOR THE                                 FOR THE
                                  INCEPTION                       PERIOD                                 PERIOD
                                  (JUNE 28,                      JUNE 28,                               JUNE 28,
                                    1995)                          1995         NINE MONTHS ENDED         1995
                                      TO         YEAR ENDED         TO            SEPTEMBER 30,            TO
                                 DECEMBER 31,   DECEMBER 31,   DECEMBER 31,   ---------------------   SEPTEMBER 30,
                                     1995           1996           1996         1996        1997          1997
                                 ------------   ------------   ------------   --------   ----------   -------------
<S>                              <C>            <C>            <C>            <C>        <C>          <C>
STATEMENT OF OPERATIONS DATA:
Revenues.......................         --              --             --           --           --            --
Operating expenses:
  Marketing and sales..........    $10,313        $ 47,019       $ 57,332     $  8,567   $  233,397    $  290,729
  General and
    administrative(1)..........     10,024         131,097        141,121       62,456      660,993       802,114
  Research and development.....      6,052         236,047        242,099      134,598    1,029,918     1,272,017
  Depreciation and
    amortization...............        798           3,618          4,416        2,180       14,668        19,084
                                   -------        --------       --------     --------   ----------    ----------
Operating loss.................     27,187         417,781        444,968      207,801    1,938,976     2,383,944
Interest income, net...........         --         (35,173)       (35,173)     (17,530)    (184,407)     (219,580)
                                   -------        --------       --------     --------   ----------    ----------
Net loss.......................    $27,187        $382,608       $409,795     $190,271   $1,754,569    $2,164,364
                                   =======        ========       ========     ========   ==========    ==========
Pro forma net loss per share...                   $   0.14       $   0.16                $     0.41    $     0.71
                                                  ========       ========                ==========    ==========
Shares used in computing pro
  forma net loss per
  share(2).....................                  2,652,250      2,487,128                 4,279,498     3,063,247
</TABLE>

    
 
   

<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              --------------------   SEPTEMBER 30,
                                                               1995        1996          1997
                                                              -------   ----------   -------------
<S>                                                           <C>       <C>          <C>
BALANCE SHEET DATA:
Cash and equivalents........................................  $ 9,109   $1,167,458    $4,737,864
Working capital.............................................    8,355    1,161,603     4,405,234
Total assets................................................   32,913    1,226,134     5,085,048
Shareholders' equity........................................   22,813    1,213,279     4,615,086
</TABLE>

    
 
- ---------------
 
   
(1) For the nine months ended September 30, 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 $109,000 of compensation
    expense related to the issuance of other stock options. See Notes 5 and 10
    of Notes to Financial Statements.
    
   
(2) The calculation of shares for all periods reflects a 2.13-for-1 stock split
    effected in September 1997 and the automatic conversion of the Series A
    Preferred Stock and Series B Preferred Stock to be effected upon completion
    of this Offering. See Notes 2 and 9 of Notes to Financial Statements.
    
 
                                       15

<PAGE>   18
 

          MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                           AND RESULTS OF OPERATIONS
 
OVERVIEW
 
     Since its organization in June 1995, the Company has devoted its resources
to funding research and development of colorless lab-created moissanite
gemstones, preliminary 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 has not produced sales revenues to date and does not anticipate
having product sales until at least 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
some or all 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 "Risk Factors -- Lack of Operating History;
Development Stage Company."
    
 
RESULTS OF OPERATIONS
 
   
     Nine Months ended September 30, 1997 compared with Nine Months ended
September 30, 1996. Research and development expenses for the nine months ended
September 30, 1997 increased by $895,320 over research and development expenses
for the nine months ended September 30, 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 nine months ended September 30, 1997
increased by $224,830 over expenses for the nine months ended September 30,
1996. The increase was due to the compensation expense of additional sales and
marketing staff hired since the prior period 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 nine months ended September 30,
1997 increased by $598,537 over general and administrative expenses for the nine
months ended September 30, 1996. 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.
During this period in 1997, the Company also recognized $66,000 of compensation
expense related to the exercise of Cree's options to acquire 24,601 shares of
Common Stock on January 2, 1997 and $109,000 of compensation expense related to
the issuance of other stock options.
    
 
   
     Interest income for the nine months ended September 30, 1997 increased by
$166,877 over interest income for the nine months ended September 30, 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 Series A Preferred Stock
offering in August 1996 and its Series B Preferred Stock offering in January and
February 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
 
                                       16

<PAGE>   19
 
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 equivalents, consisting primarily of
U.S. Treasury Bills and U.S. Treasury money 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
private equity sales totaling approximately $6.7 million. As of September 30,
1997, the Company had approximately $4.7 million of cash and equivalents. The
Company's business strategy requires a significant expenditure of funds for an
accelerated commercialization of colorless lab-created moissanite gemstones.
These expenditures are presently projected to total approximately $23.8 million
through the end of 1998. In addition, the Company intends to spend approximately
$5.5 million on research and development activities during that period. Actual
expenditures for accelerated commercialization and additional research and
development efforts could vary materially from these estimates.
    
 
   
     In connection with its planned commercial introduction of lab-created
moissanite gemstones, the Company has placed its first commercial quantity
orders with Cree. The first order calls for a quantity of crystals that will
require the use of all of the crystal growth systems that Cree is required to
provide at its expense under the Exclusive Supply Agreement. The second order,
which is contingent on Cree meeting certain development milestones for color
range and the successful completion of this offering, will require the
acquisition of additional crystal growth systems. See
"Business -- Manufacturing -- Growth of SiC Crystals." 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. If the contingencies are satisfied and Cree requires the Company to
purchase the growth systems, the Company will be obligated to spend
approximately $1.0 million to fund the purchase of such growth systems. After
the completion of the offering, the Company anticipates placing additional
orders, which will not be contingent on Cree meeting milestones under the
Development Agreement, for a quantity of crystals in 1998 and following years
that will require additional capacity at Cree to meet the Company's SiC crystal
requirements. If Cree requires the Company to purchase all of the additional
growth systems needed to fill the Company's anticipated orders, the Company will
be obligated to spend approximately $14.9 million to fund the purchase of such
growth systems in 1998. The Company also intends to spend approximately $1.9
million to purchase other equipment, including certain automated and
computerized equipment to slice and dice SiC crystals into preforms. See "Use of
Proceeds" and "Business -- Manufacturing -- Growth of SiC Crystals."
    
 
     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 and individualized jeweler training. The Company also intends to
launch a direct mail campaign to support the introduction of its
moissanite/diamond test instrument. The Company
 
                                       17

<PAGE>   20
 
   
estimates that it will spend approximately $6.1 million for sales and marketing
activities through 1998. The Company may increase its planned sales and
marketing expenditures as its business develops.
    
 
     The actual amount and timing of the Company's future capital requirements
will depend on many factors, including the extent of continued progress in its
development programs, the magnitude of these programs, the costs involved in
filing, prosecuting, enforcing and defending patent claims, the appearance of
competing technological and market developments and the success of the Company's
sales and marketing efforts. There can be no assurance that the Company's future
capital requirements will not exceed the amounts projected by its current
operating plan.
 
     The Company has no committed external sources of capital. Based on its
current operating plan, the Company anticipates that its existing capital
resources, together with the proceeds of this offering and interest earned
thereon, will be adequate to satisfy its capital requirements for at least the
12 months following this offering. 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 net proceeds
of this offering and the Company's existing capital resources. 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. See "Risk Factors -- Need for
Additional Capital."
 
   
COMPENSATION EXPENSE RELATED TO STOCK OPTIONS
    
 
   
     In the third quarter of 1997, the Company estimated it will incur
compensation expense of approximately $2.1 million over a vesting period of
primarily three years related to stock options granted in July and August 1997.
Upon completion of this offering, the stock options granted to certain officers
and directors will vest on December 31, 1997. As a result, approximately $1.4
million of this estimated compensation expense will be recognized in the quarter
ending December 31, 1997. The remaining estimated compensation expense,
approximately $589,000, will be recognized over the three-year vesting period of
the remaining options. Compensation expense recorded in the third quarter of
1997 totaled $109,000. See Note 10 of Notes to Financial Statements.
    
 
NET OPERATING LOSS CARRYFORWARD
 
     As of December 31, 1996 the Company had a net operating loss ("NOL")
carryforward of approximately $147,000, which expires in 2011. 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 PRONOUNCEMENTS
    
 
   
     In February 1997, Statement of Financial Accounting Standards ("SFAS") No.
128, "Earnings Per Share," was issued. This Statement establishes standards for
computing and presenting earnings per share ("EPS") and applies to entities with
publicly held common stock or potential common stock. This Statement simplifies
the current standards for computing earnings per share, and makes them
comparable to international EPS standards. This Statement is effective for
financial statements issued for periods ending after December 15, 1997; earlier
application is not permitted. This Statement requires restatement of all prior
period EPS data presented. The implementation of this Statement will not have a
material impact on the Company's financial statements.
    
 
   
     In June 1997, SFAS No. 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. SFAS No. 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.
    
 
                                       18

<PAGE>   21
 

 
                                   BUSINESS
 
INTRODUCTION
 
     The Company is finalizing the development of, and intends to begin
marketing during the first half of 1998, colorless lab-created moissanite
gemstones which it will sell as a substitute for diamond in the jewelry market.
The physical properties of lab-created moissanite gemstones more closely match
those of diamond than any other known gemstone material. The Company believes
that its products are superior to other commercially available diamond
substitutes and intends to position its gemstone products as the ideal
substitute for diamond. The Company believes that its products will be
attractive to working women who desire an affordable alternative to diamond and
to middle and upper-income women who desire affordable "everyday" or "security"
jewelry.
 
     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's lab-created moissanite gemstones are made from crystals of
SiC grown by Cree using patented and propriety technology. Cree has an exclusive
license to the patent related to a process for growing large single crystals of
SiC. To the Company's knowledge, there are no producers of SiC other than Cree
that could supply lab-grown SiC crystals in colors, sizes or volumes suitable
for use as a diamond substitute. The Company has certain exclusive licenses and
supply rights with Cree for SiC materials to be used for gemstone applications.
See "-- Dependence on Cree and Cree Technology." In addition, the Company has
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 of the
Company." As a result, the Company believes that its lab-created moissanite
gemstones are proprietary products and that there are technological barriers to
prevent other competitors from developing or marketing lab-created moissanite
gemstones at affordable prices.
 
   
     The Company and Cree are continuing their efforts to develop a fully
repeatable process to grow SiC crystals in colors, sizes and volumes desired for
the commercialization of lab-created gemstones. If the development objectives
are not fully accomplished, the Company believes it could market gemstones of
less than 1/2 carat in diamond color grades that have already been grown by
Cree, although at significantly lower average selling prices. Although the
Company has not yet begun to sell its products, the Company has begun qualifying
retail jewelry chains and high-volume independent retail jewelry stores in
selected U.S. cities to become distributors for sales anticipated to begin in
the first half of 1998. The Company is also evaluating alternatives for
distribution channels in the Pacific Rim and anticipates sales of its products
will also commence there in the first half of 1998.
    
 
   
     There can be no assurance that the Company's development efforts will be
successful, that the Company will be able to enter into distribution agreements
with qualified retail jewelers on terms acceptable to the Company or that
consumers will accept the Company's lab-created gemstones as a diamond
substitute. See "Risk Factors," "-- Dependence on Cree and Cree Technology,"
"-- Product Distribution" and "-- Distribution, Marketing and Sales."
    
 
INDUSTRY BACKGROUND
 
     Overview.  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 the natural gemstone but does not have the same chemical composition. A
gemstone substitute should have physical properties similar to those of the
natural gemstone with which it compares and should be comparatively inexpensive.
The Company intends to market its products as the ideal substitute for diamond.
 
     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
 
                                       19

<PAGE>   22
 
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.
 
     The following table sets forth the matrix of wholesale prices for a one
carat round brilliant cut diamond of varying colors and clarities:
 
                     PER CARAT DIAMOND WHOLESALE PRICING(1)
 

<TABLE>
<CAPTION>
                                                                       COLOR
                                                              ------------------------
CLARITY                                                        G/H      I/J      K/L
- -------                                                       ------   ------   ------
<S>                                                           <C>      <C>      <C>
Flawless....................................................  $7,450   $5,750   $4,750
Very, Very Slightly Included................................   6,775    5,375    4,525
Very Slightly Included......................................   6,125    4,925    4,125
Slightly Included...........................................   4,717    4,017    3,417
</TABLE>

 
- ---------------
 
(1) Based on the September 5, 1997 Rapaport Diamond Report.
 
     Diamond Synthetics and Substitutes.  Although the technology to produce
synthetic diamonds has existed for over 40 years, synthetic diamonds have not
been used in significant quantities in jewelry. In 1955, The General Electric
Company ("GE") produced industrial-grade synthetic diamonds by subjecting
graphite to extreme pressure and heat. In 1970, GE announced that it had
produced colorless gemstone quality synthetic diamonds in carat weight. DeBeers,
Sumitomo Corporation and certain Russian producers have also produced gemstone
quality synthetic diamonds. However, the process for growing colorless gemstone
quality synthetic diamonds is far more expensive and time-consuming than growing
industrial-grade synthetic diamonds. The Company believes that it is not
commercially feasible to grow colorless gemstone quality synthetic diamonds at
the present time.
 
     Treated diamonds, which are natural diamonds with imperfections or flaws
that have been altered in some manner to enhance their appearance, are also sold
in the jewelry industry. Diamonds with surface cracks may be filled with a
colorless substance to present a uniform appearance. The appearance of diamonds
containing inclusions, or foreign materials trapped in a diamond during its
formation, may be improved through the use of laser technology. Treated diamonds
are generally less expensive than diamonds of similar size, cut and color which
have not been treated.
 
                                       20

<PAGE>   23
 
     Industry experience has shown that certain diamond substitutes have
achieved market acceptance with consumers. Synthetic cubic zirconia, which is
often considered to be the first diamond substitute to possess physical
characteristics reasonably similar to diamond, gained rapid acceptance among
consumers after its introduction in 1976. The absence of any proprietary rights
in the process for producing synthetic cubic zirconia allowed a number of
producers to enter the market shortly after its introduction. As a result of
these factors, the wholesale price of synthetic cubic zirconia decreased by 90%
in the four years following its introduction.
 
     Synthetic cubic zirconia initially was not well accepted by jewelers.
Industry publications suggest that jewelers historically believed that sales of
diamond simulants, such as synthetic cubic zirconia, might cause a decrease in
diamond sales. Reports of diamond sales following the introduction of synthetic
cubic zirconia fail to show, however, that synthetic cubic zirconia
significantly depressed diamond sales. The Gemological Institute of America has
stated that many jewelers have found that some purchasers of diamond simulants
return to upgrade their jewelry to diamond.
 
     Based on consumer acceptance of other diamond simulants, the Company
believes that a market does exist for a realistic substitute for diamond in
jewelry. The Company believes that its products are superior to other
commercially available diamond simulants because the physical properties of
lab-created moissanite gemstones more closely match those of diamond than any
other known gemstone material. There can, however, be no assurance that
consumers will accept the Company's products as a substitute for diamond in
jewelry or that no other more realistic diamond substitutes will become
available. See "Risk Factors -- Undeveloped Markets; Unproven Acceptance of the
Company's Products."
 
BUSINESS STRATEGY
 
     The Company has developed a business strategy for achieving commercial
production and widespread market acceptance for its lab-created gemstones. The
key components of this strategy include:
 
     Exploit Proprietary Technology.  The Company has undertaken a development
program with Cree under which Cree is refining its patented core SiC technology
in order to produce large lab-grown SiC crystals in the comparable diamond color
grades "G" through "J" by a fully repeatable process. See "-- Dependence on Cree
and Cree Technology."
 
     Develop Market Recognition.  The Company plans to position its gemstone
products as the ideal substitute for diamond. The Company believes that
lab-created gemstones will be attractive to working women who desire an
affordable alternative to diamond and to middle and upper-income women who
desire affordable "everyday" or "security" jewelry. See "-- Distribution,
Marketing and Sales."
 
   
     Establish Exclusive Distribution Channels.  The Company intends to grant to
select retail jewelry chains and high volume independent retail jewelry stores
in certain U.S. cities the right to be the exclusive retail store selling
lab-created moissanite gemstones within a limited geographic territory. The
Company is also exploring distribution options for the Pacific Rim. Exclusive
distribution rights are intended to enable retailers to distinguish themselves
from competitors in the highly competitive jewelry market, which the Company
believes will encourage the retailers to focus on and promote the sale of the
Company's gemstone products. See "-- Distribution, Marketing and Sales."
    
 
     Rapidly Expand Manufacturing Capacity.  The Company is committed to rapidly
expand the capacity at Cree for producing colorless SiC crystals for gemstones.
Although the Company has certain rights under the Exclusive Supply Agreement
with Cree to cause Cree to expand capacity as needed to meet the Company's
orders for lab-grown SiC crystals, under certain circumstances, Cree's supply
obligation may be limited. See "-- Dependence on Cree and Cree Technology" and
"-- Manufacturing."
 
     Optimize SiC Crystal Yield.  After a fully repeatable process has been
developed for producing SiC crystals in comparable diamond color grades, sizes
and volumes desired for initial commercial production of the Company's colorless
lab-created moissanite gemstones, Cree will seek to expand SiC crystal size
while maintaining crystal color uniformity and volume. This development program
is intended to optimize the
 
                                       21

<PAGE>   24
 
productivity of the crystal growth process and minimize the per carat materials
cost of the Company's colorless lab-created moissanite gemstones. See
"-- Dependence on Cree and Cree Technology."
 
     Provide Reliable Test Instruments.  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 trained gemologists
to prevent fraud, which may aid in establishing market acceptance of the
Company's gemstone products. Because the Company's tests indicate that neither
visual inspection nor commonly used testing devices reliably distinguish
colorless lab-created moissanite gemstones from diamond, the Company has begun
to produce a test instrument that distinguishes colorless lab-created moissanite
gemstones from diamonds in the colors and clarities most commonly sold by retail
jewelers. See "-- Products."
 
     During the balance of 1997 and the first half of 1998, the Company will
continue to monitor closely Cree's program to develop a fully repeatable process
for producing SiC crystals with uniform color in the comparable diamond color
grades "G" through "J", with at least 50% in the comparable diamond color grades
"G" to "H". There can be no assurance that this portion of the development will
be accomplished during this time frame or at all. Once the targeted color grades
and uniformity are consistently achieved, the Company will continue to closely
monitor the on-going development program to increase crystal size while
maintaining color grade and uniformity. See "-- Dependence on Cree and Cree
Technology."
 
     If Cree achieves the desired color grades, the Company anticipates placing
production orders for SiC crystals with Cree during the balance of 1997 and the
first half of 1998 that will require the expansion of Cree's manufacturing
capacity through the addition of numerous crystal growth systems. Under the
Exclusive Supply Agreement, Cree may elect to pay the cost of building the
growth systems itself and build this cost into the price of SiC crystals sold to
the Company or to require the Company to pay for the growth systems to be built
by Cree and maintained at Cree's facilities. See "-- Dependence on Cree and Cree
Technology" and "-- Manufacturing." Because Cree has not indicated which
alternative it will elect, the Company has budgeted a portion of the proceeds of
this offering to fund the acquisition of the crystal growth systems anticipated
to be needed. See "Use of Proceeds," "Risk Factors" and "-- Manufacturing." The
Company also anticipates making other equipment purchases of approximately $1.9
million for its own facility. See "Use of Proceeds." During this same time
period, the Company will continue to assess whether additional vendors of
faceting services are needed and to enter into contracts with vendors to provide
such services as needed to meet demand.
 
   
     During the remainder of 1997 and the first half of 1998, the Company will
be developing its marketing program for introducing gemstone products for sale
in the first half of 1998. See "-- Distribution, Marketing and Sales." Through
the balance of 1997, the Company's sales force will continue to implement its
strategy for establishing product distribution channels. The Company currently
anticipates that it will begin to offer distribution arrangements in early 1998.
Assuming Cree has achieved production of SiC crystals in the comparable diamond
color grades, sizes and volumes desired by the Company, the Company will
continue to evaluate and select additional retailers or other distribution
channels for its products during the remainder of 1998.
    
 
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 numerous
features that make them a superior substitute for diamond in jewelry and that
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 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"
 
                                       22

<PAGE>   25
 
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 SiC's 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 Company
believes that the refractive index of lab-created moissanite gemstones gives
them a brilliance that is very similar to that of diamond. 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."
    
 
     An initial study indicates that the physical appearance of lab-created
moissanite gemstones is quite similar to diamond. In 1996, the Company
commissioned a market survey of 30 jewelry stores in the Midwest region of the
United States. In the survey, personnel at 28 out of 30 jewelry stores
mistakenly identified one of the Company's lab-created moissanite gemstones set
in a pendant as diamond. This study represents only one survey, and there can be
no assurance that other surveys would provide similar findings or that any
commercial market will develop for the Company's products.
 
     The Company believes that other physical properties of lab-created
moissanite gemstones are similar to diamond and will aid in jewelers' acceptance
of its products as a diamond substitute. 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 Company believes that the physical properties of lab-created moissanite
gemstones make it a more attractive substitute for diamond than synthetic cubic
zirconia. Because it has a lower refractive index than diamond, synthetic cubic
zirconia is relatively easy to distinguish from diamond in most applications.
The difference is noticeable in larger size round brilliant cut gemstones and
particularly in gemstones cut with certain facet arrangements, such as emerald
or baguette cut gemstones. In addition, as a result of their relative softness,
synthetic cubic zirconia gemstones show signs of wear over time. Substantial
degradation of the facets, which does not occur to the same degree in diamond or
lab-created moissanite gemstones, results in a marked reduction in brilliance.
 
     The following table compares the physical properties of lab-created
moissanite gemstones with other gemstone materials:
 
                        GEMSTONE MATERIAL COMPARISON(1)
 

<TABLE>
<CAPTION>
                                   HARDNESS                   REFRACTIVE                SPECIFIC
      GEMSTONE MATERIAL         (MOHS SCALE)(2)   TOUGHNESS     INDEX      DISPERSION    GRAVITY
      -----------------         ---------------   ---------   ----------   ----------   ---------
<S>                             <C>               <C>         <C>          <C>          <C>
Diamond.......................       10             Good*       2.42         .044         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    1.56-1.60      .014       2.69-2.75
                                                    Good
</TABLE>

 
- ---------------
 
 *  In cleavage direction, otherwise excellent.
(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);
 
                                       23

<PAGE>   26
 
    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 substitute. 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 Cree and the Company have not yet developed a fully
    repeatable process for producing gemstone quality SiC crystals in the
    comparable diamond color grade range of "G" through "J", 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
 
     The Company expects to sell lab-created moissanite gemstones of 1/2 to 1
carat primarily in the comparable diamond color grade range of "G" through "J"
and in the comparable diamond clarity grade range of Flawless through Slightly
Included. Cree has grown pilot samples of SiC crystals in these colors and
clarities and has undertaken a significant development program, funded by the
Company, to develop a fully repeatable process to grow SiC crystals in the
desired color, size and volume. If Cree is not successful in its development
efforts, the Company intends to manufacture, from SiC crystals grown by Cree
using its existing processes, and sell lab-created moissanite gemstones
primarily in colors lower than its target color grade range and primarily in
sizes smaller than 1/2 carat but at significantly lower average selling prices.
The development efforts for such smaller, less expensive stones has been
completed, and no significant barriers exist to prevent the Company from
manufacturing and selling such stones, if necessary. There can be no assurance
that Cree will successfully complete its planned development efforts or that a
market will develop for lab-created gemstones of any color or size.
 
     The Company currently intends to sell only loose lab-created gemstones
rather than finished jewelry products. See "-- Distribution, Marketing and
Sales." Initially, the Company plans to market round brilliant cut stones, which
are frequently used in rings, earrings, pendants and bracelets. Over time, the
Company may elect to expand its product lines by offering additional cuts or
colored lab-created gemstones. To date, Cree has produced pilot samples of
gemstone quality SiC crystals in green, blue and amber.
 
     The Company has not yet determined the price at which it will market its
products. As the Company seeks to establish distribution channels, it is
conducting preliminary market research in its target markets. The Company
intends to determine the price of its lab-created gemstones after assessing the
response from its potential customers. 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.
 
     Gemstone test instruments most commonly used by jewelry experts 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
 
                                       24

<PAGE>   27
 
find a number of ways to distinguish lab-created moissanite from diamond, the
Company believes there will be a need to introduce a readily available
moissanite/diamond test instrument concurrent with the introduction of
lab-created moissanite gemstones to help prevent fraud. The availability of this
type of test instrument also may aid market acceptance of its lab-created
gemstones.
 
     The Company anticipates introducing its moissanite/diamond test instrument
for sale during the first half of 1998. This instrument, which distinguishes
moissanite gemstones from diamonds in the colors and clarities most commonly
sold by retail jewelers, would be used in conjunction with existing thermal test
instruments. A patent application by the Company is pending for this
moissanite/diamond test instrument. There can be no assurance that a market will
develop for the Company's test instrument or that other readily available means
will not be developed which can effectively distinguish lab-created moissanite
gemstones from diamond.
 
DEPENDENCE ON CREE AND CREE TECHNOLOGY
 
     Cree, the Company's source for development and supply of lab-grown SiC
crystals, has developed or licensed numerous patented processes for the growth
of SiC crystals. The technology was initially developed for SiC uses in
semiconductors. 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 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 a diamond substitute.
 
     Cree has significant proprietary rights related to its processes for
growing SiC crystals. Cree has an exclusive license on the 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 other patents relating to aspects of its SiC crystal growth process. To
further protect its proprietary SiC crystal growth process, Cree internally
produces, with proprietary confidential technology, the crystal growth systems
used in its SiC crystal production. In addition, Cree has a pending patent
application for a process of growing colorless SiC crystals. The Company has a
royalty-free, perpetual license for the use in gemstone applications of the
technology covered by this pending patent application.
 
     The Company's success and ability to compete is heavily dependent upon
Cree's proprietary technology. However, there can be no assurance that Cree 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 "Risk Factors -- Dependence on Intellectual Property."
 
     On June 6, 1997, the Company entered into the Exclusive Supply Agreement
and a Development Agreement (the "Development Agreement") with Cree. Under the
Development Agreement and the Exclusive Supply Agreement, the Company has
concentrated both its development expenditures and its source of supply for SiC
crystals with Cree. As a result, the business of the Company will be highly
dependent on Cree's performance under these agreements. The processes and other
technology developed by Cree under the Development Agreement are expected to
have application in Cree's development of SiC technology generally, and will be
owned by and available to Cree for all uses other than gemstone applications. In
addition, the payment terms under the Exclusive Supply Agreement provide margins
and certain financial incentives to Cree that the Company believes provide
appropriate business and economic incentives for Cree to perform its obligations
under the Development Agreement and the Exclusive Supply Agreement.
 
     Under the Development Agreement, Cree is developing a fully "repeatable
process" for producing SiC crystals in comparable diamond color grades "G"
through "J", with at least 50% in the "G" to "H" range. To date, Cree has
repeatedly produced crystals of consistent, uniform quality in the comparable
diamond color grades "L" through "N" and has produced samples in the comparable
diamond color grades "G" through "K". If Cree has not developed a fully
"repeatable process" by January 1, 1998, during the 10-day period ending on
January 10, 1998, the Company may elect to reduce its funding obligations under
the Development Agreement by 50% or terminate the Development Agreement. The
Development Agreement also establishes additional milestones for crystal
production in future years, and the Company has the right to terminate the
Agreement if those milestones are not met by Cree. The Development Agreement
also provides for a five-year
 
                                       25

<PAGE>   28
 
focused development effort by Cree to increase crystal size while maintaining
color grade and uniformity. Provided the target specifications for crystal size
and color grade are met, over the five-year period of the Development Agreement
the Company could be obligated to fund approximately $12 million of development
work. See "Use of Proceeds."
 
     Under the Exclusive Supply Agreement, Cree has agreed not to sell
moissanite crystals for gemstone uses to anyone other than the Company. The
Company has agreed to purchase from Cree at least 50%, by dollar volume, of the
Company's requirements for SiC material for the production of gemstones in each
calendar quarter. Cree is obligated to supply this amount of material to the
Company. Although the Company is obligated to purchase only 50% of its
requirements from Cree, the Company does not believe there are any other
alternative sources of supply for SiC crystals suitable for gemstones.
Therefore, the Company expects to be dependent on Cree as its sole source of
supply of 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.
 
     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 "Description of Capital
Stock -- Certain Anti-Takeover Provisions -- Exclusive Supply Agreement." 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.
    
 
     Cree is also the sole supplier of a component of the Company's
moissanite/diamond test instrument that is proprietary to Cree. If Cree were to
fail to deliver this component, as required, the Company would not be able to
manufacture its test instrument. A lack or shortage of test instruments could
impact market acceptance of the Company's lab-created moissanite gemstones.
 
   
     The President of the Company and one of the founders of the Company are the
brothers of the Chief Executive Officer of Cree. After this offering, Cree and
certain of its officers and directors will own approximately 3.5% of the
outstanding Common Stock. See "Certain Transactions."
    
 
INTELLECTUAL PROPERTY OF THE COMPANY
 
     The Company has applied for a number of patents related to the production
of lab-created moissanite gemstones. The Company has pending patent applications
for lab-created moissanite gemstones and its moissanite/diamond test instrument.
Although the Company intends to vigorously prosecute all its patent
applications, there can be no assurance that such actions will be successful,
that any patents will be issued, that such patents, if issued, will not be
challenged, invalidated or circumvented or that such patents, if issued, 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 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
 
                                       26

<PAGE>   29
 
will not develop technologies that are similar or superior to its technology.
See "Risk Factors -- 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 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.
 
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. The processes for SiC crystal
growth are under continuing development by Cree, and the Company is engaged in
pilot production of lab-created moissanite gemstones at its own facilities as
part of its product development efforts.
 
     Growth of SiC Crystals.  The Company intends to source all of its SiC
crystals from Cree under the Exclusive Supply Agreement for the foreseeable
future. See "-- Dependence on Cree and Cree Technology."
 
   
     In connection with the anticipated market introduction of its lab-created
gemstones in the first half of 1998, the Company has placed its first commercial
quantity orders with Cree. The first order calls for a quantity of crystals that
will require the use of all of the crystal growth systems that Cree is required
to provide at its expense under the Exclusive Supply Agreement. The second
order, which is contingent on Cree meeting certain development milestones for
color range and the successful completion of this offering, will require the
acquisition of additional crystal growth systems. Cree has not yet informed the
Company whether Cree will purchase some or all of the additional crystal growth
systems or require the Company to do so. After the completion of this offering,
the Company anticipates placing additional orders, which will not be contingent
on Cree meeting milestones under the Development Agreement, for a quantity of
crystals that will require a significant number of additional crystal growth
systems. If Cree's development milestones are not met, the Company intends to
use the crystals from these orders to manufacture and sell lab-created
moissanite gemstones in colors lower than the Company's target color grade range
and in sizes smaller than 1/2 carat at significantly lower average selling
prices.
    
 
   
     The Company has placed and expects to place orders with Cree for SiC
crystals in advance of actual demand for the product in an effort to have
adequate quantities of its lab-created 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 Cree will meet its development milestones or 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 plans 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.
 
                                       27

<PAGE>   30
 
     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 intends to outsource all faceting of gemstones for
commercial production and will continue internal faceting for research and
development. The Company has entered into an agreement with John M. Bachman,
Inc. ("JMB") under which an affiliate of JMB will facet 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 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 intends to assess
these other vendors' production capabilities over the next year. 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 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 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 to ensure that it
meets the Company's quality control standards. This phase of manufacturing is
relatively labor-intensive and requires skills not readily available in the
general work force. 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.
 
     Test Instrument.  The Company has contracted with an unaffiliated third
party for the assembly of the moissanite/diamond test instrument from components
produced by third parties. The Company believes that, other than with respect to
the chip described below, the components and assembly functions would be readily
available from a wide variety of other suppliers. The test instrument relies
upon a proprietary semiconductor chip that the Company obtains from Cree under a
letter agreement dated February 12, 1996 which expires in 2016 (the "Instrument
Agreement"). The Instrument Agreement obligates the Company to purchase all of
the chips used in the test instrument from Cree and gives the Company the
exclusive right to purchase those chips from Cree. The Company will pay Cree a
royalty of 2 1/2% of net sales of all test instruments incorporating the Cree
chip.
 
DISTRIBUTION, MARKETING AND SALES
 
   
     The Company plans to introduce 1/2 to 1 carat round brilliant lab-created
moissanite gemstones for sale in certain large cities in the United States and
Pacific Rim in the first-half of 1998. The Company has targeted the United
States and the Pacific Rim because it believes that these markets represent a
significant portion of the worldwide jewelry market and are markets that are
relatively accepting of diamond substitutes. In connection with the planned
product introduction, the Company has begun pre-qualifying selected retail
jewelry chains and high-volume independent retail jewelry stores in targeted
U.S. cities. Distributors would be granted the right to be the exclusive retail
store selling lab-created moissanite gemstones within a limited geographic
territory. The Company is also exploring distribution options in the Pacific
Rim. The Company is currently evaluating the most appropriate structure for the
exclusive distribution agreements and may, in certain circumstances, enter into
other types of distribution agreements. The final selection of retailers and the
    
 
                                       28

<PAGE>   31
 
nature and scope of the exclusive arrangements will be based on the responses
received by the Company. The Company currently anticipates that it will begin to
offer exclusive distribution arrangements in early 1998.
 
     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 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
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 and the number of retailers handling its products. After
the introduction of lab-created moissanite gemstones in its target markets, the
Company's sales staff will divide its time between providing sales support to
its existing network of retailers and entering into new target markets and new
distribution arrangements.
 
     The Company plans to market its moissanite/diamond test instrument directly
to jewelers, gemologists and pawnbrokers. Distribution of the test instrument
will be supported by direct mailings and advertisements in trade publications.
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.
    
 
     The Company intends to develop a comprehensive marketing strategy to
support the introduction of its products in its target markets. The Company's
marketing efforts are expected to highlight the similarities of lab-created
moissanite gemstones and diamond and contrast their relative prices. The Company
expects to develop advertising campaigns for the jewelry trade and for the
consumer because the Company believes that a successful introduction of its
lab-created gemstones is dependent upon having a network of retailers committed
to aggressively market the Company's products. The Company's marketing strategy
is expected to include cooperative advertising with jewelers or other
distributors, point of purchase displays, jeweler or distributor training in
selling lab-created moissanite gemstones and providing other marketing support
services. In addition, the Company's corporate communications manager is
responsible for developing media interest in and generating positive media
reports on lab-created moissanite gemstones.
 
COMPETITION
 
     Competition in the market for gemstones is intense. The Company's
lab-created moissanite gemstones 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.
 
                                       29

<PAGE>   32
 
     The worldwide market for uncut 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 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.
 
     Synthetic diamond in gemstones or film form may also become available in
the marketplace as an alternative to the Company's gemstones. Synthetic diamonds
are regularly produced for industrial applications, and 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. The Company
believes that gemstone grade synthetic diamonds presently cannot be produced at
prices competitive with those expected to be offered for the Company's colorless
lab-created moissanite gemstones. There could, however, be technological
advances that would enable competitively priced synthetic diamonds of comparable
grade to be offered.
 
     Currently, synthetic diamond films can be grown at commercially viable
prices in thicknesses that can be applied to other surfaces. The films, however,
adhere well to only a few minerals such as diamond, silicon and SiC
(moissanite). If the technology to attach a synthetic diamond film to other
colorless minerals is improved, the resulting film-covered gemstone could
compete with moissanite as a substitute for diamond.
 
     The Company's products will 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.
 
     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 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, by other processes, SiC crystals suitable for
gemstone applications and, if developed, these SiC crystals could be used by
others to produce lab-created moissanite gemstones.
 
     The Company intends to compete primarily on the basis that the unique
qualities of its lab-created moissanite gemstones provide a substitute for
diamond that is superior to existing substitutes 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 from Cree;
(iii) obtain reliable and high quality faceting services from third parties;
(iv) respond to market entries of other gemstone materials with technological or
cost 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.
 
GOVERNMENT REGULATION
 
     The Company's products will be subject to regulation by the FTC. The FTC
has issued regulations and guidelines governing the marketing of diamond
simulants and substitutes that require diamond simulants and
 
                                       30

<PAGE>   33
 
substitutes to be clearly identified as such 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 and marketing personnel, 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.
 
FACILITIES
 
   
     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. 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 to 24 months. The Company also subleases, through January 1998,
space from a subsidiary of Cree. This space houses the Company's former offices
and was vacated by the Company in October 1997. The Company is attempting to
sublet this space. See "Certain Transactions -- Transactions with Cree -- Other
Cree Transactions."
    
 
EMPLOYEES
 
   
     At November 3, 1997, the Company had 24 full-time employees, two part-time
employees, five temporary employees and two 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.
    
 
                                       31

<PAGE>   34
 

                                   MANAGEMENT
 
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
 
   
     The directors, executive officers and key employees of the Company are as
follows:
    
 
   

<TABLE>
<CAPTION>
DIRECTORS AND EXECUTIVE OFFICERS               AGE                 POSITION
- --------------------------------               ---                 --------
<S>                                            <C>   <C>
Jeff N. Hunter...............................  40    President and Chairman of the Board
Mark W. Hahn.................................  35    Chief Financial Officer, Treasurer
                                                     and Secretary
Martin J. DeRoy..............................  50    Vice President of Marketing
Thomas G. Coleman............................  37    Director of Technology
Kurt Nassau..................................  70    Director
Howard Rubin.................................  72    Director
Frederick A. Russ............................  53    Director
Kurt Leutzinger..............................  46    Director
David B. Stewart.............................  34    Director
Ollin B. Sykes...............................  46    Director
KEY EMPLOYEES
- ---------------------------------------------
Renee McCullen...............................  38    Director of Sales
Earl R. Hines................................  60    Director of Manufacturing
</TABLE>

    
 
     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 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.
 
     MARTIN J. DEROY has served as Vice President of Marketing since September
1997. From October 1990 to September 1997, Mr. DeRoy was employed as Marketing
Director of Friedman's Inc., a retail jewelry chain with approximately 375
stores. He earned a Bachelor of Science degree in business administration, with
a major in advertising and public relations and a minor in marketing and
merchandise, at Youngstown State University.
 
     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.
 
     KURT NASSAU has served as a director of the Company since August 1996 and
has provided consulting services to the Company since April 1997. Since August
1990, Dr. Nassau has served as the President of Nassau Consultants where he
specializes in advising companies on gemology and color. Dr. Nassau is a former
Distinguished Research Scientist with AT&T Bell Labs and is the author of 16
patents and 4 books on gemology and the science of color. Dr. Nassau earned his
Ph.D. in physical chemistry at the University of Pittsburgh and is a former
20-year member of the Board of Governors of the Gemological Institute of
America.
 
   
     HOWARD RUBIN has served as a director of the Company since November 1996
and has been a consultant to the Company since February 1997. Since 1992, he has
served as President of GemDialogue Systems, Inc., a
    
 
                                       32

<PAGE>   35
 
consulting company which provides jewelry appraisal and gemological training
services to jewelers and business process improvement services to jewelry
manufacturers. Mr. Rubin received a graduate gemology degree from the
Gemological Institute of America in 1959.
 
     FREDERICK A. RUSS has served as a director of the Company since November
1996. Dr. Russ has served as Dean of the College of Business Administration at
the University of Cincinnati since September 1994. From July 1989 to September
1994, he was Marketing Department Head and Professor of Marketing at the
University of Cincinnati. Dr. Russ served on the Board of Directors of Cree from
1988 to 1992. He earned his Ph.D. in industrial administration at
Carnegie-Mellon University.
 
   
     KURT LEUTZINGER has served as a director of the Company since October 1997.
Since July 1997, Mr. Leutzinger has been employed as Vice President of Finance
and Chief Financial Officer of Abgenix, Inc., a company engaged in the business
of antibody therapeutics. From June 1987 to July 1997, he was Vice President and
Portfolio Manager for GE Investment Corporation ("GEIC"), a wholly owned
investment management subsidiary of General Electric Company. Mr. Leutzinger
earned a Master of Business Administration degree in finance from New York
University.
    
 
   
     DAVID B. STEWART has served as a director of the Company since October
1997. Since November 1992, Mr. Stewart has held various positions at GEIC and
currently is an Investment Manager in its Private Equity Group. He earned his
Bachelor of Arts degree in economics from the University of New Hampshire.
    
 
   
     OLLIN B. SYKES has served as a director of the Company since October 1997
and has been a consultant to the Company since July 1997. Since December 1984,
he has served as the president of Sykes & Company, P.A., a regional accounting
firm specializing in accounting, tax and financial advisory services. Mr. Sykes
earned his Bachelor of Science degree in accounting at Mars Hill College and is
a Certified Public Accountant and a Certified Management Accountant.
    
 
     RENEE MCCULLEN has served as Director of Sales of the Company since August
1997. From May 1983 to September 1996, she was employed in various capacities
with Art Carved Class Rings, a company engaged in the wholesale jewelry
business, most recently as Regional Vice President and Regional Sales Manager.
Ms. McCullen earned a Bachelor of Science degree in business administration,
with a concentration in marketing, at East Carolina University.
 
     EARL R. HINES has served as Director of Manufacturing of the Company since
March 1997. From April 1996 to March 1997, Mr. Hines was a lapidary consultant
to the Company. From March 1990 to March 1997, Mr. Hines owned and operated
GemCrafters of Raleigh, a business that focused on cutting colored gemstones and
repairing and appraising jewelry. Mr. Hines retired from IBM in 1990 with more
than 30 years of service, including as Manufacturing Systems Manager.
 
   
     The Company, C. Eric Hunter, a founder and beneficial owner of 15.8% of the
Common Stock outstanding after this offering, General Electric Pension Trust
("GEPT") and certain other shareholders of the Company are party to a
shareholders agreement (the "Shareholders Agreement"). Mr. Stewart has been
elected as a director pursuant to the Shareholders Agreement. In addition, the
Shareholders Agreement provides that, after the consummation of this offering
and so long as GEPT owns shares of Common Stock, the Company will (i) nominate
and recommend for election as a director one individual designated by GEPT who
shall be reasonably acceptable to the Company, (ii) if a GEPT nominee is not a
director, provide GEPT's designee with a copy of any information distributed to
the Board and allow that designee to attend and participate, but not vote, in
all meetings of the Board and (iii) not increase the size of the Board without
GEPT's consent, which will not be unreasonably withheld. The Shareholders
Agreement will terminate on the earlier of (i) March 28, 2007 or (ii) the date
on which GEPT no longer owns any shares of Common Stock or Series B Preferred
Stock.
    
 
     Directors are elected annually to serve for one-year terms and until their
successors are duly elected and qualified. The bylaws allow, at any time there
are nine or more directors, the Board to be divided into three classes of
directors serving three-year terms which expire in consecutive years for each
class of directors. Executive officers of the Company are appointed annually by
the Board of Directors and serve until their
 
                                       33

<PAGE>   36
 
successors are elected and qualified. Mr. Sykes is a second cousin once removed
of Jeff N. Hunter. Otherwise, there are no family relationships among any of the
directors or officers of the Company.
 
BOARD COMMITTEES
 
   
     The Board of Directors has an Executive Committee, a Compensation Committee
and a Finance and Audit Committee. The Executive Committee is authorized to act
on behalf of the Board during the intervals between meetings of the full board
subject to certain statutory restrictions. Mr. Hunter and Dr. Nassau compose the
Executive Committee. The Compensation Committee exercises the Board's authority
regarding the compensation of the officers and salaried employees of the Company
and administers the Company's stock option plans. See "-- Stock Option Plans."
Mr. Rubin, Dr. Russ and Mr. Sykes compose the Compensation Committee. The
Finance and Audit Committee is responsible for reviewing and evaluating the
Company's financing plans, reviewing the scope and results of audits and other
services provided by the Company's independent accountants and determining the
adequacy of the Company's internal controls and other financial reporting
matters. Messrs. Leutzinger, Stewart and Sykes compose the Finance and Audit
Committee. Both the Compensation Committee and Finance and Audit Committee have
at least two non-employee directors.
    
 
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
 
   
     To date, the Board of Directors has made all determinations with respect to
executive officer compensation. No interlocking relationships exist between the
Company's Board of Directors and the board of directors or compensation
committee of any other company, nor has any such interlocking relationship
existed in the past. Dr. Nassau, Mr. Rubin and Mr. Sykes each have a consulting
agreement with the Company. See "-- Compensation of Directors." Dr. Nassau and
Mr. Sykes have purchased and hold securities of the Company. See "Certain
Transactions" and "Principal Shareholders."
    
 
COMPENSATION OF DIRECTORS
 
   
     The Company does not presently pay cash fees to its directors but does
reimburse all non-employee directors for expenses incurred in their capacity as
directors. The Company has granted to each non-employee director or, in the case
of the GEPT nominee, to GEPT options to purchase an aggregate of 30,560 shares
of Common Stock. Options to purchase 25,560 shares were granted under the 1996
Option Plan (the "1996 Directors Options") and options to purchase 5,000 shares
were granted under the 1997 Omnibus Plan, subject to the consummation of this
offering (the "1997 Directors Options").
    
 
     The 1996 Directors Options become exercisable in three equal, annual
installments beginning on the first anniversary of the date of grant and
expiring on the tenth anniversary of the date of grant, although some of these
options will vest in full on December 31, 1997 if this offering is completed
prior to that date. The 1996 Directors Options were granted at the prices and on
the dates described below. In July 1996, Dr. Nassau was granted an option to
purchase 17,040 shares at an exercise price of approximately $1.88 per share. In
September 1996, Mr. Rubin was granted an option to purchase 17,040 shares at an
exercise price of approximately $2.70 per share. In October 1996, Dr. Russ was
granted an option to purchase 17,040 shares at an exercise price of
approximately $2.70 per share. In April 1997, GEPT was granted an option to
purchase 17,040 shares at an exercise price of approximately $3.45 per share. In
July 1997, GEPT, Dr. Nassau, Mr. Rubin and Dr. Russ were each granted an option
to purchase 8,520 shares at an exercise price of approximately $4.81 per share
and Messrs. Leutzinger and Sykes were each granted an option to purchase 25,560
shares at an exercise price of approximately $4.81 per share. The options
granted in July 1997 to GEPT and the non-employee directors will become
exercisable in full on December 31, 1997 if this offering is completed prior to
that date. See "-- Stock Option Plans -- 1996 Option Plan."
 
     The 1997 Directors Options were all granted in September 1997 at an
exercise price equal to the initial public offering price of the shares of
Common Stock offered hereby. Fifteen percent of each of the 1997 Directors
Options vest on the date of the consummation of this offering. The remaining 85%
of each of the 1997 Directors Options vests in the event the Company achieves
certain specified sales, earnings or margin
 
                                       34

<PAGE>   37
 
criteria prior to December 31, 2001. Each of the 1997 Directors Options expires
on the tenth anniversary of the date of grant. See "-- Stock Option
Plans -- 1997 Omnibus Plan."
 
   
     In February 1997, the Company entered into a letter agreement with
GemDialogue Systems, Inc., a corporation owned by Mr. Rubin ("GSI"), pursuant to
which Mr. Rubin provides consulting services to the Company on staff training in
gemological and jewelry trade skills, market research and other matters. Under
the letter agreement, the Company pays GSI a monthly retainer of $1,000 and Mr.
Rubin is obligated to provide two days of consulting per month. GSI is also
entitled to be reimbursed for any expenses incurred in connection with Mr.
Rubin's consulting activities. The Company will pay GSI $500 per day for any
consulting services in excess of two days per month. If the Company does not
require two days of consulting time in any given month, the excess time
accumulates, and the Company has the option of waiving the monthly retainer
until the accumulated time has been used or extending the term of the letter
agreement without charge until the accumulated time is used. The letter
agreement has an initial term of one year. At November 3, 1997, the Company had
paid GSI a total of $8,000 (excluding expense reimbursements) and there were no
accumulated days of unused consulting time. In September 1997, as additional
consideration for consulting services, the Company issued Mr. Rubin an option to
purchase 15,000 shares of Common Stock pursuant to the 1997 Omnibus Plan with
substantially the same terms as the 1997 Directors Options.
    
 
   
     The Company entered into a letter agreement with Dr. Nassau effective April
1997 pursuant to which Dr. Nassau provides consulting services to the Company on
gemstone color, gemological science and other matters. The terms of the letter
agreement with Dr. Nassau are substantially the same as the terms of the letter
agreement with GSI. At November 3, 1997, the Company had paid Dr. Nassau a total
of $6,125 (excluding expense reimbursements) and there were no accumulated days
of unused consulting time. In September 1997, as additional consideration for
his consulting services, the Company issued Dr. Nassau an option to purchase
15,000 shares of Common Stock pursuant to the 1997 Omnibus Plan with
substantially the same terms as the 1997 Directors Options.
    
 
     Dr. Nassau is also assisting the Company in the development of certain of
its intellectual property and inventions and, in May 1997, executed an agreement
with the Company whereby he agreed to assign to the Company all intellectual
property rights concerning the development, manufacture, production, design or
marketing of any consumer or industrial applications for SiC created by him. The
agreement also provides that, for a one year period beginning on the termination
of his service as a director of the Company, Dr. Nassau will not serve as an
officer, director, engineer, designer or manager of any entity that engages in
the business of developing, manufacturing, producing, designing or marketing SiC
material as gemstones or gemological testing instruments. The Company granted
Dr. Nassau an option to purchase 25,560 shares of Common Stock at an exercise
price of approximately $3.45 per share in consideration of this agreement. Dr.
Nassau's option becomes exercisable in three equal, annual installments
beginning on the first anniversary of the date of grant and expires on the tenth
anniversary of the date of grant.
 
   
     In July 1997, the Company entered into a consulting agreement with Mr.
Sykes pursuant to which Mr. Sykes may provide finance and business development
services to the Company at fees mutually agreed upon by Mr. Sykes and the
Company. Mr. Sykes is also entitled to be reimbursed for any expenses incurred
in connection with his consulting services. The consulting agreement has an
initial term of five years. Mr. Sykes has performed certain consulting services
for the Company without charge and, consequently, the Company has paid no cash
consulting fees to Mr. Sykes. In connection with the execution of this
consulting agreement, the Company granted Mr. Sykes an option to purchase 17,040
shares of Common Stock at an exercise price of approximately $4.81 per share.
When issued, Mr. Sykes' option was scheduled to vest in three equal, annual
installments beginning on the first anniversary of the date of grant. In
September 1997 the Company made Mr. Sykes' option exercisable in full on
December 31, 1997 if this offering is completed prior to that date. Mr. Sykes'
option expires on the tenth anniversary of the date of grant. In September 1997,
as additional consideration for his consulting services, the Company granted Mr.
Sykes an option to purchase 23,000 shares of Common Stock pursuant to the 1997
Omnibus Plan with substantially the same terms as the 1997 Directors Options.
    
 
                                       35

<PAGE>   38
 
     In September 1997, the Company issued Dr. Russ an option to purchase 5,000
shares of Common Stock pursuant to the 1997 Omnibus Plan with substantially the
same terms as the 1997 Directors Options. The option was issued in consideration
of the sales, marketing and strategic consulting services that Dr. Russ has
performed on behalf of the Company without compensation.
 

EXECUTIVE COMPENSATION
 
     The following table sets forth certain information regarding compensation
paid during the Company's fiscal year ended December 31, 1996 to each individual
who served as chief executive officer of the Company during that fiscal year. No
executive officer of the Company received salary and bonus in excess of $100,000
in 1996.
 
                           SUMMARY COMPENSATION TABLE
 

<TABLE>
<CAPTION>
                                                                                         LONG TERM
                                                                                       COMPENSATION
                                                                                          AWARDS
                                                                                   ---------------------
                                                                       ANNUAL      SECURITIES UNDERLYING
                                                           FISCAL   COMPENSATION       OPTIONS/SARS
NAME AND PRINCIPAL POSITION                                 YEAR       SALARY         (NO. OF SHARES)
- ---------------------------                                ------   ------------   ---------------------
<S>                                                        <C>      <C>            <C>
Jeff N. Hunter...........................................   1996      $26,833             51,120
  President and Chairman of the Board
Paula K. Berardinelli(1).................................   1996      $25,733             12,780
  Former President and former Chairman of the Board
</TABLE>

 
- ---------------
 
(1) Dr. Berardinelli began a one-year unpaid leave of absence on May 1, 1997.
    Dr. Berardinelli served as President and Chairman of the Board of the
    Company from June 1995 to May 1996 and as Vice President of Sales and
    Marketing from June 1996 to April 1997. Dr. Berardinelli currently has a
    consulting agreement with the Company and is entitled to return to a
    position comparable to her prior position as Vice President of Sales and
    Marketing at the conclusion of her leave of absence. Dr. Berardinelli is the
    wife of Jeff N. Hunter, President and Chairman of the Board.
 
EMPLOYMENT AGREEMENTS
 
     The Company has entered into employment agreements with Jeff N. Hunter,
President and Chairman of the Board, Mark W. Hahn, Chief Financial Officer,
Treasurer and Secretary, Martin J. DeRoy, Vice President of Marketing, Thomas G.
Coleman, Director of Technology, Renee McCullen, Director of Sales, and Earl R.
Hines, Director of Manufacturing.
 
     Under the agreement with Mr. Hunter, which expires May 31, 2000, Mr. Hunter
is entitled to receive a base salary of $110,000 per year and to participate in
the Company's incentive compensation plan. If the Company terminates Mr.
Hunter's employment without cause, Mr. Hunter is entitled to receive, for the
remaining term of his employment agreement, annual compensation equal to the
highest annual compensation (including all cash bonuses and other cash-based
benefits) received by him during the immediately preceding three calendar years
(the "Termination Consideration"), and the Company will take such action as may
be required to vest any unvested benefits under any employee stock-based or
benefit plan. If the Company experiences a change of control and Mr. Hunter
voluntarily terminates his employment following a reduction in his
responsibilities, pay or position, or if his employment is terminated following
such change in control, the Company is obligated to pay Mr. Hunter a lump sum
equal to approximately three times his Termination Consideration and to continue
his benefits for a period of two years, and any unvested benefits under any
employee benefit plan will immediately vest and become exercisable. Upon the
termination of his employment with the Company, Mr. Hunter is prohibited from
competing with the Company or attempting to solicit the Company's customers or
employees for a period of one year.
 
     Mr. Hahn's employment agreement, which expires July 29, 2002, entitles Mr.
Hahn to receive a base salary of $95,000 per year, which base salary shall
increase to $122,000 per year upon the consummation of
 
                                       36

<PAGE>   39
 
this offering, and to participate in the Company's incentive compensation plan.
Mr. Hahn has rights substantially the same as those granted to Mr. Hunter in the
event his employment is terminated without cause or in the event of a change in
control. Upon the termination of his employment with the Company, Mr. Hahn is
prohibited from competing with the Company or attempting to solicit the
Company's customers or employees for a period of one year.
 
     By action of the Board of Directors, in the event of a change in control of
the Company, all stock options granted pursuant to the 1996 Option Plan will
immediately vest and become exercisable. As a result, the options granted to Mr.
Hunter and Mr. Hahn under the 1996 Option Plan pursuant to their respective
employment agreements or otherwise will vest and become immediately exercisable
upon any change in control of the Company.
 
     The Company has adopted an annual incentive compensation plan (the "Annual
Plan") whereby eligible employees are entitled to receive a cash bonus based on
the Company's performance in 1998. Each eligible employee is assigned a target
bonus equal to 20% to 70% of such employee's base salary. If the Company's net
revenues and pre-tax income meet or exceed the Company's targeted performance
level, each eligible employee will receive 100% of his or her target bonus. The
Annual Plan provides for increasing cash bonuses if the Company's net revenues
and pre-tax income exceed specified amounts. If pre-tax income is positive, but
below the targeted level, the employee's target bonus shall be reduced on a
linear basis. No bonuses will be earned or paid if the Company does not achieve
positive pre-tax income.
 
OPTION GRANTS TO CERTAIN EXECUTIVE OFFICERS
 
     The following table sets forth for each of the persons named in the Summary
Compensation Table certain information concerning stock options granted during
the year ended December 31, 1996.
 

<TABLE>
<CAPTION>
                                                    INDIVIDUAL GRANTS                      POTENTIAL REALIZABLE
                                  -----------------------------------------------------      VALUE AT ASSUMED
                                  NUMBER OF       PERCENT OF                              ANNUAL RATES OF STOCK
                                  SECURITIES     TOTAL OPTIONS                            PRICE APPRECIATION FOR
                                  UNDERLYING      GRANTED TO     EXERCISE                     OPTION TERM(3)
                                   OPTIONS       EMPLOYEES IN    PRICE PER   EXPIRATION   ----------------------
NAME                               GRANTED        FISCAL 1996      SHARE        DATE         5%          10%
- ----                              ----------     -------------   ---------   ----------   ---------   ----------
<S>                               <C>            <C>             <C>         <C>          <C>         <C>
Jeff N. Hunter..................    51,120(1)         48%          $1.88      5/31/06       $60,374     $152,999
Paula K. Berardinelli...........    12,780(2)         12%          $1.88      5/31/06       $15,093     $ 38,250
</TABLE>

 
- ---------------
 
(1) The option vests and becomes exercisable in three equal installments on each
    of the first three anniversaries of the date of grant (June 1, 1996) and
    expires to the extent not exercised on May 31, 2006.
(2) The option vested and became exercisable on April 30, 1997 and expires to
    the extent not exercised on May 31, 2006.
(3) The potential realizable value is calculated based on the term of the option
    at its time of grant (10 years) and is calculated by assuming that the stock
    price on the date of grant as determined by the Board of Directors
    appreciates at the indicated annual rate compounded annually for the entire
    term of the option and that the option is exercised and sold on the last day
    of its term for the appreciated price. The 5% and 10% assumed rates of
    appreciation are derived from the rules of the Securities and Exchange
    Commission and do not represent the Company's estimate or projection of the
    future Common Stock price.
 
     In July 1997, the Board of Directors granted the following options pursuant
to the 1996 Option Plan: Jeff N. Hunter -- 51,120 shares; and Paula K.
Berardinelli -- 12,780 shares each at an exercise price of approximately $4.81.
When issued, Mr. Hunter's option was scheduled to vest and become exercisable in
three equal, annual installments beginning on the first anniversary of the date
of grant, but in September 1997, the Company made Mr. Hunter's option
exercisable in full on December 31, 1997 if this offering is completed prior to
that date. Dr. Berardinelli's option vests and becomes exercisable upon the
completion of this offering. These options expire on the tenth anniversary of
the date of grant. See "-- Stock Option Plans -- 1996 Option Plan."
 
                                       37

<PAGE>   40
 
   
     In September 1997, subject to the completion of this offering, the Board of
Directors granted to Mr. Hunter an option to purchase 70,000 shares of Common
Stock pursuant to the 1997 Omnibus Plan at an exercise price equal to the
initial public offering price of the shares of Common Stock offered hereby.
Fifteen percent of the option vests and becomes exercisable on the completion of
this offering. The remaining 85% of the option vests in the event that the
Company achieves certain specified sales, earnings or profit margin goals prior
to December 31, 2001. The option expires on the tenth anniversary of the date of
grant. See "-- Stock Option Plans -- 1997 Omnibus Plan."
    
 
STOCK OPTION PLANS
 
  1996 Option Plan
 
     The 1996 Stock Option Plan of C3, Inc., as subsequently amended (the "1996
Option Plan"), was originally adopted by the Board of Directors and approved by
the shareholders of the Company effective as of June 1, 1996. The 1996 Option
Plan provides for the grant of options to purchase up to 777,450 shares of
Common Stock, subject to adjustment upon the occurrence of certain events
affecting the Company's capitalization, to the Company's key employees,
officers, directors and independent contractors. The Company currently has no
plans to award additional options under the 1996 Option Plan.
 
   
     The 1996 Option Plan has been administered since its inception by the Board
of Directors, but in October 1997 the Board of Directors authorized the
Compensation Committee to administer the 1996 Option Plan. The Compensation
Committee has authority to determine, subject to the provisions of the 1996
Option Plan, to whom and at what time options may be granted, the per share
exercise price, the duration of each option, the number of shares subject to
each option, the time when each option shall become exercisable and other terms,
conditions, limitations and restrictions of an option. The Board of Directors
has determined that, in the event of a change in control of the Company, all
stock options granted pursuant to the 1996 Option Plan will immediately vest and
become exercisable.
    
 
   
     Under the 1996 Option Plan, no option granted to an optionee who was an
employee of the Company at the time of grant may be exercised unless the
optionee (i) is, at the time of exercise, an employee of the Company and has
been an employee continuously since the date the option was granted or (ii) was,
within 90 days prior to the date of exercise, an employee of the Company and,
prior to the optionee's termination as an employee, had been an employee
continuously since the date the option was granted. The employment relationship
of an employee is treated as continuing intact for any period that the optionee
is on military or sick leave or other bona fide leave of absence, provided that
the period of such leave does not exceed 90 days, or, if longer, as long as the
optionee's right to reemployment is guaranteed either by statute or by contract.
The employment relationship of an optionee shall also be treated as continuing
intact while the optionee is not in active service because of "disability" as
defined in the 1996 Option Plan. If the employment of an optionee is terminated
because of a "disability" or death, the option may be exercised to the extent
exercisable on the date of the optionee's termination of employment (the
"Termination Date") for a period ending on the earlier of (i) the first
anniversary of the optionee's Termination Date or (ii) the expiration of the
option period. The Board of Directors may, in its discretion, accelerate the
date for exercising all or any part of an option which was not otherwise
exercisable on the Termination Date. In the event of the optionee's death, the
option will be exercisable by the person or persons who acquired the right to
exercise the option by will or by the laws of intestate succession.
    
 
   
     Unless an individual agreement provides otherwise, options granted to a
non-employee director of the Company or an independent contractor may be
exercised only if the optionee (i) is, at the time of exercise, a director of
the Company or independent contractor (as applicable) and has been in service
continuously since the date the option was granted or (ii) was, within 90 days
prior to the date of exercise, a director of the Company or independent
contractor (as applicable) and, prior to the optionee's termination from
service, had been a director or independent contractor (as applicable)
continuously since the date the option was granted. If service as a director or
independent contractor is terminated because of death, the option may be
exercised to the extent exercisable on the date of the optionee's death for a
period ending on the earlier of (i) the first anniversary of the optionee's
death or (ii) the expiration of the option period. In the event of the
optionee's
    
 
                                       38

<PAGE>   41
 
death, the option will be exercisable by such person or persons as shall have
acquired the right to exercise the option by will or by the laws of intestate
succession.
 
   
     At November 3, 1997, the Company had granted pursuant to the 1996 Option
Plan options to purchase 348,681 shares of Common Stock to employees (including
certain officers, see "-- Option Grants to Certain Executive Officers" and
"Principal Shareholders"), options to purchase 117,150 shares of Common Stock to
non-employee consultants and options to purchase 195,960 shares of Common Stock
to non-employee directors (see "-- Compensation of Directors" and "Principal
Stockholders"). All of such options remain outstanding. The exercise prices of
options granted under the 1996 Option Plan range from approximately $1.88 to
approximately $7.63 per share, with a weighted average of $3.95 per share. At
November 3, 1997, none of these options has been exercised. In addition, the
Company has issued options (the "Consultant Options") to purchase an additional
37,275 shares of Common Stock to certain independent consultants in connection
with the provision of services to the Company. All of these options are
currently exercisable at an exercise price of approximately $1.88 and expire
between May 25, 2001 and June 6, 2001.
    
 
  1997 Omnibus Plan
 
   
     The 1997 Omnibus Stock Plan of C3, Inc. (the "1997 Omnibus Plan") was
adopted by the Board of Directors and approved by the Company's shareholders
effective as of October 1, 1997. 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. Initially, a maximum of 477,979 shares of Common Stock may be
delivered pursuant to awards granted under the 1997 Omnibus Plan, and the Board
of Directors has reserved that number of shares for this purpose. 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.
    
 
   
     The 1997 Omnibus Plan has been administered by the Board of Directors, but
on October 27, 1997, the Board of Directors authorized the Compensation
Committee to administer the 1997 Omnibus Plan. The Compensation Committee has
the authority to take any action with respect to the plan and to determine all
matters relating to awards, including selection of individuals to be granted
awards, the types of awards, the number of shares of Common Stock subject to an
award, and the terms, conditions, restrictions and limitations of an award. The
Compensation Committee may delegate to the Company's chief executive officer the
authority to grant awards. The 1997 Omnibus Plan may be amended or terminated at
any time by the Board of Directors, subject to the following: (i) no amendment
or termination may adversely affect the rights of an award recipient with
respect to an outstanding award without the recipient's consent; and (ii)
shareholder approval is required of any amendment that would increase the number
of shares issuable under the 1997 Omnibus Plan (except to the extent of
adjustments, as discussed above), or materially change the requirements for
eligibility, unless such approval is not required under applicable law or rules.
    
 
     Stock appreciation rights ("SARs") may be granted with respect to all or a
portion of the shares of Common Stock subject to a related option or may be
granted separately. Upon exercise of an SAR, a participant is entitled to
receive from the Company consideration equal to the excess of the fair market
value of a share of Common Stock on the date of exercise over the SAR price
(subject to certain plan limitations). The consideration may be paid in cash,
shares of Common Stock (valued at fair market value on the date of the SAR
exercise), or a combination of cash and shares of Common Stock.
 
     Restricted awards may also be granted as the Compensation Committee may
determine. A restricted award may consist of a restricted stock award or a
restricted unit, or both. Restricted awards are payable in cash or whole shares
of Common Stock (including restricted stock), or partly in cash and partly in
whole shares of Common Stock, in the discretion of the Compensation Committee.
 
                                       39

<PAGE>   42
 
     The 1997 Omnibus Plan also provides that, upon a change of control of the
Company (as defined in the 1997 Omnibus Plan), all options and SARs outstanding
as of the date of the change of control shall become fully exercisable, any
restrictions applicable to any restricted awards shall be deemed to have
expired, and restricted awards shall become fully vested and payable to the
fullest extent of the original award. In the event of a merger, share exchange,
or other business combination affecting the Company in which the Board of
Directors or the surviving or acquiring corporation takes actions which, in the
opinion of the Compensation Committee, are equitable or appropriate to protect
the rights and interest of participants under the plan, the Compensation
Committee may determine that any or all awards shall not vest or become
exercisable on an accelerated basis.
 
   
     At November 3, 1997, the Board of Directors had granted, subject to the
completion of this offering, options to purchase 196,000 shares of Common Stock
to employees (including certain officers, see "-- Option Grants to Certain
Executive Officers"), options to purchase 26,000 shares of Common Stock to
non-employee consultants and options to purchase 88,000 shares of Common Stock
to non-employee directors (see "-- Compensation of Directors"). All these
options remain outstanding. The exercise price of these options will be equal to
the initial public offering price of the shares of Common Stock offered hereby.
    
 
                                       40

<PAGE>   43
 
                             PRINCIPAL SHAREHOLDERS
 
   
     The following table sets forth information with respect to the beneficial
ownership of Common Stock as of November 3, 1997, and as adjusted to reflect the
sale of shares of Common Stock offered hereby, by (i) each person known by the
Company to own beneficially five percent or more of the Company's outstanding
shares of Common Stock; (ii) each director of the Company; (iii) the executive
officers named in the Summary Compensation Table; and (iv) all current directors
and executive officers as a group. Beneficial ownership is determined in
accordance with the rules of the Securities and Exchange Commission (the
"Commission"). In computing the number of shares beneficially owned by a person
and the percentage ownership of that person, shares of Common Stock subject to
options or warrants held by that person that are currently exercisable or that
are or may become exercisable within 60 days of the date of this table are
deemed outstanding. Such shares, however, are not deemed outstanding for the
purposes of computing the percentage ownership of any other person. Except as
indicated in the footnotes to this table and pursuant to applicable community
property laws, each shareholder named in the table has sole voting and
investment power with respect to the shares set forth opposite such
shareholder's name.
    
 
   

<TABLE>
<CAPTION>
                                                                         PERCENTAGE OF
                                                          COMMON STOCK    CLASS PRIOR    PERCENTAGE OF
                                                          BENEFICIALLY        TO          CLASS AFTER
NAME(1)                                                      OWNED         OFFERING        OFFERING
- -------                                                   ------------   -------------   -------------
<S>                                                       <C>            <C>             <C>
C. Eric Hunter(2).......................................   1,054,627         26.8%           15.8%
General Electric Pension Trust(3).......................     587,032         14.9%            8.8%
Jeff N. Hunter(4).......................................     249,060          6.2%            3.7%
Paula K. Berardinelli(5)................................     195,960          4.9%            2.9%
Ollin B. Sykes(6).......................................     124,012          3.1%            1.8%
Kurt Leutzinger(7)......................................      26,310           *               *
Kurt Nassau(8)..........................................      20,927           *               *
Howard Rubin(9).........................................      17,200           *               *
Frederick A. Russ(10)...................................      15,700           *               *
Directors and Executive Officers as a Group (10
  persons)(11)..........................................     699,644         16.1%            9.9%
</TABLE>

    
 
- ---------------
 
   * Indicates less than one percent
 (1) Unless otherwise indicated, the address of each person is 3800 Gateway
     Boulevard, Suite 310 Morrisville, NC 27560.
 (2) Includes 23,430 shares of Common Stock held jointly by Mr. Hunter and his
     wife, Jocelyn Hunter. Mr. Hunter has shared voting and investment power
     over such shares. Mr. Hunter, one of the founders of the Company, was one
     of the founders of Cree and was formerly the President and Chief Executive
     Officer of Cree. Mr. Hunter's mailing address is 3104 Hillsborough Street,
     Box 189, Raleigh, North Carolina 27607.
   
 (3) Includes 9,270 shares of Common Stock issuable upon exercise of options
     granted under the 1986 Option Plan and 1997 Omnibus Plan. See
     "Management -- Stock Option Plans." The address of General Electric Pension
     Trust is 3003 Summer Street, Stamford, Connecticut 06904.
    
   
 (4) Includes (i) 170,400 shares of Common Stock held jointly by Mr. Hunter and
     his wife, Paula K. Berardinelli, over which Mr. Hunter has shared voting
     and investment power and (ii) 78,660 shares of Common Stock issuable upon
     exercise of options granted under the 1996 Option Plan and 1997 Omnibus
     Plan. See "Management -- Stock Option Plans." Does not include 25,560
     shares of Common Stock issuable to Dr. Berardinelli upon exercise of
     options granted under the 1996 Option Plan. Mr. Hunter disclaims beneficial
     ownership of such shares.
    
   
 (5) Includes (i) 170,400 shares of Common Stock held jointly by Dr.
     Berardinelli and her husband, Jeff N. Hunter, over which Dr. Berardinelli
     has shared voting and investment power and (ii) 25,560 shares of Common
     Stock issuable upon exercise of options granted under the 1996 Option Plan.
     See "Management -- Stock Option Plans -- 1996 Option Plan." Does not
     include 78,660 shares of Common Stock issuable upon exercise of options
     granted to Mr. Hunter under the 1996 Option Plan and 1997 Omnibus Plan. Dr.
     Berardinelli disclaims beneficial ownership of such shares.
    
   
 (6) Includes (i) 14,910 shares of Common Stock held by the Sykes & Co., P.A.
     Profit Sharing Plan & Trust and (ii) 46,800 shares of Common Stock issuable
     upon exercise of options granted under the 1996
    
 
                                       41

<PAGE>   44
 
   
     Option Plan and 1997 Omnibus Plan. See "Management -- Compensation of
     Directors" and "-- Stock Option Plans."
    
   
 (7) Includes 26,310 shares of Common Stock issuable upon exercise of options
     granted under the 1996 Option Plan and 1997 Omnibus Plan. See
     "Management -- Compensation of Directors" and "-- Stock Option Plans."
    
   
 (8) Includes (i) 3,727 shares of Common Stock held jointly by Dr. Nassau and
     his wife, Julia Nassau, over which Dr. Nassau has shared voting and
     investment power and (ii) 17,200 shares of Common Stock issuable upon
     exercise of options granted under the 1996 Option Plan and 1997 Omnibus
     Plan. See "Management -- Compensation of Directors" and "-- Stock Option
     Plans."
    
   
 (9) Includes 17,200 shares of Common Stock issuable upon exercise of options
     granted under the 1996 Option Plan and 1997 Omnibus Plan. See
     "Management -- Compensation of Directors" and "-- Stock Option Plans."
    
   
(10) Includes 15,700 shares of Common Stock issuable upon exercise of options
     granted under the 1996 Option Plan and 1997 Omnibus Plan. See
     "Management -- Compensation of Directors" and "-- Stock Option Plans."
    
   
(11) Includes (i) 174,127 shares of Common Stock over which certain directors
     and executive officers have shared voting and investment power and (ii)
     404,640 shares of Common Stock issuable upon exercise of options granted
     under the 1996 Option Plan and 1997 Omnibus Plan. See
     "Management -- Compensation of Directors" and "-- Stock Option Plans."
    
 

                              CERTAIN TRANSACTIONS
 
PRIVATE PLACEMENT TRANSACTIONS
 
     Since the incorporation of the Company in June 1995, the Company has
issued, in private placement transactions, shares of stock as follows (in each
case, before giving effect to the 2.13-for-1 stock split): 250,000 shares of
Common Stock at $4.00 per share in cash; 105,000 shares of Series A Preferred
Stock at $5.75 per share in cash; and 682,500 shares of Series B Preferred Stock
at $7.35 per share in cash. The Company has also issued shares of Common Stock
to certain founders of the Company and to Cree. See "-- Transactions with
Cree -- Other Transactions" and "-- Other Transactions." Each outstanding share
of Common Stock was split into 2.13 shares of Common Stock in September 1997,
and the outstanding shares of Series A Preferred Stock and Series B Preferred
Stock will automatically be converted into an aggregate of 1,677,375 shares of
Common Stock upon the consummation of this offering. The holders of shares of
Series B Preferred Stock are entitled to certain registration rights with
respect to the Common Stock issued or issuable upon conversion thereof. See
"Description of Capital Stock -- Registration Rights." The following table sets
forth the number of shares of Common Stock, Series A Preferred Stock and Series
B Preferred Stock purchased by the Company's directors, executive officers and
five percent shareholders and their respective affiliates and the number of
shares of Common Stock issuable, giving effect to the stock split and the
conversion of the Series A Preferred Stock and Series B Preferred Stock:
 
   

<TABLE>
<CAPTION>
                                                                                  COMMON
                                                     SERIES A     SERIES B      STOCK AFTER
                                         COMMON      PREFERRED    PREFERRED      SPLIT AND
INVESTOR                                STOCK(1)     STOCK(1)     STOCK(1)     CONVERSION(1)
- --------                                ---------    ---------    ---------    -------------
<S>                                     <C>          <C>          <C>          <C>
General Electric Pension Trust(2).....       --           --       271,250        577,762
F. Neal Hunter(3).....................   30,000        7,000            --         78,810
Ollin B. Sykes(4).....................   10,000           --        26,250         77,212
Thomas G. Coleman(5)..................   10,000        5,250         5,250         43,665
C. Eric Hunter(6).....................    7,500        3,500         1,750         27,157
William J. Sykes, Jr.(7)..............       --           --         8,750         18,637
Mark Harrill(8).......................    5,000           --         1,750         14,377
Monica R. Hunter(9)...................    5,000           --            --         10,650
Robert Angel(10)......................    2,500           --            --          5,325
Annabel C. Harrill(11)................    2,500           --            --          5,325
Kurt Nassau(12).......................       --           --         1,750          3,727
</TABLE>

    
 
See footnotes on following page.
 
                                       42

<PAGE>   45
 
- ---------------
 
 (1) Each share of outstanding Common Stock was split into 2.13 shares of Common
     Stock in September 1997 and each share of outstanding Series A Preferred
     Stock and Series B Preferred Stock will be automatically converted into
     2.13 shares of Common Stock contemporaneously with the consummation of this
     offering. Only the last column gives effect to these transactions.
   
 (2) David B. Stewart, who is a director of the Company, is an investment
     manager at General Electric Investment Company which is the investment
     advisor to GEPT.
    
   
 (3) Mr. Hunter is the President, CEO and a director of Cree and the brother of
     Jeff N. Hunter, who is President and Chairman of the Board of the Company,
     and C. Eric Hunter, who is the beneficial owner of 15.8% of the Company's
     Common Stock, giving effect to this offering.
    
   
 (4) Includes 7,000 shares of Series B Preferred Stock owned by Sykes & Company,
     P.A. Profit Sharing Plan and Trust of which Mr. Sykes is sole trustee.
    
   
 (5) Mr. Coleman is the Director of Technology of the Company.
    
 (6) Includes 7,500 shares of Common Stock and 3,500 shares of Series A
     Preferred Stock owned jointly by Mr. Hunter and his wife, Jocelyn Hunter.
     Mr. Hunter is the brother of Jeff N. Hunter.
   
 (7) Includes 8,750 shares of Series B Preferred Stock owned jointly by Mr.
     Sykes and his wife, Joyce M. Sykes. Mr. Sykes is the brother of Ollin B.
     Sykes, a director of the Company.
    
 (8) Includes (i) 5,000 shares of Common Stock owned jointly by Mr. Harrill and
     his wife, Melissa W. Harrill and (ii) 1,750 shares of Series B Preferred
     Stock owned by Foscoe Realty and Development Corporation, Inc., of which
     Mr. Harrill is the sole shareholder. Mr. Harrill is the step-brother of
     Jeff N. Hunter and C. Eric Hunter.
 (9) Dr. Hunter was, at the time of purchase, a sister-in-law of Jeff N. Hunter
     and C. Eric Hunter.
(10) Mr. Angel is the brother-in-law of Jeff N. Hunter and C. Eric Hunter.
(11) Includes 2,500 shares of Common Stock owned jointly by Mrs. Harrill and her
     husband, James Edward Harrill. Mrs. Harrill is the mother of Jeff N. Hunter
     and C. Eric Hunter.
(12) Includes 1,750 shares of Series B Preferred Stock owned jointly by Dr.
     Nassau, who is a director, and his wife, Julia Nassau.
 
TRANSACTIONS WITH CREE
 
   
     The Company is heavily dependent on Cree and Cree's technology. See
"Business -- Dependence on Cree and Cree Technology." Jeff N. Hunter, one of the
founders of the Company, President and Chairman of the Board, and C. Eric
Hunter, one of the founders of the Company and the beneficial owner of 15.8% of
the Common Stock outstanding after this offering, are the brothers of F. Neal
Hunter, the Chief Executive Officer of Cree. C. Eric Hunter was one of the
founders of Cree and was the President and Chief Executive Officer of Cree prior
to the time of any transactions between the Company and Cree. In May 1995, Mr.
Hunter entered into a consulting and noncompetition agreement with Cree
effective from July 1995 through July 1998 under which Cree is entitled to
request Mr. Hunter to provide consulting services. Mr. Hunter has agreed that
during the term of the agreement, he will not, among other activities, provide
services to, or have certain interests or positions in, businesses engaged in
the production of SiC substrates, the distribution of SiC substrates not
produced or purchased from Cree, or research and development in SiC substrates.
Cree and certain of its officers and directors will own approximately 3.5% of
the Common Stock outstanding after this offering. GEPT, which is the beneficial
owner of 8.8% of the Common Stock after giving effect to the automatic
conversion of the 1997 Series B Preferred Stock and this offering, was, as of
October 2, 1997, the beneficial owner of approximately 10.1% of the outstanding
common stock of Cree.
    
 
  Exclusive Supply Agreement
 
     On June 6, 1997, the Company and Cree entered into the Exclusive Supply
Agreement. See "Business -- Dependence on Cree and Cree Technology" for a more
detailed description of the terms of the Exclusive Supply Agreement. Under the
provisions of the Exclusive Supply Agreement, 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. Cree is
obligated to supply this amount of materials to the Company, and Cree has agreed
not to sell SiC crystals to anyone other than the Company for gemstone use.
 
                                       43

<PAGE>   46
 
The price for SiC crystals is equal to Cree's loaded manufacturing cost plus a
margin, which margin may increase if the price of crystals falls below a
specified amount.
 
     Under the Exclusive Supply Agreement, Cree may elect to have the Company
purchase the additional growth systems that will be required to meet the
Company's anticipated demand for SiC crystals or Cree may fund the costs of
these systems 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 Cree
elects to have the Company purchase the additional crystal growth systems, such
systems must remain at Cree's facilities and ownership of such systems will
transfer to Cree when the Company has fully depreciated their cost.
 
   
     The Exclusive Supply Agreement also prohibits the Company from entering
into certain types of arrangements with certain specified parties. See
"Description of Capital Stock -- Certain Anti-Takeover Provisions -- Exclusive
Supply Agreement." 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 million. The Company expects to meet this threshold and
extend the term of the Agreement.
    
 
  Development Agreement
 
     The Company is concentrating all of its development efforts with Cree under
the Development Agreement. For a full description of the Development Agreement,
see "Business -- Dependence on Cree and Cree Technology." 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. In addition, if Cree meets certain
development milestones by January 1, 1998, the Company will pay Cree a $200,000
bonus.
 
  Other Cree Transactions
 
     In June 1995, the Company granted to Cree the right 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 consideration and issue the
stock at any time during the option period. In January 1997, the Company issued
24,601 shares of Common Stock to Cree in satisfaction of these obligations. See
Note 5 of Notes to Financial Statements.
 
     In January 1996, the Company and Cree entered into a letter agreement under
which the Company agreed to assist Cree in prosecuting its patent application
for a particular process of producing colorless SiC crystals, and Cree granted
the Company an irrevocable nonexclusive royalty-free license to use that process
in connection with the manufacture, use and sale of lab-created moissanite
gemstones. Under this agreement, the Company is obligated to reimburse Cree for
all legal expenses incurred by Cree in preparing, filing, prosecuting and
maintaining any patents issued in connection with that process for producing
colorless SiC crystals.
 
     Under a February 1996 letter agreement, the Company has agreed to purchase
all of its requirements for the semiconductor chip component of its
moissanite/diamond test instrument from Cree, and Cree granted the Company the
exclusive right to purchase such chips for use in gemstone analysis and
verification equipment. The Company is obligated to purchase all of its
requirements for such chips from Cree at prices that may not exceed Cree's then
current list price for such chips and to pay Cree a royalty of 2 1/2% of net
sales of all test instruments incorporating the Cree chip. The letter agreement
has a term of twenty years.
 
   
     In February 1997, the Company subleased approximately 3,000 square feet of
mixed use space from Real Color Displays, Inc., a wholly owned subsidiary of
Cree. The lease agreement has an initial term ending in January 1998 and
provides for annual lease payments of $24,000 and a one-time payment of $6,000
for leasehold improvements. The Company has vacated these premises and is
attempting to sub-lease the premises to an unaffiliated third party for the
remainder of the lease term.
    
 
                                       44

<PAGE>   47
 
OTHER TRANSACTIONS
 
   
     In connection with the formation of the Company on June 30, 1995, the
Company issued 1,465,440 shares of Common Stock to C. Eric Hunter, a founder of
the Company and brother of Jeff N. Hunter, for an aggregate consideration of
$50,000. On June 30, 1995, the Company also issued to Jeff N. Hunter, a founder
of the Company, President and Chairman of the Board and Paula K. Berardinelli, a
founder of the Company, former President and Chairman of the Board and wife of
Jeff N. Hunter, as joint tenants with rights of survivorship, 170,400 shares of
Common Stock in consideration of services to be performed by them as officers of
the Company. The Company also issued, on June 30, 1995, an aggregate of 68,160
shares of Common Stock to two independent contractors who are not affiliates of
the Company. See Note 3 of Notes to Financial Statements.
    
 
     In connection with the financing of the Company during its start-up phase,
the Company borrowed funds and issued promissory notes to certain founders to
evidence such borrowings. In November 1995, the Company issued a note in the
principal amount of $10,000 to C. Eric Hunter. In January 1996, the Company
issued a note in the principal amount of $3,000 to Jeff N. Hunter and Paula K.
Berardinelli. In February 1996, the Company issued a promissory note in the
principal amount of $50,000 to C. Eric Hunter. All of these notes, which were
unsecured and bore interest at the rate of seven percent per annum, have been
paid in full. See Note 8 of Notes to Financial Statements.
 
     In August 1996, the Company entered into a consulting agreement with Thomas
G. Coleman, now the Director of Technology and an executive officer of the
Company, pursuant to which Mr. Coleman provided consulting services related to
the dicing of SiC crystals into lab-created moissanite gemstones for fees to be
mutually agreed upon plus expenses. The consulting agreement was terminated in
March 1997 when Mr. Coleman became an employee of the Company. During the term
of the agreement, the Company did not make any payments to Mr. Coleman. As
additional consideration for the consulting services to be performed by Mr.
Coleman, the Company granted Mr. Coleman an option to purchase 31,950 shares of
Common Stock at an exercise price of approximately $2.70. Mr. Coleman's option
was originally scheduled to vest and become exercisable in three equal
installments on each of the first three anniversaries of the date of grant. The
Company subsequently made these options exercisable in full upon the
consummation of this offering. Mr. Coleman's options expire on the tenth
anniversary of the date of grant.
 
     In May 1997, the Company entered into a consulting agreement with Paula K.
Berardinelli pursuant to which Dr. Berardinelli may provide marketing, sales,
management, organizational and other services to the Company for fees to be
mutually agreed upon plus expenses. From June 1996 to May 1997, Dr. Berardinelli
served as Vice President of Sales and Marketing of the Company, and the
consulting agreement was entered into in connection with Dr. Berardinelli
commencing a one-year unpaid leave of absence. If Dr. Berardinelli elects to
return to the Company, she will be entitled to a position comparable to her
prior position as Vice President of Sales and Marketing. To date, the Company
has not requested that Dr. Berardinelli perform consulting services under the
agreement and, consequently, has paid no fees to Dr. Berardinelli. Dr.
Berardinelli is the wife of Jeff N. Hunter, the President and Chairman of the
Board of the Company.
 
     In September 1997, the Company entered into a consulting agreement with C.
Eric Hunter pursuant to which Mr. Hunter will assist the Company in filing,
prosecuting and maintaining certain patents relating to the Company's
technology. The Company is obligated to pay Mr. Hunter a monthly consulting fee
of $1,800, and the first such payment is due in November 1997. The consulting
agreement has an initial term of two years.
 
   
     The Company has entered into employment agreements with certain of its
executive officers and consulting agreements with certain of its directors. The
Company has also granted options to purchase Common Stock under the 1996 Option
Plan and 1997 Omnibus Plan to certain executive officers and directors. See
"Management -- Employment Agreements," "-- Director Compensation" and "-- Stock
Option Plans."
    
 
   
FAIRNESS OF TRANSACTIONS
    
 
   
     The Company believes that all of the transactions listed under the caption
"Certain Transactions" were made on terms no less favorable to the Company than
could have been obtained in substantially similar transactions with unaffiliated
third parties. Future transactions between the Company and any officer,
director,
    
 
                                       45

<PAGE>   48
 
   
five percent shareholder or affiliate of the Company will be approved by a
majority of the Board of Directors and will be on terms no less favorable to the
Company than could be obtained in substantially similar transactions with
unaffiliated third parties.
    
 

                          DESCRIPTION OF CAPITAL STOCK
 
   
     Upon completion of this offering, the authorized capital stock of the
Company will consist of 50,000,000 shares of Common Stock, no par value, and
10,000,000 shares of Preferred Stock, no par value (the "Preferred Stock"), of
which 6,688,476 shares of Common Stock and no shares of Preferred Stock will be
issued and outstanding. All outstanding shares of Common Stock are, and the
shares of Common Stock offered hereby will be, when issued, duly authorized,
validly issued, fully paid and nonassessable shares of Common Stock of the
Company.
    
 
COMMON STOCK
 
     The holders of Common Stock are entitled to one vote per share on all
matters on which the holders of Common Stock are entitled to vote and do not
have cumulative voting rights in the election of directors. Holders of Common
Stock are entitled to receive dividends when, as and if declared by the
Company's Board of Directors out of funds legally available therefor. In the
event of the liquidation, dissolution or winding up of the Company, holders of
Common Stock will be entitled to share ratably in the assets, if any, available
for distribution after payment of all creditors and the liquidation preferences
on any outstanding shares of Preferred Stock. Holders of Common Stock have no
preemptive rights to subscribe for any additional securities of any class which
the Company may issue, nor any conversion, redemption or sinking fund rights.
The rights and privileges of holders of Common Stock are subject to the
preferences of any shares of Preferred Stock that the Company may issue in the
future.
 
NEW PREFERRED STOCK
 
     The Company may issue shares of Preferred Stock in one or more series as
may be determined by the Company's Board of Directors, who may establish, from
time to time, the number of shares to be included in each series, may fix the
designation, powers, preferences and rights of the shares of each such series
and any qualifications, limitations or restrictions thereof, and may increase or
decrease the number of shares of any such series without any further vote or
action by the shareholders. Any Preferred Stock so issued by the Board of
Directors may rank senior to the Common Stock with respect to the payment of
dividends or amounts upon liquidation, dissolution or winding up of the Company,
or both. In addition, any such shares of Preferred Stock may have class or
series voting rights. Moreover, under certain circumstances, the issuance of
Preferred Stock or the existence of the unissued Preferred Stock may tend to
discourage or render more difficult a merger or other change in control of the
Company. See "Risk Factors -- Anti-Takeover and Certain Other Provisions."
 
SERIES A PREFERRED STOCK AND SERIES B PREFERRED STOCK
 
   
     At November 3, 1997, the Company has issued and outstanding 105,000 shares
of Series A Preferred Stock and 682,500 shares of Series B Preferred Stock.
Under the Company's articles of incorporation, contemporaneously with the
effective date of this offering, the outstanding shares of Series A Preferred
Stock and Series B Preferred Stock will be converted automatically into an
aggregate of 1,677,375 shares of Common Stock pursuant to their terms, and
thereafter no shares of the Series A Preferred Stock or the Series B Preferred
Stock will be outstanding. No dividends have been or will be declared or paid on
the Series A Preferred Stock or Series B Preferred Stock.
    
 
CERTAIN ANTI-TAKEOVER 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
 
                                       46

<PAGE>   49
 
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 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.
 
     Certain Business Combinations.  The Company's articles of incorporation
require that any business combination, as defined in the articles, to be entered
into by the Company with a person or entity beneficially owning 10% or more of
the Company's outstanding voting shares (an "Interested Shareholder") be
approved by the affirmative vote of the holders of at least two-thirds of the
outstanding voting shares, including a majority of the outstanding voting shares
held by persons other than such Interested Shareholder and its affiliates, or,
alternatively, by two-thirds of certain members of the Board of Directors not
affiliated with such Interested Shareholder, unless all of the holders of the
Common Stock receive in the business combination an amount of consideration per
share equal to or greater than the highest price paid by the Interested
Shareholder in acquiring any of its holdings of Common Stock and the transaction
meets certain other minimum price requirements. The business combinations that
are subject to these provisions include a merger or share exchange with an
Interested Shareholder, sales to an Interested Shareholder of assets of the
Company having a value of $5.0 million or more and the issuances or transfers to
an Interested Shareholder by the Company or any of its subsidiaries of equity
securities of the Company or such subsidiary having a value of $5.0 million or
more. These provisions will make a takeover of the Company more difficult and
may have the effect of diminishing the possibility of certain types of
"front-end loaded" acquisitions of the Company or other unsolicited attempts to
acquire the Company.
 
     Advance Notice Requirements for Shareholder Proposals and Director
Nominations.  The Company's bylaws provide that a special meeting of
shareholders may be called only by the Board of Directors and certain designated
officers of the Company. Special meetings may not be called by the shareholders.
The Company's bylaws establish advance notice procedures for shareholder
proposals and the nomination, other than by or under the direction of the Board
of Directors or a committee thereof, of candidates for election as directors.
These procedures provide that the notice of shareholder proposals and
shareholder nominations for the election of directors be in writing, contain
certain specified information and be received by the Secretary of the Company
(i) in the case of an annual meeting that is called for a date that is within 30
days before or after the anniversary date of the immediately preceding annual
meeting of shareholders, not less than 60 days nor more than 90 days prior to
such anniversary date, and (ii) in the case of an annual meeting that is called
for a date that is not within 30 days before or after the anniversary date of
the immediately preceding annual meeting or, in the case of a special meeting of
shareholders, not later than the close of business on the tenth day following
the day on which notice of the date of the meeting was mailed or public
disclosure of the date of the meeting was made, whichever occurs first. These
provisions may preclude some shareholders from bringing matters before the
shareholders at any annual or special meeting, including making nominations for
directors.
 
   
     Amendment of Articles and Bylaws.  Subject to the North Carolina Business
Corporation Act, the Company's articles of incorporation may be amended by the
affirmative vote of a majority of the outstanding shares entitled to vote
thereon. Notwithstanding the foregoing, at a time that one or more Interested
Shareholders exist, the amendment or repeal of certain provisions of the
articles relating to the shares which the Company shall have authority to issue,
the approval of certain business combinations as described above and certain
other matters require the affirmative vote of the holders of two-thirds of the
Company's voting securities, unless approved by two-thirds of the members of the
Board of Directors not affiliated with the Interested Shareholder, other than
securities held by an Interested Shareholder. The articles further provide that
at a time that one or more Interested Shareholders exist, certain provisions of
the bylaws relating to the size and composition of the Board of Directors and
meetings of shareholders may be amended by the shareholders, only by the
affirmative vote of the holders of two-thirds of the outstanding shares of
voting securities, unless approved by two-thirds of the members of the Board of
Directors not affiliated with the Interested Shareholder. Moreover, the articles
provide that the Board of Directors may repeal, amend or adopt any bylaw
adopted, amended or repealed by the shareholders. These provisions will make it
more difficult for shareholders to amend the articles or bylaws.
    
 
                                       47

<PAGE>   50
 
  Exclusive Supply Agreement
 
   
     The terms of the Exclusive Supply Agreement prohibit the Company from
entering into an exclusive marketing or distribution agreement with DeBeers or
its affiliates or the Central Selling Organization, which is the international
diamond cartel, 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, asset sale or similar transactions with a Prohibited Party.
The Exclusive Supply Agreement may prevent the Company from entering into
certain potentially profitable transactions with the Prohibited Parties and may
limit the price that third parties might be willing to pay for some or all of
the shares of the Company's Common Stock.
    
 
ANTI-TAKEOVER LEGISLATION
 
     Pursuant to the Company's articles of incorporation, the Company has
elected not to be governed by the North Carolina Control Share Act, which
restricts the right of certain shareholders who acquire specified amounts of
Common Stock from voting those shares without certain approval by other
shareholders of the Company, and the North Carolina Shareholder Protection Act,
which imposes certain requirements for approval of transactions between the
Company and a shareholder beneficially owning in excess of 20% of the Common
Stock.
 
REGISTRATION RIGHTS
 
   
     The Company has entered into an agreement under which the current holders
of Series B Preferred Stock (the "Investor Holders") are entitled to certain
rights as described below with respect to the registration under the Securities
Act of 1933, as amended (the "Securities Act"), of the sale of up to 1,453,725
shares of Common Stock which will be issued upon the conversion of the Series B
Preferred Stock (the "Registrable Securities"). Subject to certain exceptions,
if the Company proposes to register the sale of any Common Stock for its own
account or the account of others, the Investor Holders are entitled to notice of
such registration and to include the Registrable Securities therein at the
Company's expense. The Company has obtained waivers of the foregoing rights from
the Investor Holders in connection with this offering. After March 18, 1998,
Investor Holders owning at least 40% of the Registrable Securities may require
the Company to file a registration statement at the Company's expense with
respect to the Registrable Securities held by the Investor Holders, and the
Company must use its diligent best efforts to effect such registration. The
Investor Holders may not require the Company to file more than two registration
statements pursuant to their demand registration rights. The foregoing
registration rights are subject to certain conditions and limitations, including
(i) the right of the Company not to effect a requested registration during the
90 days following this offering, (ii) the right of the Company not to effect a
requested registration during the 180 days following a request for such
registration if the Board of Directors determines that such registration would
be seriously detrimental to the Company and (iii) the right of the underwriters
of an offering to limit the number of Registrable Securities in the offering,
unless other holders of the Company's securities are permitted to include their
securities in such offering. Certain of the Investor Holders are subject to
additional limitations with respect to the exercise of registration rights under
certain contractual provisions agreed to with the Representative in connection
with this offering. See "Underwriting."
    
 
TRANSFER AGENT AND REGISTRAR
 
     The Transfer Agent and Registrar for the Company's Common Stock is First
Union National Bank. Its address is 230 South Tryon Street, Charlotte, NC
28288-1179, and its telephone number at this location is 704-383-5406.
 
LISTING
 
     The Company has applied for inclusion of the Common Stock on the Nasdaq
National Market under the symbol "CTHR."
 
                                       48

<PAGE>   51
 
                        SHARES ELIGIBLE FOR FUTURE SALE
 
     Prior to this offering, there has been no market for the Common Stock.
Future sales of substantial amounts of Common Stock in the public market could
adversely affect market prices prevailing from time to time. Furthermore,
because only a limited number of shares will be available for sale shortly after
this offering as a result of certain contractual and legal restrictions on
resale as described below, sales of substantial amounts of Common Stock in the
public market after the restrictions lapse could adversely affect the prevailing
market price and the ability of the Company to raise equity capital in the
future.
 
   
     Upon completion of this offering, the Company will have outstanding an
aggregate of 6,688,476 shares of Common Stock, assuming no exercise of the
Over-allotment Option and no exercise of outstanding options to purchase Common
Stock. Of these shares, the 2,750,000 shares sold in this offering will be
freely tradeable without restriction or further registration under the
Securities Act (except for any shares purchased by "affiliates," as that term is
defined in Rule 144 under the Securities Act ("Affiliate")). Of the remaining
shares of Common Stock, the Company believes that 1,951,994 shares (the
"Affiliate Shares") will be held by Affiliates and 1,986,482 shares (the
"Nonaffiliate Shares") will be held by nonaffiliates of the Company. All of such
shares of Common Stock are "restricted securities" as that term is defined in
Rule 144 under the Securities Act ("Restricted Shares"). Restricted Shares may
be sold in the public market only if registered or if they qualify for an
exemption from registration under Rules 144 (including Rule 144(k)) or 701
promulgated under the Securities Act, which rules are summarized below or if
another exemption from registration is available. Pursuant to the provisions of
Rules 144 (including Rule 144(k)) and 701, the Company believes Restricted
Shares will be available for sale in the public market as follows: (i) no
Restricted Shares will be eligible for immediate sale on the date of this
Prospectus; (ii) 1,897,020 Nonaffiliate Shares and 24,601 Affiliate Shares will
be eligible for sale 90 days after the effective date of this offering (the date
on which these shares will be eligible for resale is assumed to be February 12,
1998); (iii) 1,927,393 Affiliate Shares will be eligible for sale upon
expiration of lock-up agreements one year after the date of this Prospectus; and
(iv) 89,462 Nonaffiliate Shares will become eligible for sale upon the
expiration of their one-year holding periods between February 13, 1998 and March
7, 1998.
    
 
   
     Beginning on March 18, 1997, the holders of 1,453,725 shares of Common
Stock issued upon the automatic conversion of the Series B Preferred Stock, or
their transferees, will be entitled to cause the Company to register their
shares for sale. In addition, such holders will be entitled to participate in
any registration of securities effected by the Company after the consummation of
this offering. See "Description of Capital Stock -- Registration Rights."
Registration of such shares under the Securities Act would result in such shares
becoming freely tradeable without restriction under the Securities Act (except
for shares purchased by Affiliates) immediately upon the effectiveness of such
registration.
    
 
   
     In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this Prospectus, a person (or persons whose shares are aggregated)
who has beneficially owned Restricted Shares for at least one year (including
the holding period of any prior owner except an Affiliate) would be entitled to
sell within any three-month period a number of shares that does not exceed the
greater of: (i) one percent of the number of shares of Common Stock then
outstanding (which will equal approximately 66,884 shares immediately after this
offering); or (ii) the average weekly trading volume of the Common Stock on the
Nasdaq National Market during the four calendar weeks preceding the filing of a
notice on Form 144 with respect to such sale. Sales under Rule 144 are also
subject to certain manner of sale provisions and notice requirements and to the
availability of current public information about the Company. Under Rule 144(k),
a person who is not deemed to have been an Affiliate of the Company at any time
during the 90 days preceding a sale, and who has beneficially owned the shares
proposed to be sold for at least two years (including the holding period of any
prior owner except an Affiliate), is entitled to sell such shares without
complying with the manner of sale, public information, volume limitation or
notice provisions of Rule 144; therefore, unless otherwise restricted, "144(k)
shares" may be sold immediately upon the completion of this offering. In
general, under Rule 701 of the Securities Act as currently in effect, any
employee, consultant or advisor of the Company who purchased shares from the
Company in connection with a compensatory stock or option plan or other written
compensation agreement is eligible to resell such shares 90 days after the
effective date of this offering in
    
 
                                       49

<PAGE>   52
 
reliance on Rule 144, but without compliance with certain restrictions,
including the holding period, contained in Rule 144.
 
   
     All of the Common Shares held by the Company's officers, directors and
beneficial owners of more than five percent of the Company's Common Stock,
aggregating 1,927,393 shares, are subject to lock-up agreements with the
Underwriters and may not be sold or otherwise transferred until one year after
the date of this Prospectus without the consent of the Representative. The
Representative may, in its sole discretion and at any time without notice,
release all or any portion of the securities subject to these lock-up
agreements.
    
 
   
     The Company intends to file registration statements under the Securities
Act covering shares of Common Stock reserved for issuance under the 1996 Option
Plan and the 1997 Omnibus Plan. Based on the number of options outstanding under
the 1996 Option Plan and the number of shares reserved for issuance under the
1997 Omnibus Plan, such registration statements would cover approximately
1,139,770 shares. See "Management -- Stock Option Plans." Such registration
statements are expected to be filed and become effective as soon as practicable
after the effective date of this offering. Accordingly, shares registered under
such registration statements will, subject to Rule 144 volume limitations
applicable to Affiliates, be available for sale in the open market, unless such
shares are subject to vesting restrictions with the Company or the lock-up
agreements described above. At November 3, 1997, options to purchase 971,791
shares of Common Stock were issued and outstanding under the 1996 Option Plan
and 1997 Omnibus Plan. See "Management -- Director Compensation" and "-- Stock
Option Plans."
    
 
                                       50

<PAGE>   53
 

                                  UNDERWRITING
 
     The Underwriters named below, acting through Paulson Investment Company,
Inc., the Representative, have agreed, severally and not jointly, subject to the
terms and conditions contained in the Underwriting Agreement, to purchase the
Common Stock offered hereby in the amounts set forth below:
 
   

<TABLE>
<CAPTION>
                                                              NUMBER OF
                        UNDERWRITER                            SHARES
                        -----------                           ---------
<S>                                                           <C>
Paulson Investment Company, Inc.............................
 
                                                              ---------
          Total.............................................  2,750,000
                                                              =========
</TABLE>

    
 
     The Underwriting Agreement provides that the Underwriters are obligated to
purchase all of the shares of the Common Stock offered hereby if any shares are
purchased. The Company has been advised that the Underwriters propose to offer
the Common Stock to the public initially at the offering price shown on the
cover page of this Prospectus and to selected dealers, including Underwriters,
at that price less a concession to be determined by the Representative. After
the initial public offering of the Common Stock, the public offering price and
other offering terms may be changed.
 
   
     The Company has granted the Underwriters the Over-allotment Option,
exercisable by the Representative during the 45-day period after the date of
this Prospectus, to purchase up to 412,500 additional shares on the same terms
as the Common Stock being purchased by the Underwriters from the Company. The
Representative may exercise this option only to cover over-allotments in the
sale of the Common Stock.
    
 
     The Underwriters will purchase the Common Stock (including the shares
subject to the Over-allotment Option) offered hereby at a discount equal to
       % of the public offering price, or $          per share. The
Representative will also receive at the Closing a non-accountable expense
allowance equal to 1% of the aggregate initial public offering price of the
Common Stock sold in this offering of which $35,000 has already been paid. In
the event the offering is not consummated, any non-accountable portion of the
advanced payment will be returned to the Company.
 
   
     The Company has agreed to issue the Representative's Warrants to the
Representative. The Representative's Warrants will allow the Representative to
purchase up to 275,000 shares of Common Stock. The Representative's Warrants are
exercisable for a period of four years beginning one year from the date of this
Prospectus, at a price of $          per share (120% of the initial public
offering price of the shares) and are nontransferable for one year after the
date of this Prospectus except (i) to any of the Underwriters or to individuals
who are either an officer or a partner of an Underwriter or (ii) by will or the
laws of descent and distribution. The holders of the Representative's Warrants
will have, in that capacity, no voting, dividend or other shareholder rights.
Any profits realized on the sale of the Common Stock issuable on exercise of the
Representative's Warrants may be deemed to be additional underwriting
compensation.
    
 
     The sale of the shares issuable upon exercise of the Representative's
Warrants could dilute the interests of the other holders of Common Stock, and
the existence of the Representative's Warrants may make the raising of
additional capital by the Company more difficult. At any time at which exercise
of the Representative's Warrants might be expected, it is likely that the
Company could raise additional capital on terms more favorable than the terms of
the Representative's Warrants.
 
   
     All officers, directors and five percent shareholders of the Company, who
own an aggregate of 1,927,393 shares of Common Stock, have agreed not to sell
any Common Stock of the Company owned by such person, pursuant to Rule 144 under
the Securities Act or otherwise, and the Company has agreed not to sell any
Common Stock (other than shares issuable upon the exercise of options under the
1996 Option Plan or the
    
 
                                       51

<PAGE>   54
 
   
1997 Omnibus Plan), without the prior written consent of the Representative, for
a period of one year after the date of this Prospectus. In addition, for the
two-year period following this offering certain officers, directors and five
percent shareholders of the Company holding an aggregate of 1,349,631 shares
have agreed to give the Representative prior notice of any sale to be effected
pursuant to Rule 144 under the Securities Act.
    
 
     In addition, the Company has agreed to indemnify the Underwriters against
certain liabilities, including liabilities under the Securities Act, and to
contribute in certain events to any liabilities incurred by the Underwriters in
connection with the sale of the Common Stock.
 
   
     At the request of the Company, the Underwriters have reserved approximately
100,000 of the shares of Common Stock offered by the Company hereby for sale at
the initial public offering price to directors, officers, employees and certain
individuals associated with the Company, its directors, its officers or its
employees. The number of shares of Common Stock available to the public will be
reduced to the extent such persons purchase such reserved shares. Any reserved
shares that are not so purchased will be offered by the Underwriters to the
general public on the same basis as the other shares offered hereby.
    
 
     The Representative has advised the Company that, pursuant to Regulation M
under the Securities Act, certain persons participating in the offering may
engage in transactions, including stabilizing bids, syndicate covering
transactions or the imposition of penalty bids, which may have the effect of
stabilizing or maintaining the market price of the Common Stock at a level above
that which might otherwise prevail in the open market. A "stabilizing bid" is a
bid for or the purchase of the Common Stock on behalf of the Underwriters for
the purpose of fixing or maintaining the price of the Common Stock. A "syndicate
covering transaction" is the bid for or the purchase of Common Stock on behalf
of the Underwriters to reduce a short position incurred by the Underwriters in
connection with the offering. A "penalty bid" is an arrangement permitting the
Representative to reclaim the selling concession otherwise accruing to an
Underwriter or syndicate member in connection with the offering if the Common
Stock originally sold by such Underwriter or syndicate member is purchased by
the Representative in a syndicate covering transaction and has therefore not
been effectively placed by such Underwriter or syndicate member. The
Representative has advised the Company that such transactions may be effected on
the Nasdaq National Market or otherwise and, if commenced, may be discontinued
at any time.
 
     Prior to the offering, there has been no public market for the Common
Stock. The price to the public for the Common Stock will be determined through
negotiations between the Company and the Representative and will be based on,
among other things, the Company's financial condition, the prospects of the
Company and its industry in general, the management of the Company and the
market prices of securities of companies engaged in business similar to those of
the Company.
 

                                 LEGAL MATTERS
 
     The validity of the Common Stock offered hereby will be passed upon for the
Company by Womble Carlyle Sandridge & Rice, PLLC, Research Triangle Park, North
Carolina. One of the members of Womble Carlyle Sandridge & Rice, PLLC holds
10,650 shares of Common Stock, which were purchased from the Company in May 1996
in a private placement transaction. Certain legal matters in connection with
this offering will be passed upon for the Underwriters by Grover T. Wickersham,
P.C., Palo Alto, California.
 

                                    EXPERTS
 
     The financial statements as of December 31, 1996 and 1995 and for the year
ended December 31, 1996, the seven-month period ended December 31, 1995, and the
period from June 28, 1995 (date of inception) to December 31, 1996 included in
this Prospectus have been audited by Deloitte & Touche LLP, independent
auditors, as stated in their report appearing herein, and are included in
reliance upon the report of such firm given upon their authority as experts in
accounting and auditing.
 
                                       52

<PAGE>   55
 
                             ADDITIONAL INFORMATION
 
     The Company has filed with the Commission a registration statement on Form
S-1 (the "Registration Statement") (which term shall encompass all amendments,
exhibits and schedules thereto) under the Securities Act with respect to the
shares of Common Stock offered hereby. This Prospectus, which constitutes part
of the Registration Statement, does not contain all the information set forth in
the Registration Statement, certain parts of which are omitted in accordance
with the rules and regulations of the Commission, and to which reference is
hereby made. For further information with respect to the Company and the Common
Stock, reference is hereby made to the Registration Statement. Statements made
in this Prospectus as to the contents of any contract, agreement or other
document referred to are not necessarily complete. With respect to each such
contract, agreement or other document filed as an exhibit to the Registration
Statement, reference is made to the exhibit for a more complete description of
the matter involved, and each such statement shall be deemed qualified in its
entirety by such reference. The Registration Statement can be inspected and
copied at the Public Reference Section of the Commission at Room 1024, 450 Fifth
Street, N.W., Washington, D.C. 20549, and at the Commission's regional offices
at Seven World Trade Center, 13th Floor, New York, New York 10048, and Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511.
Copies of the Registration Statement can be obtained from the Public Reference
Section of the Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C.
20549, at prescribed rates. In addition, the Commission maintains a World Wide
Web site on the Internet at http://www.sec.gov that contains reports, proxy and
information statements and other documents filed electronically with the
Commission, including the Registration Statement.
 
     The Company intends to furnish its shareholders with annual reports
containing financial statements audited by its independent public accountants
and quarterly reports containing unaudited financial information for the first
three quarters of each fiscal year.
 
                                       53

<PAGE>   56
 
                                    C3, INC.
 

                         INDEX TO FINANCIAL STATEMENTS
 
   

<TABLE>
<S>                                                           <C>
Independent Auditors' Report................................  F-2
 
Balance Sheets as of December 31, 1995 and 1996, and
  September 30, 1997........................................  F-3
 
Statements of Operations for the seven-month period ended
  December 31, 1995, the year ended December 31, 1996, the
  period from June 28, 1995 (date of inception) to December
  31, 1996, the nine months ended September 30, 1996 and
  1997, and the period from June 28, 1995 (date of
  inception) to September 30, 1997..........................  F-4
 
Statements of Shareholders' Equity for the seven-month
  period ended December 31, 1995, the year ended December
  31, 1996, and for the nine months ended September 30,
  1997......................................................  F-5
 
Statements of Cash Flows for the seven-month period ended
  December 31, 1995, the year ended December 31, 1996, the
  period from June 28, 1995 (date of inception) to December
  31, 1996, the nine months ended September 30, 1996 and
  1997, and the period from June 28, 1995 (date of
  inception) to September 30, 1997..........................  F-6
 
Notes to Financial Statements...............................  F-7
</TABLE>

    
 
                                       F-1

<PAGE>   57
 

                          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, 1995 and 1996, and the related statements of
operations, shareholders' equity, and cash flows for the seven-month period
ended December 31, 1995, the year ended December 31, 1996, and the period from
June 28, 1995 (date of inception) to December 31, 1996.
 
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, 1995 and 1996
and the results of its operations, and cash flows for the seven-month period
ended December 31, 1995, the year ended December 31, 1996, and the period from
June 28, 1995 (date of inception) to December 31, 1996 in conformity with
generally accepted accounting principles.
 
Deloitte & Touche LLP
 
Raleigh, North Carolina
March 11, 1997, except for Note 9, as to which the date is September 25, 1997

 
                                       F-2

<PAGE>   58
 
                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
 
                                 BALANCE SHEETS
 
   

<TABLE>
<CAPTION>
                                                                                        PROFORMA
                                                                      SEPTEMBER 30,   SEPTEMBER 30,
                                                1995        1996          1997            1997
                                              --------   ----------   -------------   -------------
                                                                                       (UNAUDITED)
                                                                       (UNAUDITED)      (NOTE 2)
<S>                                           <C>        <C>          <C>             <C>
                                              ASSETS
CURRENT ASSETS:
  Cash and equivalents......................  $  9,109   $1,167,458     $ 4,737,864     $ 4,737,864
  Miscellaneous receivable..................                                  1,000           1,000
  Inventory.................................                                 17,911          17,911
  Prepaid and other assets..................     9,346        7,000         118,421         118,421
                                              --------   ----------     -----------     -----------
          Total current assets..............    18,455    1,174,458       4,875,196       4,875,196
EQUIPMENT, net of accumulated depreciation
  of $542 and $2,352 at December 31, 1995
  and 1996, respectively....................     5,560       14,081          94,380          94,380
PATENT AND LICENSE RIGHTS, net of
  accumulated amortization of $256 and
  $2,064 at December 31, 1995 and 1996,
  respectively..............................     8,898       37,595         115,472         115,472
                                              --------   ----------     -----------     -----------
          TOTAL ASSETS......................  $ 32,913   $1,226,134     $ 5,085,048     $ 5,085,048
                                              ========   ==========     ===========     ===========
CURRENT LIABILITIES:
  Notes payable (Note 8)....................  $ 10,100   $              $               $

  Accounts payable..........................                 12,855         469,962         469,962
                                              --------   ----------     -----------     -----------
          Total current liabilities.........    10,100       12,855         469,962         469,962
                                              --------   ----------     -----------     -----------
COMMITMENTS (Note 7)
SHAREHOLDERS' EQUITY
  (Notes 3, 4, 5 and 9):
  1996 Series A preferred stock, no par
     value; 105,000 shares authorized,
     issued and outstanding at December 31,
     1996 and September 30, 1997
     (unaudited); none authorized or issued
     and outstanding on a pro forma basis at
     September 30, 1997 (unaudited).........                593,271         593,271
  1997 Series B preferred stock, no par
     value; 682,500 shares authorized,
     issued and outstanding at September 30,
     1997 (unaudited); none authorized or
     issued and outstanding on a pro forma
     basis at September 30, 1997
     (unaudited)............................                              4,981,376
  Common stock, no par value; 10 million
     shares authorized; 1,704,000 shares,
     2,236,500 shares, 2,261,101 shares and
     3,938,476 shares issued and outstanding
     at December 31, 1995 and 1996,
     September 30, 1997 (unaudited) and
     September 30, 1997 on a pro forma basis
     (unaudited), respectively..............    50,000    1,029,803       1,095,803       6,670,450
  Additional paid-in capital -- stock
     options................................                                109,000         109,000
  Deficit accumulated during the development
     stage..................................   (27,187)    (409,795)     (2,164,364)     (2,164,364)
                                              --------   ----------     -----------     -----------
          Total shareholders' equity........    22,813    1,213,279       4,615,086       4,615,086
                                              --------   ----------     -----------     -----------
TOTAL LIABILITIES AND SHAREHOLDERS'
  EQUITY....................................  $ 32,913   $1,226,134     $ 5,085,048     $ 5,085,048
                                              ========   ==========     ===========     ===========
</TABLE>

    
 
                       See notes to financial statements.
 
                                       F-3

<PAGE>   59
 
                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
 
                            STATEMENTS OF OPERATIONS
 
   

<TABLE>
<CAPTION>
                                                         CUMULATIVE
                        SEVEN-MONTH                    FOR THE PERIOD       NINE MONTHS ENDED          CUMULATIVE
                        PERIOD ENDED    YEAR ENDED    JUNE 28, 1995 TO        SEPTEMBER 30,          FOR THE PERIOD
                        DECEMBER 31,   DECEMBER 31,     DECEMBER 31,     -----------------------    JUNE 28, 1995 TO
                            1995           1996             1996            1996         1997      SEPTEMBER 30, 1997
                        ------------   ------------   ----------------   ----------   ----------   ------------------
                                                                               (UNAUDITED)            (UNAUDITED)
<S>                     <C>            <C>            <C>                <C>          <C>          <C>
OPERATING EXPENSES:
  Marketing and
     sales............   $   10,313     $   47,019       $   57,332      $    8,567   $  233,397       $  290,729
  General and
     administrative...       10,024        131,097          141,121          62,456      660,993          802,114
  Research and
     development......        6,052        236,047          242,099         134,598    1,029,918        1,272,017
  Depreciation and
     amortization.....          798          3,618            4,416           2,180       14,668           19,084
                         ----------     ----------       ----------      ----------   ----------       ----------
OPERATING LOSS........       27,187        417,781          444,968         207,801    1,938,976        2,383,944
INTEREST INCOME,
  net.................                     (35,173)         (35,173)        (17,530)    (184,407)        (219,580)
                         ----------     ----------       ----------      ----------   ----------       ----------
NET LOSS..............   $   27,187     $  382,608       $  409,795      $  190,271   $1,754,569       $2,164,364
                         ==========     ==========       ==========      ==========   ==========       ==========
Pro forma net loss per
  share (Note 2)......   $     0.01     $     0.14       $     0.16      $     0.08   $     0.41       $     0.71
                         ==========     ==========       ==========      ==========   ==========       ==========
Pro forma weighted
  average common
  shares and
  equivalent common
  shares outstanding
  (Note 2)............    2,204,062      2,652,250        2,487,128       2,549,595    4,279,498        3,063,247
                         ==========     ==========       ==========      ==========   ==========       ==========
</TABLE>

    
 
                       See notes to financial statements.
 
                                       F-4

<PAGE>   60
 
                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
 
                       STATEMENTS OF SHAREHOLDERS' EQUITY
   

<TABLE>
<CAPTION>
                                  1996                    1997
                                SERIES A                SERIES A                                   ADDITIONAL     DEFICIT
                            PREFERRED STOCK         PREFERRED STOCK            COMMON STOCK         PAID-IN     ACCUMULATED
                          --------------------   ----------------------   ----------------------   CAPITAL --   DURING THE
                          NUMBER OF              NUMBER OF                NUMBER OF                  STOCK      DEVELOPMENT
                           SHARES      AMOUNT     SHARES       AMOUNT      SHARES       AMOUNT      OPTIONS        STAGE
                          ---------   --------   ---------   ----------   ---------   ----------   ----------   -----------
<S>                       <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 be
    provided............              $                      $            1,704,000   $   50,000    $           $
         Net loss.......                                                                                            (27,187)
                           -------    --------    -------    ----------   ---------   ----------    --------    -----------
BALANCE, DECEMBER 31,
  1995..................                                                  1,704,000       50,000                    (27,187)
  Issuance of common
    stock, net of
    offering costs of
    $20,197.............                                                   532,500       979,803
  Issuance of 1996
    Series A preferred
    stock, net of
    offering costs of
    $10,479.............   105,000     593,271
         Net loss.......                                                                                           (382,608)
                           -------    --------    -------    ----------   ---------   ----------    --------    -----------
BALANCE, DECEMBER 31,
  1996..................   105,000     593,271                            2,236,500    1,029,803                   (409,795)
  Exercise of stock
    option..............                                                    24,601        66,000
  Issuance of 1997
    Series B preferred
    stock, net of
    offering costs of
    $34,999.............                          682,500     4,981,376
  Compensation expense
    related to stock
    options.............                                                                             109,000
         Net loss.......                                                                                         (1,754,569)
                           -------    --------    -------    ----------   ---------   ----------    --------    -----------
BALANCE, SEPTEMBER 30,
  1997 (UNAUDITED)......   105,000    $593,271    682,500    $4,981,376   2,261,101   $1,095,803    $109,000    $(2,164,364)
                           =======    ========    =======    ==========   =========   ==========    ========    ===========
 
<CAPTION>
 
                              TOTAL
                          SHAREHOLDERS'
                             EQUITY
                          -------------
<S>                       <C>
BALANCE, JUNE 28, 1995
  (date of inception) --
  Issuance of common
    stock to founders
    and independent
    contractors for cash
    and consideration of
    services to be
    provided............   $    50,000
         Net loss.......       (27,187)
                           -----------
BALANCE, DECEMBER 31,
  1995..................        22,813
  Issuance of common
    stock, net of
    offering costs of
    $20,197.............       979,803
  Issuance of 1996
    Series A preferred
    stock, net of
    offering costs of
    $10,479.............       593,271
         Net loss.......      (382,608)
                           -----------
BALANCE, DECEMBER 31,
  1996..................     1,213,279
  Exercise of stock
    option..............        66,000
  Issuance of 1997
    Series B preferred
    stock, net of
    offering costs of
    $34,999.............     4,981,376
  Compensation expense
    related to stock
    options.............       109,000
         Net loss.......    (1,754,569)
                           -----------
BALANCE, SEPTEMBER 30,
  1997 (UNAUDITED)......   $ 4,615,086
                           ===========
</TABLE>

    
 
                       See notes to financial statements.
 
                                       F-5

<PAGE>   61
 
                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
 
                            STATEMENTS OF CASH FLOWS
 
   

<TABLE>
<CAPTION>
                                                               CUMULATIVE
                              SEVEN-MONTH                    FOR THE PERIOD        NINE MONTHS ENDED           CUMULATIVE
                              PERIOD ENDED    YEAR ENDED    JUNE 28, 1995 TO         SEPTEMBER 30,           FOR THE PERIOD
                              DECEMBER 31,   DECEMBER 31,     DECEMBER 31,     -------------------------    JUNE 28, 1995 TO
                                  1995           1996             1996            1996          1997       SEPTEMBER 30, 1997
                              ------------   ------------   ----------------   -----------   -----------   ------------------
                                                                                      (UNAUDITED)             (UNAUDITED)
<S>                           <C>            <C>            <C>                <C>           <C>           <C>
OPERATING ACTIVITIES:
  Net loss..................    $(27,187)     $ (382,608)      $ (409,795)     $  (190,271)  $(1,754,569)     $(2,164,364)
  Adjustments:
    Depreciation and
      amortization..........         798           3,618            4,416            2,180        14,668           19,084
    Compensation expense
      related to exercise
      and issuance of stock
      options...............                                                                     175,000          175,000
    Changes in assets and
      liabilities:
      Miscellaneous
        Receivable..........                                                                      (1,000)          (1,000)
      Inventory.............                                                                     (17,911)         (17,911)
      Prepaid and other
        assets..............      (9,346)          2,346           (7,000)           9,446      (111,421)        (118,421)
      Accounts payable......                      12,855           12,855             (100)      457,107          469,962
                                --------      ----------       ----------      -----------   -----------      -----------
        Net cash used in
          operating
          activities........     (35,735)       (363,789)        (399,524)        (178,745)   (1,238,126)      (1,637,650)
                                --------      ----------       ----------      -----------   -----------      -----------
INVESTING ACTIVITIES:
  Purchase of equipment.....      (6,102)        (10,331)         (16,433)          (1,744)      (91,317)        (107,750)
  Patent costs..............      (9,154)        (30,505)         (39,659)         (24,162)      (81,527)        (121,186)
                                --------      ----------       ----------      -----------   -----------      -----------
        Net cash used in
          investing
          activities........     (15,256)        (40,836)         (56,092)         (25,906)     (172,844)        (228,936)
                                --------      ----------       ----------      -----------   -----------      -----------
FINANCING ACTIVITIES:
  Proceeds from notes
    payable.................      10,100          53,000           63,100                                          63,100
  Repayment of notes
    payable.................                     (63,100)         (63,100)         (10,000)                       (63,100)
  Proceeds from common stock
    offerings, net of
    costs...................      50,000         979,803        1,029,803          979,803                      1,029,803
  Proceeds from preferred
    stock offerings, net of
    costs...................                     593,271          593,271          593,271     4,981,376        5,574,647
                                --------      ----------       ----------      -----------   -----------      -----------
        Net cash provided by
          financing
          activities........      60,100       1,562,974        1,623,074        1,563,074     4,981,376        6,604,450
                                --------      ----------       ----------      -----------   -----------      -----------
INCREASE IN CASH AND
  EQUIVALENTS...............       9,109       1,158,349        1,167,458        1,358,423     3,570,406        4,737,864
CASH AND EQUIVALENTS,
  BEGINNING OF PERIOD.......                       9,109                             9,109     1,167,458
                                --------      ----------       ----------      -----------   -----------      -----------
CASH AND EQUIVALENTS, END OF
  PERIOD....................    $  9,109      $1,167,458       $1,167,458      $ 1,367,532   $ 4,737,864      $ 4,737,864
                                ========      ==========       ==========      ===========   ===========      ===========
</TABLE>

    
 
                       See notes to financial statements.
 
                                       F-6

<PAGE>   62
 
                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
 
                         NOTES TO FINANCIAL STATEMENTS
  SEVEN-MONTH PERIOD ENDED DECEMBER 31, 1995 AND YEAR ENDED DECEMBER 31, 1996
     AND PERIOD FROM JUNE 28, 1995 (DATE OF INCEPTION) TO DECEMBER 31, 1996
   
    (INFORMATION FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)
    
 
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 synthetic moissanite gemstones (hereinafter referred to as
"moissanite" or "moissanite gemstones"), the Company is working to develop a
test instrument for manufacture and sale which will be able to distinguish
moissanite gemstones from diamond.
 
     C3 is a development stage company which has devoted substantially all of
its efforts to research and product development and has not yet generated any
revenues, nor is there any assurance of 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
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. At December 31, 1996
and September 30, 1997, cash equivalents consisted of money market accounts and
U.S. Treasury bills.
    
 
     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 five to six 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 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 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.
 
     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.
 
                                       F-7

<PAGE>   63
 
                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
    (INFORMATION FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)
 
     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.
 
   
     Pro Forma Net Loss Per Share -- Pro forma net loss per share applicable to
common shareholders is computed using the weighted average number of shares of
common stock outstanding which gives effect to a 2.13-for-1 stock split effected
in September 1997 (see Note 9 of Notes to Financial Statements) and the
conversion of all outstanding shares of the Company's 1996 Series A and 1997
Series B preferred stock into common stock. Common and common equivalent shares
from stock options issued by the Company at prices below the initial public
offering price during the twelve-month period prior to the initial public
offering have been included in the calculation as if they were outstanding for
all periods presented (using the treasury stock method utilizing the midpoint of
the range of the estimated offering price) even if anti-dilutive. 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.
    
 
   
     Interim Financial Information -- Interim financial information as of
September 30, 1997 and for the nine months ended September 30, 1997 and 1996 is
unaudited. In the opinion of management, this interim financial data includes
all adjustments, consisting only of normal recurring adjustments, necessary for
a fair presentation of such data. The operating results for any interim period
are not necessarily indicative of the results that may be expected for any
future periods.
    
 
   
     Unaudited Pro Forma Balance Sheet at September 30, 1997 -- The Company's
pro forma balance sheet as of September 30, 1997 gives effect to the automatic
conversion of all outstanding 1996 Series A preferred stock and 1997 Series B
preferred stock into an aggregate of 1,677,375 shares of common stock upon
consummation of the Company's initial public offering.
    
 
   
     Newly Issued Accounting Pronouncements -- In February 1997, Statement of
Financial Accounting Standards ("SFAS") No. 128, Earnings Per Share, was issued.
This Statement establishes standards for computing and presenting earnings per
share ("EPS") and applies to entities with publicly held common stock or
potential common stock. This Statement simplifies the current standards for
computing EPS, and makes them comparable to international EPS standards. This
Statement is effective for financial statements issued for periods ending after
December 15, 1997; earlier application is not permitted. This Statement requires
restatement of all prior period EPS data presented. The implementation of this
Statement will not have a material impact on the Company's financial statements.
    
 
   
     In June 1997, SFAS No. 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. SFAS No. 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
    
 
                                       F-8

<PAGE>   64
 
                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
    (INFORMATION FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)
 
   
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. The effect of this stock split is reflected as if it 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).
 
4.  PREFERRED STOCK
 
     The Company has authorized 5 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 has 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).
 
     1997 Series B Preferred Stock -- The Company has authorized 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 ("Preferred
Stock"), 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.
 
     Liquidation -- After payment of the Company's debts and obligations, any
remaining assets are distributed to shareholders as follow: (i) $4.00 per share
together with any accrued and unpaid dividends to holders of 1997 Series B
preferred stock, (ii) $3.00 per share together with any accrued dividends to
holders of 1996 Series A preferred stock, and (iii) any remaining assets are
then distributed to all shareholders equally based on their relative percentage
of total shares outstanding.
 
     Voting -- Holders of 1996 Series A preferred stock and 1997 Series B
preferred stock are not entitled to vote, except as otherwise required by the
North Carolina Business Corporation Act (the "NCBCA"). The NCBCA generally
provides voting rights to any shares of stock, otherwise nonvoting, in
connection with amendments to the articles of incorporation affecting certain
rights of the shares.
 
   
     Conversion/Redemption -- Holders of 1996 Series A preferred stock and 1997
Series B preferred stock have the right, at their option at any time after the
earlier of (i) July 31, 1998 (Series A) or January 1, 1999 (Series B) or (ii)
the closing of the sale of common stock in an offering registered under the
Securities Act of 1933 with net proceeds to the Company and/or any selling
shareholders of $8 million or more, to convert any or all of their shares of
preferred stock into shares of common stock at the conversion ratio of one share
of common stock for each share of preferred stock. The conversion ratio is
subject to adjustment upon the occurrence of certain events to protect against
dilution. Each share of 1996 Series A preferred stock and 1997 Series B
preferred stock will be automatically converted into common stock upon and at
the effective time of any merger of the Company with any other entity, any share
exchange of the common stock effected with any other entity or any sale of all
or substantially all the assets of the Company.
    
 
     The Company is not bound by any mandatory redemption, sinking fund or other
similar provisions with respect to the 1996 Series A preferred stock or the 1997
Series B preferred stock. At any time at which the 1996 Series A preferred stock
or the 1997 Series B preferred stock is convertible into common stock, the
Company may redeem the 1996 Series A preferred stock or the 1997 Series B
preferred stock, at the Company's sole discretion, in whole but not in part,
upon not less than 30 days prior written notice at the cash
 
                                       F-9

<PAGE>   65
 
                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
    (INFORMATION FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)
 
price of $5.75 per share (Series A) or $7.35 per share (Series B) plus any
accrued and unpaid dividends. After notice of redemption has been given but
before the date stated for redemption, holders of 1996 Series A preferred stock
or the 1997 Series B preferred stock would be able to convert the shares into
common stock.
 
     Dividends -- The Company does not anticipate the payment of dividends on
its common or preferred stock in the near future and intends to retain any
earnings indefinitely. If dividends are declared and paid on the common stock,
the Company's bylaws require that dividends are to be declared and paid to
holders of 1996 Series A and 1997 Series B preferred stock. Each share of 1996
Series A and 1997 Series B preferred stock shall be entitled to receive the same
dividends that would have been payable upon such share if that share of
preferred stock had been converted into common stock immediately prior to the
declaration of such dividend on the common stock.
 
5.  STOCK OPTION PLAN
 
     The Company has adopted the 1996 Incentive Stock Option Plan ("Stock Plan")
under which options to acquire 255,600 common shares, reduced by the number of
options granted outside the Stock Plan, may be granted to key employees,
directors and independent consultants. Under the Stock 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 Stock Plan generally vest equally over a three-year
period and have terms of 10 years.
 
     During 1996 options to acquire 200,220 shares of common stock were granted
under the Stock Plan with exercise prices ranging from $1.88-$2.70 per share
(weighted average exercise price of $2.37 per share). At December 31, 1996 all
of these options were outstanding and none were exercisable. Additionally,
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 5 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.
 
     All stock options are granted at fair market value of the common stock at
the grant date. Had compensation cost for the Stock Plan been determined
consistent with FAS 123, the Company's pro forma net loss for 1996 would have
been $404,375. The fair value of each option grant is estimated on the date of
grant using the minimum value method with the following assumptions: dividend
yield of 0.0%; risk-free interest rate of 6.0%; and a weighted average expected
option term of 1.8 years.
 
   
     Subsequent to December 31, 1996, the Board of Directors authorized, subject
to shareholder approval, an increase in the number of shares for issuance under
the Stock Plan to 777,450. During the nine months ended September 30, 1997,
options to acquire 461,571 shares of common stock were granted under the Stock
Plan with exercise prices ranging from $3.45-$7.63 per share (weighted average
exercise price of $4.64). The Company currently has no plans to award additional
options under the Stock Plan.
    
 
                                      F-10

<PAGE>   66
 
                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
    (INFORMATION FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)
 
6.  INCOME TAXES
 
     At December 31, 1995 and 1996, the Company had deferred tax assets of
$10,700 and $57,600, respectively, relating to federal net operating and state
economic loss carryforwards. In accordance with FAS 109, a valuation allowance
has been provided against these 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 for the seven-month period
ended December 31, 1995 and the year ended December 31, 1996 follows:
 

<TABLE>
<CAPTION>
                                                              DECEMBER 31,   DECEMBER 31,
                                                                  1995           1996
                                                              ------------   ------------
<S>                                                           <C>            <C>
Anticipated income tax benefit at the statutory federal
  rate......................................................    $(9,250)       $(40,600)
State income tax benefit, net of federal tax effect.........     (1,450)         (6,300)
Increase in valuation allowance.............................     10,700          46,900
                                                                -------        --------
Income tax (benefit) expense................................    $    --        $     --
                                                                =======        ========
</TABLE>

 
     At December 31, 1996, the Company has operating and economic loss
carryforwards of approximately $147,000, expiring through 2011, which can be
offset against future federal and state taxable income.
 
7.  COMMITMENTS
 
   
     Operating Lease -- On February 4, 1997, the Company entered into a lease
agreement for office space with Real Color Displays, Inc. ("RCD"), a related
party. The agreement specifies rent of $2,000 per month and a one-time payment
of $6,000 for leasehold improvements. The lease expires January 31, 1998 and may
be renewed at the Company's option for two additional one-year terms, with
annual rent increases of $750 per annum. Future minimum lease payments under
this agreement for 1997 and 1998 are $24,000 and $2,000, respectively.
    
 
   
     Purchase Commitment -- In connection with an Exclusive Supply Agreement,
the Company has committed to purchase a minimum of 50% (by dollar volume) of its
requirements for SiC crystals from Cree, a related company. 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.
    
 
     During 1995 and 1996, the Company made purchases from Cree of approximately
$13,500 and $189,600, respectively, for SiC materials and research and
development costs.
 
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.  COMMON STOCK SPLIT
 
     On September 25, 1997, the Company effected a 2.13-for-1 stock split of its
common stock. All shares of common stock, common stock options and per share
amounts included in the accompanying financial statements have been
retroactively adjusted to reflect the stock split.
 
10.  SUBSEQUENT EVENTS (UNAUDITED)
 
     On June 6, 1997, the Company entered into an Amended and Restated Exclusive
Supply Agreement ("Amended Agreement") and a Development Agreement with Cree.
The Amended Agreement has an initial
 
                                      F-11

<PAGE>   67
 
                                    C3, INC.
                      (A COMPANY IN THE DEVELOPMENT STAGE)
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
    (INFORMATION FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)
 
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 Amended Agreement. 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. In addition, if Cree meets certain development milestones by January
1, 1998, the Company will pay Cree a $200,000 bonus.
 
   
     In the third quarter of 1997, the Company estimated it will incur
compensation expense of approximately $2.1 million related to stock options
granted in July and August 1997 based upon a fair value of $10.80 per share of
common stock. Upon consummation of the Company's initial public offering, the
stock options granted to certain officers and directors will vest on December
31, 1997, in which event approximately $1.4 million of this estimated
compensation expense will be recognized in the quarter ending December 31, 1997.
The remaining estimated compensation expense will be recognized over the
three-year vesting period of the remaining options. Compensation expense
recorded in the third quarter of 1997 totaled $109,000.
    
 
     The Company has entered into agreements with certain directors pursuant to
which such directors provide consulting services to the Company. Consideration
paid for services provided to the Company through June 30, 1997 was
insignificant.
 
   
     In September 1997, the Board of Directors adopted the 1997 Omnibus Stock
Plan of C3, Inc. (the "1997 Omnibus Plan") and recommended its approval to the
Company's shareholders. The 1997 Omnibus Plan is subject to approval by the
shareholders of the Company, which approval must occur, if at all, within 12
months of the adoption of the plan by the Board of Directors. Awards granted
prior to shareholder approval are conditioned upon and shall be effective only
upon (i) approval of the 1997 Omnibus Plan by the shareholders of the Company on
or before such date, and (ii) upon the consummation of the Company's first
offering of Common Stock registered under the Securities Act. The Company has
granted options to acquire 310,000 shares of Common Stock under the 1997 Omnibus
Plan at an exercise price equal to the initial public offering price of Common
Stock offered.
    
 
     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. Initially, a maximum of 477,979
shares of common stock may be delivered pursuant to awards granted under the
1997 Omnibus Plan, and the Board of Directors has reserved that number of shares
for this purpose. 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 Stock 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.
 
   
     In October 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 October 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.
    
 
                                      F-12

<PAGE>   68
 
             ======================================================
 
  NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS, AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY ANY OF THE
SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE HEREOF, OR THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS
OF THE COMPANY SINCE SUCH DATE.
 
                             ---------------------
 
 
                              TABLE OF CONTENTS
 

<TABLE>
<CAPTION>
                                        PAGE
                                        ----
<S>                                     <C>
Prospectus Summary....................    3
Risk Factors..........................    5
Use of Proceeds.......................   12
Dividend Policy.......................   12
Dilution..............................   13
Capitalization........................   14
Selected Financial Data...............   15
Management's Discussion and Analysis
  of Financial Condition and Results
  of Operations.......................   16
Business..............................   19
Management............................   32
Principal Shareholders................   41
Certain Transactions..................   42
Description of Capital Stock..........   46
Shares Eligible for Future Sale.......   49
Underwriting..........................   51
Legal Matters.........................   52
Experts...............................   52
Additional Information................   53
Index to Financial Statements.........  F-1
</TABLE>

 
                             ---------------------
  Until             , 1997 (25 days after the date of this Prospectus), all
dealers effecting transactions in the Common Stock offered hereby, whether or
not participating in this distribution, may be required to deliver a Prospectus.
This is in addition to the obligation of dealers to deliver a Prospectus when
acting as underwriters and with respect to their unsold allotments or
subscriptions.
 
             ======================================================
             ======================================================
 
   
                                2,750,000 SHARES
    
                                     [LOGO]
 
                                    C3, INC.
 
                                  COMMON STOCK
                           -------------------------
                                   PROSPECTUS
                           -------------------------
                               PAULSON INVESTMENT
                                 COMPANY, INC.
                                           , 1997
 
             ======================================================

<PAGE>   69
 

                                    PART II
                     INFORMATION NOT REQUIRED IN PROSPECTUS
 

ITEM 13.  OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
 
     Other expenses of issuance and distribution payable by the Registrant are
estimated as follows:
 
   

<TABLE>
<S>                                                           <C>
Securities and Exchange Commission registration fee.........  $   15,875
National Association of Securities Dealers, Inc. filing
  fee.......................................................       5,739
Nasdaq National Market Quotation Fee........................      50,000
Accounting fees and expenses................................      30,000
Legal fees and expenses.....................................     250,000
Printing and engraving......................................     100,000
Fees of Transfer Agent and Registrar........................       5,000
State Blue Sky registration fees and expenses (including
  counsel fees).............................................      10,000
Representative's Non-Accountable Expense Allowance..........     371,250
Directors and Officers Insurance Premium....................     150,000
Miscellaneous expenses......................................      12,136
                                                              ----------
          Total.............................................  $1,000,000
                                                              ==========
</TABLE>

    
 

ITEM 14.  INDEMNIFICATION OF DIRECTORS AND OFFICERS.
 
     Sections 55-8-50 through 55-8-58 of the North Carolina Business Corporation
Act contains specific provisions relating to indemnification of directors and
officers of North Carolina corporations. In general, such sections provide that
(i) a corporation must indemnify a director or officer who is wholly successful
in his defense of a proceeding to which he is a party because of his status as
such, unless limited by the articles of incorporation, and (ii) a corporation
may indemnify a director or officer if he is not wholly successful in such
defense and it is determined as provided by statute that the director or officer
meets a certain standard of conduct, but the corporation may not indemnify a
director or officer if he is liable to the corporation or is adjudged liable on
the basis that personal benefit was improperly received by him. A director or
officer of a corporation who is a party to a proceeding may also apply to the
courts for indemnification, and the court may order indemnification under
certain circumstances set forth in the statute. A corporation may, in its
articles of incorporation or bylaws or by contract or resolution, provide
indemnification in addition to that provided by statute, subject to certain
conditions.
 
     The Registrant's bylaws provide for the indemnification of any director or
officer of the Registrant against liabilities and litigation expenses arising
out of his status as such, excluding (i) any liabilities or litigation expenses
relating to activities which were at the time taken known or believed by such
person to be clearly in conflict with the best interest of the Registrant and
(ii) that portion of any liabilities or litigation expenses with respect to
which such person is entitled to receive payment under any insurance policy.
 
     The Registrant's articles of incorporation provide for the elimination of
the personal liability of each director of the Registrant to the fullest extent
permitted by law.
 
     In connection with this offering, the Registrant intends to obtain
directors' and officers' liability insurance, under which any controlling
person, director or officer of the Registrant will be insured or indemnified
against certain liabilities which he may incur in his capacity as such.
 
     Under the underwriting agreement to be entered into by the Registrant,
certain controlling persons, directors and officers of the Registrant may be
entitled to indemnification by underwriters who participate in the distribution
of securities covered by the Registration Statement against certain liabilities,
including liabilities under the Securities Act.
 
                                      II-1

<PAGE>   70
 

ITEM 15.  RECENT SALES OF UNREGISTERED SECURITIES.
 
     (a) The Registrant was incorporated on June 28, 1995 under the laws of the
State of North Carolina. Except as set forth below, no securities of the
Registrant have been sold by the Registrant without registration under the
Securities Act. Amounts of Common Stock have been adjusted to reflect an 8-for-1
stock split, effected on April 2, 1996, and a 2.13-for-1 stock split effected on
September 25, 1997.
 
   
     (b) On June 28, 1995, the Registrant issued to Cree an option covering a
number of shares equal to one percent of the Common Stock outstanding on the
date of exercise in exchange for certain intellectual property rights. Cree had
the right to exercise the option upon payment of an aggregate exercise price of
$500 and the Registrant retained the right to waive the payment of the exercise
consideration and issue the stock at any time during the option period. This
option was issued in reliance on the exemption from registration provided by
Section 4(2) under the Securities Act of 1933, as amended (the "Securities
Act").
    
 
   
     (c) On June 30, 1995, the Registrant issued 170,400 shares of Common Stock
to Jeff N. Hunter, a founder, President and Chairman of the Board of the
Company, and Paula K. Berardinelli, a founder of the Company, as joint tenants
with rights of survivorship, in consideration of services to be performed by
each of them on behalf of the Registrant in reliance on the exemption from
registration provided by Section 4(2) under the Securities Act. On June 30,
1995, the Registrant also issued 1,465,440 shares of Common Stock to C. Eric
Hunter, a founder of the Company believed to qualify as an "accredited investor"
as defined in Rule 501(a) under the Securities Act, for an aggregate
consideration of $50,000 in reliance on the exemption from registration provided
by Section 4(2) of the Securities Act. Also on June 30, 1995, the Registrant
issued 68,160 shares of Common Stock to two individuals who were consultants to
the Registrant in consideration of services to be performed by them on behalf of
the Registrant. Such shares were issued in reliance on the exemption from
registration provided by Section 4(2) and Rule 701 under the Securities Act.
    
 
     (d) Between May 2 and May 24, 1996, the Registrant issued an aggregate of
532,500 shares of Common Stock to certain individual investors in exchange for
an aggregate consideration of $1 million in reliance on the exemption from
registration provided by Rule 505 under the Securities Act.
 
     (e) Between May 25, 1996 and June 6, 1996, the Registrant issued options
covering an aggregate of 37,275 shares of Common Stock to four individuals who
were consultants to the Registrant for an aggregate consideration of $3 and in
consideration of services performed or to be performed by them on behalf of the
Registrant. Such options were issued in reliance on the exemption from
registration provided by Section 4(2) and Rule 701 under the Securities Act.
 
   
     (f) Between June 1, 1996 and August 18, 1997, the Registrant issued options
covering an aggregate of 661,791 shares of Common Stock to certain employees,
directors and consultants of the Registrant pursuant to the 1996 Option Plan and
in consideration of services rendered and to be rendered to the Registrant. The
options have exercise prices between approximately $1.88 per share and
approximately $7.62 per share with a weighted average exercise price of $3.95
per share. The Registrant granted the options in reliance on the exemption from
registration provided by Section 4(2) and Rule 701 under the Securities Act.
    
 
   
     (g) Between August 5, 1996 and September 3, 1996, the Registrant issued an
aggregate of 105,000 shares of 1996 Series A Preferred Stock (currently
convertible into 223,650 shares of Common Stock) to certain individual investors
in exchange for an aggregate consideration of $603,750 in reliance on the
exemption from registration provided by Rule 506 under the Securities Act.
    
 
     (h) On January 2, 1997, the Registrant issued 24,601 shares of Common Stock
to Cree in accordance with the terms of an option previously issued to Cree.
Such shares were issued in reliance on the exemption from registration provided
by Section 4(2) of the Securities Act.
 
   
     (i) Between January 9, 1997 and March 17, 1997, the Registrant issued an
aggregate of 682,500 shares of 1997 Series B Preferred Stock (currently
convertible into 1,453,725 shares of Common 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.
    
 
                                      II-2

<PAGE>   71
 
     (j) In September 1997, the Registrant issued options covering 310,000
shares of Common Stock to certain employees, directors and consultants of the
Registrant pursuant to the 1997 Omnibus Plan and in consideration of services
rendered and to be rendered to the Registrant. The options have an exercise
price equal to the initial public offering price of the shares of Common Stock
being offered in this offering. The Registrant granted the options in reliance
on the exemption from registration provided by Section 4(2) and Rule 701 under
the Securities Act.
 
     (k) At or prior to the consummation of this offering, the Registrant will
issue, in reliance on the exemption from registration provided by Section
3(a)(9) of the Securities Act, 1,677,375 shares of Common Stock upon the
automatic conversion of outstanding shares of 1996 Series A Preferred Stock and
1997 Series B Preferred Stock.
 

ITEM 16.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
 
     (a) Exhibits
 
     The following exhibits listed in accordance with the number assigned to
each in the exhibit table of Item 601 of Regulation S-K are included in Part II
of this Registration Statement.
 
   

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                 DESCRIPTION
- -------                                -----------
<C>       <C>  <S>
 1         --  Form of Underwriting Agreement*
 3.1       --  Amended and Restated Articles of Incorporation of C3, Inc.
 3.2       --  Amended and Restated Bylaws of C3, Inc.
 4.1       --  Specimen Certificate of Common Stock
 4.2       --  Form of Representative's Warrant*
 5         --  Opinion of Womble Carlyle Sandridge & Rice, PLLC
10.1       --  Consulting Agreement, dated May 1, 1997, between Kurt Nassau
               and C3, Inc.*
10.2       --  Letter Agreement, dated May 17, 1997, between Kurt Nassau
               and C3, Inc.*
10.3       --  Letter Agreement, dated February 17, 1997, between Howard
               Rubin and C3, Inc.*
10.4       --  Independent Contractor Agreement, dated May 1, 1997, between
               Paula K. Berardinelli and C3, Inc.*
10.5       --  Independent Contractor Agreement, dated September 3, 1997,
               between C. Eric Hunter and C3, Inc.*
10.6       --  Independent Contractor Agreement dated July 10, 1997 between
               Ollin B. Sykes and C3, Inc.*
10.7       --  Employment Agreement, dated June 1, 1997, between Jeff N.
               Hunter and C3, Inc.*
10.8       --  Employment Agreement, dated July 30, 1997, between Mark W.
               Hahn and C3, Inc.*
10.9       --  Employment Agreement, dated September 15, 1997, between
               Martin J. DeRoy and C3, Inc.*
10.10      --  Employment Agreement, dated March 1, 1997, between Thomas G.
               Coleman and C3, Inc.*
10.11      --  Amended and Restated Exclusive Supply Agreement, dated June
               6, 1997, between Cree Research, Inc. and C3, Inc.*+
10.12      --  Development Agreement, dated as of June 6, 1997, between
               Cree Research, Inc. and C3, Inc.+
10.13      --  Letter Agreement, dated July 14, 1997, between Cree
               Research, Inc. and C3, Inc.*+
10.14      --  Letter Agreement, dated January 31, 1996, between Cree
               Research, Inc. and C3, Inc.*+
10.15      --  1996 Stock Option Plan of C3, Inc. (as amended October 27,
               1997)
10.16      --  1997 Omnibus Stock Plan of C3, Inc.*
10.17      --  Restricted Stock Agreement, dated June 30, 1995, between
               Jeff N. Hunter and Paula K. Berardinelli and C3, Inc.*
10.18      --  Shareholders Agreement, dated March 18, 1997, between
               General Electric Pension Trust, C. Eric Hunter and C3, Inc.*
</TABLE>

    
 
                                      II-3

<PAGE>   72
   

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                 DESCRIPTION
- -------                                -----------
<C>       <C>  <S>
10.19      --  Registrations Rights Agreement, dated March 18, 1997,
               between General Electric Pension Trust and C3, Inc.*
10.20      --  Agreement, dated September 24, 1997, between John M.
               Bachman, Inc. and C3, Inc.*+
10.21      --  Agreement, dated September 12, 1997, between QMD, Inc. and
               C3, Inc.*+
23.1       --  Consent of Womble Carlyle Sandridge & Rice, PLLC (included
               in Exhibit 5)
23.2       --  Consent of Deloitte & Touche LLP
23.3       --  Consent of Kurt Leutzinger*
23.4       --  Consent of David B. Stewart*
23.5       --  Consent of Ollin B. Sykes*
24         --  Power of Attorney (included on the signature page of this
               Registration Statement)*
27         --  Financial Data Schedule
</TABLE>

    
 
- ---------------
 
 * Previously filed.
   
 + The registrant has requested that certain portions of this exhibit be given
confidential treatment.
    
 
     (b) Financial Statement Schedules
 
     All schedules are omitted because they are not required, they are not
applicable or the information is already included in the financial statements or
notes thereto.
 

ITEM 17.  UNDERTAKINGS.
 
     1. The undersigned registrant hereby undertakes that:
 
          (a) For purposes of determining any liability under the Securities Act
     of 1933, the information omitted from the form of prospectus filed as part
     of this registration statement in reliance upon Rule 430A and contained in
     the form of prospectus filed by the registrant pursuant to Rule 424(b)(1)
     or (4) or 497(h) under the Securities Act shall be deemed to be part of
     this registration statement as of the time it was declared effective.
 
          (b) For the purpose of determining any liability under the Securities
     Act of 1933, each post-effective amendment that contains a form of
     prospectus shall be deemed to be a new registration statement relating to
     the securities offered therein, and the offering of such securities at that
     time shall be deemed to be the initial bona fide offering thereof.
 
     2. The undersigned registrant hereby undertakes to provide to the
underwriter at the closing specified in the underwriting agreements certificates
in such denominations and registered in such names as required by the
underwriter to permit prompt delivery to each purchaser.
 
   
     3. The undersigned registrant hereby undertakes:
    
 
   
          (a) To file, during any period in which offers or sales are being
     made, a post-effective amendment to this registration statement:
    
 
   
             (i) To include any prospectus required by section 10(a)(3) of the
        Securities Act of 1933;
    
 
   
             (ii) To reflect in the prospectus any facts or events arising after
        the effective date of the registration statement (or the most recent
        post-effective amendment thereof) which, individually or in the
        aggregate, represent a fundamental change in the information set forth
        in the registration statement. Notwithstanding the foregoing, any
        increase or decrease in volume of securities offered (if the total
        dollar value of securities offered would not exceed that which was
        registered) and any deviation from the low or high end of the estimated
        maximum offering range may be reflected in the form of prospectus filed
        with the Commission pursuant to Rule 424(b) if, in the aggregate, the
        changes in volume and price represent no more than a 20% change in the
        maximum aggregate
    
 
                                      II-4

<PAGE>   73
 
   
        offering price set forth in the "Calculation of Registration Fee" table
        in the effective registration statement;
    
 
   
             (iii) To include any material information with respect to the plan
        of distribution not previously disclosed in the registration statement
        or any material change to such information in the registration
        statement.
    
 
   
          (b) That, for the purpose of determining any liability under the
     Securities Act of 1933, each such post-effective amendment shall be deemed
     to be a new registration statement relating to the securities offered
     therein, and the offering of such securities at that time shall be deemed
     to be the initial bona fide offering thereof.
    
 
   
          (c) To remove from registration by means of a post-effective amendment
     any of the securities being registered which remain unsold at the
     termination of the offering.
    
 
   
     4. Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question of whether such indemnification by it is against
public policy as expressed in the Act and will be governed by the final
adjudication of such issue.
    
 
                                      II-5

<PAGE>   74
 

                                   SIGNATURES
 
   
     Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Amendment No. 2 to the registration statement to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Morrisville, State of North Carolina, on November 5, 1997.
    
 
                                          C3, INC.
 
                                          By:      /s/ JEFF N. HUNTER
                                            ------------------------------------
                                                       Jeff N. Hunter
                                                         President
 
   
     Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 2 to the registration statement has been signed by the following persons on
November 5, 1997 in the capacities indicated.
    
 

<TABLE>
<C>                                                    <C>
                 /s/ JEFF N. HUNTER                                   /s/ FREDERICK A. RUSS*
- -----------------------------------------------------  -----------------------------------------------------
                   Jeff N. Hunter                                        Frederick A. Russ
               President and Director                                        Director
            (principal executive officer)
 
                  /s/ KURT NASSAU*                                       /s/ MARK W. HAHN
- -----------------------------------------------------  -----------------------------------------------------
                     Kurt Nassau                                           Mark W. Hahn
                      Director                                        Chief Financial Officer
                                                           (principal financial and accounting officer)
 
                  /s/ HOWARD RUBIN*
- -----------------------------------------------------
                    Howard Rubin
                      Director
 
               *By: /s/ JEFF N. HUNTER
  ------------------------------------------------
                   Jeff N. Hunter
                  Attorney-in-Fact
</TABLE>

 
                                      II-6





<PAGE>   1

                                                                   EXHIBIT 3.1


                              AMENDED AND RESTATED
                            ARTICLES OF INCORPORATION

         Pursuant to Section 55-10-07 of the General Statutes of North Carolina,
C3, Inc. hereby submits the following for the purpose of amending and restating
its articles of incorporation.

                                       I.

         The name of the corporation is C3, Inc. (the "Corporation").


                                       II.

         The Corporation is authorized to issue two (2) classes of capital stock
to be designated, respectively, Common Stock ("Common Stock") and Preferred
Stock ("Preferred Stock"). The total number of shares of capital stock that the
Corporation is authorized to issue is sixty million (60,000,000). The total
number of shares of Common Stock the Corporation shall have authority to issue
is fifty million (50,000,000), and the total number of shares of Preferred Stock
the Corporation shall have authority to issue is ten million (10,000,000). The
Common Stock shall have no par value per share, and the Preferred Stock shall
have no par value per share.

         A. Common Stock. All shares of Common Stock will be identical and will
entitle holders thereof to the same preferences, limitations and relative rights
set forth below.

                  (1) Voting Rights. Each outstanding share of Common Stock
         shall be entitled to vote on each matter on which the shareholders
 of
         the Corporation shall be entitled to vote, and each holder of Common
         Stock shall be entitled to one vote for each share of such Common Stock
         held by such holder.

                  (2) Dividends. The Board of Directors of the Corporation may
         cause dividends to be paid to holders of Common Stock ratably on a per
         share basis out of funds legally available for the payment of
         dividends.

                  (3) Liquidation. In the event of any voluntary or involuntary
         liquidation, dissolution or winding up of the Corporation, the holders
         of the Common Stock shall be entitled, after payment or provision for
         payment of the debts and other liabilities of the Corporation and the
         payment of any preferences for the Preferred Stock to receive on a per
         share basis the remaining assets of the Corporation.

         B. Preferred Stock. The Preferred Stock shall be divided into series.
The first series shall consist of 105,000 shares and is designated as 1996
Series A Preferred Stock (the "1996 Series A Stock") with the preferences,
limitations and relative rights set forth below. The second series shall consist
of 682,500 shares and is designated as 1997 Series B Preferred Stock (the "1997
Series B Stock") with the preferences, limitations and relative rights set forth
below. The remaining shares of Preferred Stock may be issued from time to time
in one or more series, and with such preferences, limitations and relative
rights as the Board of the Corporation (the "Board") may determine, all of which
shall be stated and expressed in one or more amendment(s) to the Corporation's
Articles of Incorporation adopted by the Board providing for the issue of such
series as permitted by the North Carolina Business Corporation Act.





<PAGE>   2



         C. 1996 Series A Stock. The preferences, limitations and relative
rights of the 1996 Series A Stock are as set forth below.

                  (a)      Voting Rights. Except as otherwise required under
                           North Carolina law, the holders of 1996 Series A
                           Stock shall not be entitled to vote. In any matter in
                           which the holders of 1996 Series A Stock shall be
                           entitled to vote pursuant to applicable law, each
                           holder shall be entitled to one vote for each share
                           of 1996 Series A Stock held by such holder.

                  (b)      Dividends. The Board shall cause dividends to be
                           declared and paid to holders of 1996 Series A Stock
                           as, when and if declared on the Common Stock. Each
                           share of 1996 Series A Stock shall be entitled to
                           receive dividends equal to the cash, property or
                           other item of value that would have been such payable
                           upon such share if that share of 1996 Series A Stock
                           had been converted into shares of Common Stock
                           immediately prior to the declaration of such dividend
                           on the Common Stock.

                  (c)      Conversion.

                           (i) Optional Conversion. Each share of 1996 Series A
                           Stock shall be convertible into one share of Common
                           Stock (the "Series A Conversion Ratio"), at the
                           option of the holder thereof, at any time after the
                           earlier of (i) July 31, 1998 or (ii) the date on
                           which the Corporation closes the sale of Common Stock
                           in an offering registered under the Securities Act of
                           1933, as amended, with net proceeds to the
                           Corporation and/or any selling shareholders of at
                           least $8.0 million (after deductions for
                           underwriters' discounts and expenses relating to the
                           issuance, including without limitation fees of the
                           Corporation's counsel). The Series A Conversion Ratio
                           shall be adjusted as hereinafter provided.

                           (ii) Automatic Conversion. Each share of 1996 Series
                           A Stock shall automatically be converted into shares
                           of Common Stock at the then effective Series A
                           Conversion Ratio immediately upon, and
                           contemporaneously with, the earlier of (A) the
                           effective time of any merger of the Corporation with
                           any other entity, any share exchange of the Common
                           Stock effected with any other entity or any sale of
                           all or substantially all the assets of the
                           Corporation or (B) the date on which the Corporation
                           closes the sale of Common Stock in an offering
                           registered under the Securities Act of 1933, as
                           amended, with net proceeds to the Corporation and/or
                           any selling shareholders of at least $12.0 million
                           (after deductions for underwriters' discounts and
                           expenses relating to the issuance, including without
                           limitation, fees of the Corporation's counsel).

                           (iii) Mechanics of Conversion. In order to convert
                           shares of 1996 Series A Stock into shares of Common
                           Stock other than pursuant to clause (ii) above, the
                           holder thereof shall surrender the certificate or
                           certificates therefor, duly endorsed, at the
                           principal office of the Corporation or of any
                           transfer agent for such stock, and shall give written
                           notice to the Corporation at such office that he
                           elects to convert the same and shall state therein
                           the name or names in which he wishes the certificate
                           or certificates representing shares of Common Stock
                           to be issued. The

                                       -2-


<PAGE>   3



                           Corporation shall, as soon as practicable thereafter,
                           issue and deliver at such office to such holder of
                           1996 Series A Stock a certificate or certificates for
                           the number of shares of Common Stock to which he
                           shall be entitled as aforesaid. Such conversion shall
                           be deemed to have been made immediately prior to the
                           close of business on the date of surrender of the
                           shares of 1996 Series A Stock to be converted, and
                           the person or persons entitled to receive the shares
                           of Common Stock issuable upon such conversion shall
                           be treated for all purposes as the record holder or
                           holders of such shares of Common Stock on such date.

                           (iv) Adjustments to Conversion Ratio for Stock
                           Combinations or Subdivisions of Common Stock. If the
                           Corporation at any time or from time to time after
                           the date on which shares of 1996 Series A Stock are
                           first issued shall declare or pay, without
                           consideration, any right to acquire Common Stock for
                           no consideration (other than pursuant to a stock or
                           other dividend for which a dividend is payable to the
                           holders of 1996 Series A Stock pursuant to
                           subparagraph C(b) above), or shall effect a
                           subdivision of the outstanding shares of Common Stock
                           into a greater number of shares of Common Stock (by
                           stock split, reclassification or in any way other
                           than by payment of a dividend in Common Stock), or in
                           the event the outstanding shares of Common Stock
                           shall be combined or consolidated, by
                           reclassification or otherwise, into a lesser number
                           of shares of Common Stock, then the Series A
                           Conversion Ratio in effect immediately prior to such
                           event shall, concurrently with the effectiveness of
                           such event, be proportionately decreased or
                           increased, as appropriate.

                           (v) Adjustments for Reclassification and
                           Reorganization. If the Common Stock issuable upon
                           conversion of the 1996 Series A Stock shall be
                           changed into the same or a different number of shares
                           of any other class or classes of stock, whether by
                           reclassification of stock or otherwise (other than a
                           subdivision or combination of shares provided for in
                           subparagraph (iv) above), the Series A Conversion
                           Ratio then in effect shall, concurrently with the
                           effectiveness of such reorganization or
                           reclassification, be proportionately adjusted so that
                           the 1996 Series A Stock shall be convertible into, in
                           lieu of the number of shares of Common Stock which
                           the holders would otherwise have been entitled to
                           receive, that number of shares of such other class or
                           classes of stock equivalent to the number of shares
                           of Common Stock that would have been subject to
                           receipt by the holders upon conversion of the 1996
                           Series A Stock immediately before that change.

                           (vi) No Impairment. The Corporation will not, by
                           amendment of its Articles of Incorporation or through
                           any reorganization, transfer of assets,
                           consolidation, merger, dissolution, issue or sale of
                           securities or any other voluntary action, avoid or
                           seek to avoid the observance or performance of any of
                           the terms of the 1996 Series A Stock but will at all
                           times in good faith assist in the carrying out of all
                           the provisions of this section and in the taking of
                           all such action as may be necessary or appropriate in
                           order to protect the conversion rights of the holders
                           of the 1996 Series A Stock against impairment.

                           (vii) Certificates as to Adjustments. Upon the
                           occurrence of each adjustment or readjustment of the
                           Series A Conversion Ratio, the Corporation at its
                           expense

                                       -3-


<PAGE>   4



                           shall promptly compute such adjustment or
                           readjustment in accordance with the terms hereof and
                           prepare and furnish to each holder of 1996 Series A
                           Stock a certificate executed by the Corporation's
                           President or Chief Financial Officer setting forth
                           such adjustment or readjustment and showing in detail
                           the facts upon which such adjustment or readjustment
                           is based. The Corporation shall, upon the written
                           request at any time of any holder of 1996 Series A
                           Stock, furnish or cause to be furnished to such
                           holder a like certificate setting forth (A) such
                           adjustments and readjustments, (B) the Series A
                           Conversion Ratio at the time in effect, and (C) the
                           number of shares of Common Stock and the amount, if
                           any, of other property which at the time would be
                           received upon the conversion of the 1996 Series A
                           Stock.

                           (viii) Reservation of Stock Issuable Upon Conversion.
                           The Corporation shall at all times reserve and keep
                           available out of its authorized but unissued shares
                           of Common Stock, solely for the purpose of effecting
                           the conversion of the shares of 1996 Series A Stock,
                           such number of its shares of Common Stock as shall
                           from time to time be sufficient to effect the
                           conversion of all outstanding shares of the 1996
                           Series A Stock.

                           (ix) Fractional Shares. No fractional share shall be
                           issued upon the conversion of any share or shares of
                           1996 Series A Stock. If the conversion would result
                           in the issuance of a fraction of a share of Common
                           Stock, the Corporation shall, in lieu of issuing any
                           fractional share, pay the holder otherwise entitled
                           to such fraction a sum of cash equal to the fair
                           market value of such fraction on the date of
                           conversion as determined in good faith by the Board.

                  (d)      Redemption Rights of the Corporation. At the option
                           of the Board, the Corporation may, at any time at
                           which the 1996 Series A Stock is convertible into
                           Common Stock, redeem from any source of funds legally
                           available therefor, all or any portion of the
                           outstanding shares of 1996 Series A Stock, at a
                           redemption price per share equal to $5.75 (the
                           "Series A Redemption Price") plus all declared and
                           unpaid dividends thereon, by giving written notice to
                           each holder of record of 1996 Series A Stock to be
                           redeemed (a "Series A Redemption Notice") at its post
                           office address last shown on the records of the
                           Corporation, not later than 30 days prior to the date
                           fixed for any redemption (a "Series A Redemption
                           Date") specifying the number of shares of 1996 Series
                           A Stock that are to be redeemed on the Series A
                           Redemption Date specified in such Series A Redemption
                           Notice. On such Series A Redemption Date, the
                           Corporation will pay to each holder of 1996 Series A
                           Stock, upon surrender for cancellation to the
                           Corporation at its principal office of the
                           certificates, duly endorsed in blank, representing
                           the shares of 1996 Series A Stock to be redeemed on
                           such Series A Redemption Date, an amount per share
                           equal to the Series A Redemption Price thereof plus
                           all declared but unpaid dividends thereon. If less
                           than all of the shares represented by any such
                           certificate are redeemed, the shares to be redeemed
                           shall be selected from the then outstanding shares on
                           a pro rata basis and a new certificate shall be
                           issued representing the unredeemed shares. Until the
                           Series A Redemption Date, holders of the 1996 Series
                           A Stock shall be

                                       -4-


<PAGE>   5



                           entitled to the full preferences, limitations and
                           relative rights of such stock. The holders of such
                           shares of 1996 Series A Stock shall cease to have any
                           further rights, other than the right to receive the
                           Series A Redemption Price thereof plus such declared
                           and unpaid dividends, with respect to the 1996 Series
                           A Stock on the Series A Redemption Date.

                  (e)      Liquidation Rights. In the event of any liquidation,
                           dissolution or winding up of the affairs of the
                           Corporation, whether voluntary or involuntary, the
                           holders of shares of 1996 Series A Stock then
                           outstanding shall be entitled to be paid, in cash,
                           out of the assets of the Corporation available for
                           distribution to its stockholders, before any payment
                           or declaration and setting apart for payment of any
                           amount shall be made in respect of any shares of
                           Common Stock or any other shares of the Corporation
                           junior or subordinate to the 1996 Series A Stock, (i)
                           $3.00 per share, together with all declared and
                           unpaid dividends on the 1996 Series A Stock, plus
                           (ii) an amount equal to the Corporation's net assets
                           remaining after the payment of the amount described
                           in clause (i) above, multiplied by the percentage of
                           the Common Stock that would be owned by holders of
                           the 1996 Series A Stock if converted on the date of
                           such payment into Common Stock, such amount to be
                           distributed among the holders of the 1996 Series A
                           Stock on a pro rata basis. If, upon any liquidation,
                           dissolution or winding up of the Corporation, whether
                           voluntary or involuntary, the assets to be
                           distributed among the holders of shares of 1996
                           Series A Stock are insufficient to permit the payment
                           to such holders of the entire preferential amount
                           provided for in clause (i) above, then all of the net
                           assets of the Corporation shall be distributed pro
                           rata among the holders of shares of 1996 Series A
                           Stock.

                  (f)      No Reissuance of Stock. No 1996 Series A Stock
                           acquired by the Corporation by reason of redemption,
                           purchase, or otherwise shall be reissued, and all
                           such shares shall be canceled, retired and eliminated
                           from the 1996 Series A Stock and shall return to the
                           status of Preferred Stock authorized without
                           designation.

         D. 1997 Series B Stock. The preferences, limitations and relative
rights of the 1997 Series B Stock are as set forth below.

                  (a)      Voting Rights. Except as otherwise required under
                           North Carolina law, the holders of 1997 Series B
                           Stock shall not be entitled to vote. In any matter in
                           which the holders of 1997 Series B Stock shall be
                           entitled to vote pursuant to applicable law, each
                           holder shall be entitled to one vote for each share
                           of 1997 Series B Stock held by such holder.

                  (b)      Dividends. The Board shall cause dividends to be
                           declared and paid to holders of 1997 Series B Stock
                           as, when and if declared on the Common Stock. Each
                           share of 1997 Series B Stock shall be entitled to
                           receive dividends equal to the cash, property or
                           other item of value that would have

                                       -5-


<PAGE>   6



                           been payable upon such share if that share of
                           1997 Series B Stock had been converted into shares of
                           Common Stock immediately prior to the declaration of
                           such dividend on the Common Stock.

                  (c)      Conversion.

                           (i) Optional Conversion. Each share of 1997 Series B
                           Stock shall be convertible into one share of Common
                           Stock (the "Series B Conversion Ratio"), at the
                           option of the holder thereof, at any time after the
                           earlier of (i) January 1, 1999 or (ii) the date on
                           which the Corporation closes the sale of Common Stock
                           in an offering registered under the Securities Act of
                           1933, as amended, with net proceeds to the
                           Corporation and/or any selling shareholders of at
                           least $8.0 million (after deductions for
                           underwriters' discounts and expenses relating to the
                           issuance, including without limitation, fees of the
                           Corporation's counsel). The Series B Conversion Ratio
                           shall be adjusted as hereinafter provided.

                           (ii) Automatic Conversion. Each share of 1997 Series
                           B Stock shall automatically be converted into shares
                           of Common Stock at the then effective Series B
                           Conversion Ratio immediately upon, and
                           contemporaneously with, the earlier of (A) the
                           effective time of any merger of the Corporation with
                           any other entity, any share exchange of the Common
                           Stock effected with any other entity or any sale of
                           all or substantially all the assets of the
                           Corporation, or (B) the date on which the Corporation
                           closes the sale of Common Stock in an offering
                           registered under the Securities Act of 1933, as
                           amended, with net proceeds to the Corporation and/or
                           any selling shareholders of at least $12.0 million
                           (after deductions for underwriters' discounts and
                           expenses relating to the issuance, including without
                           limitation, fees of the Corporation's counsel).

                           (iii) Mechanics of Conversion. In order to convert
                           shares of 1997 Series B Stock into shares of Common
                           Stock other than pursuant to (ii) above, the holder
                           thereof shall surrender the certificate or
                           certificates therefor, duly endorsed, at the
                           principal office of the Corporation or of any
                           transfer agent for such stock, and shall give written
                           notice to the Corporation at such office that he
                           elects to convert the same and shall state therein
                           the name or names in which he wishes the certificate
                           or certificates representing shares of Common Stock
                           to be issued. The Corporation shall, as soon as
                           practicable thereafter, issue and deliver at such
                           office to such holder of 1997 Series B Stock a
                           certificate or certificates for the number of shares
                           of Common Stock to which he shall be entitled as
                           aforesaid. Such conversion shall be deemed to have
                           been made immediately prior to the close of business
                           on the date of surrender of the shares of 1997 Series
                           B Stock to be converted, and the person or persons
                           entitled to receive the shares of Common Stock
                           issuable upon such conversion shall be treated for
                           all purposes as the record holder or holders of such
                           shares of Common Stock on such date.

                                       -6-


<PAGE>   7




                           (iv) Adjustments to Conversion Ratio for Stock
                           Combinations or Subdivisions of Common Stock. If the
                           Corporation at any time or from time to time after
                           the date on which shares of 1997 Series B Stock are
                           first issued shall declare or pay, without
                           consideration, any right to acquire Common Stock for
                           no consideration (other than pursuant to a stock or
                           other dividend for which a dividend is payable to the
                           holders of 1997 Series B Stock pursuant to
                           subparagraph D(b) above), or shall effect a
                           subdivision of the outstanding shares of Common Stock
                           into a greater number of shares of Common Stock (by
                           stock split, reclassification or in any way other
                           than by payment of a dividend in Common Stock), or in
                           the event the outstanding shares of Common Stock
                           shall be combined or consolidated, by
                           reclassification or otherwise, into a lesser number
                           of shares of Common Stock, then the Series B
                           Conversion Ratio in effect immediately prior to such
                           event shall, concurrently with the effectiveness of
                           such event, be proportionately decreased or
                           increased, as appropriate.

                           (v) Adjustments for Reclassification and
                           Reorganization. If the Common Stock issuable upon
                           conversion of the 1997 Series B Stock shall be
                           changed into the same or a different number of shares
                           of any other class or classes of stock, whether by
                           reclassification of stock or otherwise (other than a
                           subdivision or combination of shares provided for in
                           subparagraph (iv) above), the Series B Conversion
                           Ratio then in effect shall, concurrently with the
                           effectiveness of such reorganization or
                           reclassification, be proportionately adjusted so that
                           the 1997 Series B Stock shall be convertible into, in
                           lieu of the number of shares of Common Stock which
                           the holders would otherwise have been entitled to
                           receive, that number of shares of such other class or
                           classes of stock equivalent to the number of shares
                           of Common Stock that would have been subject to
                           receipt by the holders upon conversion of the 1997
                           Series B Stock immediately before that change.

                           (vi) Further Adjustment to the Number of Shares of
                           Common Stock Issuable Upon Conversion.

                           (A) Adjustment to the Conversion Price - If and 
                           whenever after the date hereof the Corporation
                           shall issue or sell any shares of its Common Stock
                           for a consideration per share less than the
                           conversion price in effect immediately prior to the
                           time of such issue or sale (the "Conversion Price";
                           the initial Conversion Price shall be $7.35) or the
                           Market Price (as defined below) at the time of such
                           issue or sale, then, forthwith upon such issue or
                           sale, the Conversion Price with respect to the 1997
                           Series B Stock subsequent to such event shall be
                           reduced (but not increased, except as otherwise
                           specifically provided in subclause (D) below) to the
                           lower of the prices (calculated to the nearest cent)
                           determined as follows: (1) by dividing (i) an amount
                           equal to the sum of (A) the aggregate number of
                           shares of Common Stock outstanding immediately prior
                           to such issue or sale multiplied by the then
                           existing Conversion Price, and (B) the
                           consideration, if any, received by the Corporation
                           upon such issue or sale, by (ii) the aggregate
                           number of shares of Common Stock of all classes
                           outstanding immediately after such issue or sale; or
                           (2) by multiplying the Conversion Price in 


                                       -7-


<PAGE>   8



                           effect immediately prior to the time of such issue or
                           sale by a fraction, the numerator of which shall be
                           the sum of (i) the aggregate number of shares of
                           Common Stock outstanding immediately prior to such
                           issue or sale multiplied by the Market Price
                           immediately prior to such issue or sale plus (ii) the
                           consideration received by the Corporation upon such
                           issue or sale, and the denominator of which shall be
                           the product of (iii) the aggregate number of shares
                           of Common Stock of all classes outstanding
                           immediately after such issue or sale, multiplied by
                           (iv) the Market Price immediately prior to such issue
                           or sale. No adjustment of the Conversion Price,
                           however, shall be made in an amount of less than 1%
                           of the Conversion Price, but any such lesser
                           adjustment shall be carried forward and shall be made
                           at the time of and together with the next subsequent
                           adjustment. "Market Price" shall mean, for any day,
                           the average of the final sale prices of the Common
                           Stock on all exchanges on which the Common Stock may
                           at the time be listed or the final bid prices on the
                           NASDAQ National Market System or NASDAQ
                           over-the-counter market, in each such case, unless
                           otherwise provided herein, averaged over a period of
                           forty-five consecutive trading days ending 2 days
                           prior to the day as of which "Market Price" is being
                           determined; provided, however, that in connection
                           with a firm underwriting of a public offering of
                           Common Stock, Market Price shall mean the initial
                           public offering price in such underwritten offering.
                           If at any time the Common Stock is not listed on any
                           such exchange or quoted in any such domestic
                           over-the-counter market, the "Market Price" shall be
                           deemed to be the fair market value thereof as
                           determined by an investment banks firm mutually
                           acceptable to the Company and the holders of at least
                           a majority of the outstanding 1997 Series B Preferred
                           Stock then outstanding; provided, however, that the
                           appointment of an investment banking firm shall be
                           unnecessary if the Board of Directors unanimously
                           agrees on the Market Price. Upon any adjustment in
                           the Conversion Price, the then Series B Conversion
                           Ratio in effect immediately prior to such event
                           shall, concurrently with the effectiveness of the
                           event giving rise to such adjustment, be
                           proportionately decreased or increased, as
                           appropriate.

                           (B) Issuance of Rights or Options - In case at any
                           time after the date hereof the Corporation shall in
                           any manner grant (whether directly or by assumption
                           in a merger or otherwise), any rights to subscribe
                           for or to purchase, or any options for the purchase
                           of, Common Stock or any stock or securities
                           convertible into or exchangeable for Common Stock
                           (such convertible or exchangeable stock or securities
                           being herein called "Convertible Securities", but
                           excluding options granted under stock option plans
                           approved by the Corporation), whether or not such
                           rights or options or the right to convert or exchange
                           any such Convertible Securities are immediately
                           exercisable, and the price per share for which Common
                           Stock is issuable upon the exercise of such rights or
                           options or upon conversion or exchange of such
                           Convertible Securities (determined by dividing (1)
                           the total amount, if any, received or receivable by
                           the Corporation as consideration for the granting of
                           such rights or options, plus the minimum aggregate
                           amount of additional consideration, if any, payable
                           to the Corporation upon the exercise of such rights
                           or options, plus, in the case of such rights or
                           options which relate to Convertible Securities, the
                           minimum aggregate amount of additional consideration,
                           if any, payable upon the issue or sale of such
                           Convertible Securities and upon the conversion or
                           exchange thereof, by (2) the total maximum number

                                       -8-


<PAGE>   9



                           of shares of Common Stock issuable upon the exercise
                           of such rights or options or upon the conversion or
                           exchange of all such Convertible Securities issuable
                           upon the exercise of such rights or options) shall be
                           less than the Conversion Price in effect immediately
                           prior to the time of the granting of such rights or
                           options (or less than the Market Price, determined as
                           of the date of granting such rights or options, as
                           the case may be), then the total maximum number of
                           shares of Common Stock issuable upon the exercise of
                           such rights or options or upon conversion or exchange
                           of all such Convertible Securities issuable upon the
                           exercise of such rights or options shall (as of the
                           date of granting of such rights or options) be deemed
                           to be outstanding and to have been issued for such
                           price per share. Except as provided in subclause (D)
                           below, no further adjustment of the Conversion Price
                           shall be made upon the actual issue of such Common
                           Stock or of such Convertible Securities upon exercise
                           of such rights or options or upon the actual issue of
                           such Common Stock upon conversion or exchange of such
                           Convertible Securities.

                           (C) Issuance of Convertible Securities - In case at
                           any time after the date hereof the Corporation shall
                           in any manner issue (whether directly or by
                           assumption in a merger or otherwise) or sell any
                           Convertible Securities, whether or not the rights to
                           exchange or convert thereunder are immediately
                           exercisable, and the price per share for which Common
                           Stock is issuable upon such conversion or exchange
                           (determined by dividing (1) the total amount received
                           or receivable by the Corporation as consideration for
                           the issue or sale of such Convertible Securities,
                           plus the minimum aggregate amount of additional
                           consideration, if any, payable to the Corporation
                           upon the conversion or exchange thereof, by (2) the
                           total maximum number of shares of Common Stock
                           issuable upon the conversion or exchange of all such
                           Convertible Securities) shall be less than the
                           Conversion Price in effect immediately prior to the
                           time of such issue or sale (or less than the Market
                           Price, determined as of the date of such issue or
                           sale of such Convertible Securities, as the case may
                           be), then the total maximum number of shares of
                           Common Stock issuable upon conversion or exchange of
                           all such Convertible Securities shall (as of the date
                           of the issue or sale of such Convertible Securities)
                           be deemed to be outstanding and to have been issued
                           for such price per share; provided, however, that (a)
                           except as otherwise provided in subclause (D) below,
                           no further adjustment of the Conversion Price shall
                           be made upon the actual issue of such Common Stock
                           upon conversion or exchange of such Convertible
                           Securities, and (b) if any such issue or sale of such
                           Convertible Securities is made upon exercise of any
                           rights to subscribe for or to purchase or any option
                           to purchase any such Convertible Securities for which
                           adjustments of the Conversion Price have been or are
                           to be made pursuant to other provisions of this
                           clause (vi), no further adjustment of the Conversion
                           Price shall be made by reason of such issue or sale.

                           (D) Change in Option Price or Conversion Rate - Upon
                           the happening of any of the following events, namely,
                           if the purchase price provided for in any right or
                           option referred to in subclause (B), the additional
                           consideration, if any, payable upon the conversion or
                           exchange of any Convertible Securities referred to in
                           subclause (B) or (C), or the rate at which any
                           Convertible Securities referred to in subclause (B)
                           or (C) are convertible into or exchangeable for
                           Common Stock shall

                                       -9-


<PAGE>   10



                           change (other than under or by reason of provisions
                           designed to protect against dilution), the Conversion
                           Price then in effect hereunder shall forthwith be
                           readjusted (increased or decreased, as the case may
                           be) to the Conversion Price which would have been in
                           effect at such time had such rights, options or
                           Convertible Securities still outstanding provided for
                           such changed purchase price, additional consideration
                           or conversion rate, as the case may be, at the time
                           initially granted, issued or sold. On the expiration
                           of any such option or right referred to in subclause
                           (B) or the termination of any such right to convert
                           or exchange any such Convertible Securities referred
                           to in subclause (B) or (C), the Conversion Price then
                           in effect hereunder shall forthwith be readjusted
                           (increased or decreased, as the case may be) to the
                           Conversion Price which would have been in effect at
                           the time of such expiration or termination had such
                           right, option or Convertible Securities, to the
                           extent outstanding immediately prior to such
                           expiration or termination, never been granted, issued
                           or sold, and the Common Stock issuable thereunder
                           shall no longer be deemed to be outstanding. If the
                           purchase price provided for in any such right or
                           option referred to in subclause (B) or the rate at
                           which any Convertible Securities referred to in
                           subclause (B) or (C) are convertible into or
                           exchangeable for Common Stock shall be reduced at any
                           time under or by reason or provisions with respect
                           thereto designed to protect against dilution, then in
                           case of the delivery of shares of Common Stock upon
                           the exercise of any such right or option or upon
                           conversion or exchange of any such Convertible
                           Securities, the Conversion Price then in effect
                           hereunder shall, if not already adjusted, forthwith
                           be adjusted to such amount as would have obtained had
                           such right, option or Convertible Securities never
                           been issued as to such shares of Common Stock and had
                           adjustments been made upon the issuance of the shares
                           of Common Stock delivered as aforesaid, but only if
                           as a result of such adjustment the Conversion Price
                           then in effect hereunder is thereby reduced.

                           (vii) No Impairment. The Corporation will not, by
                           amendment of its Articles of Incorporation or through
                           any reorganization, transfer of assets,
                           consolidation, merger, dissolution, issue or sale of
                           securities or any other voluntary action, avoid or
                           seek to avoid the observance or performance of any of
                           the terms of the 1997 Series B Stock but will at all
                           times in good faith assist in the carrying out of all
                           the provisions of this section and in the taking of
                           all such action as may be necessary or appropriate in
                           order to protect the conversion rights of the holders
                           of the 1997 Series B Stock against impairment.

                           (viii) Certificates as to Adjustments. Upon the
                           occurrence of each adjustment or readjustment of the
                           Series B Conversion Ratio, the Corporation at its
                           expense shall promptly compute such adjustment or
                           readjustment in accordance with the terms hereof and
                           prepare and furnish to each holder of 1997 Series B
                           Stock a certificate executed by the Corporation's
                           President or Chief Financial Officer setting forth
                           such adjustment or readjustment and showing in detail
                           the facts upon which such adjustment or readjustment
                           is based. The Corporation shall, upon the written
                           request at any time of any holder of 1997 Series B
                           Stock, furnish or cause to be furnished to such
                           holder a like certificate setting forth (i) such
                           adjustments and readjustments, (ii) the

                                      -10-


<PAGE>   11



                           Series B Conversion Ratio at the time in effect, and
                           (iii) the number of shares of Common Stock and the
                           amount, if any, of other property which at the time
                           would be received upon the conversion of the 1997
                           Series B Stock.

                           (ix) Reservation of Stock Issuable Upon Conversion.
                           The Corporation shall at all times reserve and keep
                           available out of its authorized but unissued shares
                           of Common Stock, solely for the purpose of effecting
                           the conversion of the shares of 1997 Series B Stock,
                           such number of its shares of Common Stock as shall
                           from time to time be sufficient to effect the
                           conversion of all outstanding shares of the 1997
                           Series B Stock.

                           (x) Fractional Shares. No fractional share shall be
                           issued upon the conversion of any share or shares of
                           1997 Series B Stock. If the conversion would result
                           in the issuance of a fraction of a share of Common
                           Stock, the Corporation shall, in lieu of issuing any
                           fractional share, pay the holder otherwise entitled
                           to such fraction a sum of cash equal to the fair
                           market value of such fraction on the date of
                           conversion as determined in good faith by the Board.

                  (d)      Redemption Rights of the Corporation. At the option
                           of the Board, the Corporation may, at any time at
                           which the 1997 Series B Stock is convertible into
                           Common Stock, redeem from any source of funds legally
                           available therefor, all or any portion of the
                           outstanding shares of 1997 Series B Stock, at a
                           redemption price per share equal to $7.35 (the
                           "Series B Redemption Price") plus all declared and
                           unpaid dividends thereon, by giving written notice to
                           each holder of record of 1997 Series B Stock to be
                           redeemed (a "Series B Redemption Notice") at its post
                           office address last shown on the records of the
                           Corporation, not later than 30 days prior to the date
                           fixed for any redemption (a "Series B Redemption
                           Date") specifying the number of shares of 1997 Series
                           B Stock that are to be redeemed on the Series B
                           Redemption Date specified in such Series B Redemption
                           Notice. On such Series B Redemption Date, the
                           Corporation will pay to each holder of 1997 Series B
                           Stock, upon surrender for cancellation to the
                           Corporation at its principal office of the
                           certificates, duly endorsed in blank, representing
                           the shares of 1997 Series B Stock to be redeemed on
                           such Series B Redemption Date, an amount per share
                           equal to the Series B Redemption Price thereof plus
                           all declared but unpaid dividends thereon. If less
                           than all of the shares represented by any such
                           certificate are redeemed, the shares to be redeemed
                           shall be selected from the then outstanding shares on
                           a pro rata basis and a new certificate shall be
                           issued representing the unredeemed shares. Until the
                           Series B Redemption Date, holders of the 1997 Series
                           B Stock shall be entitled to the full preferences,
                           limitations and relative rights of such stock. The
                           holders of such shares of 1997 Series B Stock shall
                           cease to have any further rights, other than the
                           right to receive the Series B Redemption Price
                           thereof plus such declared and unpaid dividends, with
                           respect to the 1997 Series B Stock on the Series B
                           Redemption Date.

                                      -11-


<PAGE>   12



                  (e)      Liquidation Rights. In the event of any liquidation,
                           dissolution or winding up of the affairs of the
                           Corporation, whether voluntary or involuntary, the
                           holders of shares of 1997 Series B Stock then
                           outstanding shall be entitled to be paid, in cash,
                           out of the assets of the Corporation available for
                           distribution to its stockholders, before any payment
                           or declaration and setting apart for payment of any
                           amount shall be made in respect of any shares of
                           Common Stock or any other shares of the Corporation
                           junior or subordinate to the 1997 Series B Stock, (i)
                           $4.00 per share, together with all declared and
                           unpaid dividends on the 1997 Series B Stock, plus
                           (ii) an amount equal to the Corporation's net assets
                           remaining after the payment of the amount described
                           in clause (i) above and reduced by the amount payable
                           to the holders of the 1996 Series A Stock as provided
                           in clause (i) of Section C(e) of these Articles of
                           Incorporation, multiplied by the percentage of the
                           Common Stock, on a fully diluted basis, that would be
                           owned by holders of the 1997 Series B Stock if
                           converted into Common Stock, such amount to be
                           distributed among the holders of the 1997 Series B
                           Stock on a pro rata basis. The preferential
                           liquidation rights of the 1997 Series B Stock shall
                           be superior to preferential liquidation rights of the
                           1996 Series A Stock. If, upon any liquidation,
                           dissolution or winding up of the Corporation, whether
                           voluntary or involuntary, the assets to be
                           distributed among the holders of shares of 1997
                           Series B Stock are insufficient to permit the payment
                           to such holders of the entire preferential amount
                           provided for in clause (i) above, then all of the net
                           assets of the Corporation shall be distributed pro
                           rata and in proportion to the amounts each holder is
                           entitled to receive among the holders of shares of
                           1997 Series B Stock.

                  (f)      Protective Provisions. For as long as 1997 Series B
                           Stock is outstanding, the Corporation shall not,
                           without the prior written consent or affirmative vote
                           of holders of at least a majority of the outstanding
                           1997 Series B Stock:

                           (1) authorize or issue any other capital shares of
                               the Corporation which rank superior to the 1997
                               Series B Stock with respect to conversion,
                               dividends, redemption, liquidation, antidilution
                               or other preferences, designations, rights or
                               powers;

                           (2) authorize or issue any securities of the
                               Corporation which have voting rights superior to
                               1997 Series B Stock; or

                           (3) otherwise amend, alter or repeal the preferences,
                               designations, rights or powers of the 1997 Series
                               B Stock, or enter into any transaction that shall
                               result in any such amendment, alteration or
                               repeal, which would have an adverse effect upon
                               holders of such shares. For this purpose, without
                               limiting the generality of the foregoing, the
                               authorization or issuance of other securities
                               with preference or priority over the 1997 Series
                               B Stock as to the right to receive either
                               dividends or amounts distributable upon
                               liquidation, dissolution or winding up of the
                               Corporation, shall be deemed to affect adversely
                               holders of the 1997 Series B Stock.


                                      -12-


<PAGE>   13



                  (g)      No Reissuance of Stock. No 1997 Series B Stock
                           acquired by the Corporation by reason of redemption,
                           purchase, or otherwise shall be reissued, and all
                           such shares shall be canceled, retired and eliminated
                           from the 1997 Series B Stock and shall return to the
                           status of Preferred Stock authorized without
                           designation.



                                      III.

                  The Corporation shall have its registered office at 3800
Gateway Boulevard, Suite 310, Wake County, Raleigh, North Carolina, 27560, and
the name of its registered agent at such address is Jeff N. Hunter.


                                       IV.

                  Except as otherwise provided in these articles or the bylaws,
the Board of Directors of the Corporation shall have the power, by vote of a
majority of all the directors, and without the assent or vote of the
shareholders, to make, offer, amend, and rescind the Corporation's bylaws at any
regular or special meeting of the Board of Directors.


                                       V.

         The following provisions shall govern certain business combinations
involving the Corporation. Capitalized terms not otherwise defined in these
articles shall have the meanings ascribed to them in Section V.D. of these
articles.

         A. Business Combinations. Any Business Combination shall require only
such affirmative vote as is required by law and any other provision of these
articles if either all of the conditions set forth in clauses (1), (2) and (3)
of Section V.A. have been satisfied or if the condition set forth in clause (4)
of Section V.A. have been satisfied:

                  (1) Form of Consideration. The consideration to be received by
         holders of Common Stock shall be cash or in the same form as previously
         has been paid by or on behalf of any Interested Shareholder in
         connection with its direct or indirect acquisition of beneficial
         ownership of any shares of Common Stock. If the consideration paid by
         or on behalf of the Interested Shareholder for shares of Common Stock
         varied as to form, the form of consideration to be received by holders
         of Common Stock shall be either cash or the form used to acquire
         beneficial ownership of the largest number of shares of Common Stock
         previously acquired by the Interested Shareholder.

                  (2) Amount of Consideration. The aggregate amount of the cash
         and the Fair Market Value of consideration other than cash to be
         received per share by holders of Common Stock in any Business
         Combination shall be at least equal to the greater of (a) the Fair
         Market Value per share of Common Stock on the date of the first public
         announcement of the proposal of a Business Combination (the
         "Announcement Date") or on the date on which the Interested Shareholder
         became an Interested Shareholder, whichever is higher, multiplied by
         the ratio of (i) the highest per

                                      -13-


<PAGE>   14



         share price (including any brokerage commissions, transfer taxes and
         soliciting dealers' fees) paid by the Interested Shareholder for any
         shares of Common Stock acquired by it within the two-year period
         immediately prior to the Announcement Date to (ii) the Fair Market
         Value per share of Common Stock on the first day in such two-year
         period on which the Interested Shareholder acquired any shares of
         Common Stock or (b) the highest per share price (including brokerage
         commissions, transfer taxes and soliciting dealers' fees) paid by such
         Interested Shareholder in acquiring any of the Corporation's Common
         Stock.

                  (3) Restrictions. After becoming an Interested Shareholder and
         prior to the consummation of any Business Combination, (a) such
         Interested Shareholder shall not have acquired any newly issued shares
         of capital stock, directly or indirectly, from the Corporation (except
         upon conversion of convertible securities acquired by it prior to
         becoming an Interested Shareholder or upon compliance with the
         provisions of Section V of these articles or as a result of a pro rata
         stock dividend or stock split) and (b) such Interested Shareholder
         shall not have received the benefit, directly or indirectly (except
         proportionately as a shareholder), of any loans, advances, guarantees,
         pledges or other financial assistance or tax credits provided by the
         Corporation, or made any significant changes in the Corporation's
         business or equity capital structure.

                  (4) Fairness Opinion. The Business Combination shall have been
         approved by at least two-thirds of the Continuing Directors and, if
         deemed advisable by a majority of the Continuing Directors, the Board
         of Directors shall have obtained an opinion of a reputable investment
         banking firm to the effect that the financial terms of such Business
         Combination are fair from a financial point of view to the holders of
         Voting Shares (other than the Interested Shareholder) (such investment
         banking firm to be selected by a majority of the Continuing Directors,
         to be furnished with all information it reasonably requests and to be
         paid a reasonable fee for its services upon receipt by the Corporation
         of such opinion).

         B. Shareholder Vote. If the provisions of Section V.A. have not been
satisfied, any Business Combination shall require the affirmative vote, in
person or by proxy, at any meeting called as provided in the bylaws, of the
holders of at least two-thirds in interest of the issued and outstanding Voting
Shares of the Corporation, including a majority in interest of the holders of
issued and outstanding Voting Shares of the Corporation held by Persons other
than an Interested Shareholder or any Affiliate or Associate of any Interested
Shareholder. Such affirmative vote shall be required notwithstanding the fact
that no vote may be required, or that some lesser percentage may be specified by
law or in any agreement with any national securities exchange or otherwise.

         C. Exception. The provisions of Sections V.A. and V.B. shall not be
applicable to any particular Business Combination, and such Business Combination
shall require only such affirmative vote, if any, as is required by law and any
other provision of these articles, if such Business Combination constitutes a
transaction between the Corporation or any Subsidiary and any corporation of
which a majority of the outstanding shares of all classes of stock entitled to
vote in elections of directors is owned of record or beneficially by the
Corporation or its Subsidiaries, provided that this Section V.C. shall not apply
to any transaction to which any Affiliate of any Interested Shareholder is a
party.

         D. Definitions. For the purposes of these articles:


                                      -14-


<PAGE>   15



                  (1) The term "Business Combination" shall mean any transaction
         which is referred to in any one or more of clauses (a) through (f) of
         this paragraph (1):

                           (a) Any merger, share exchange or consolidation of
                  the Corporation or any Subsidiary with or into (A) any
                  Interested Shareholder or (B) any other entity (whether or not
                  itself an Interested Shareholder) which immediately before is,
                  or after such merger, share exchange or consolidation would
                  be, an Affiliate of an Interested Shareholder;

                           (b) Any sale, lease, exchange, mortgage, pledge,
                  transfer or other disposition (in one transaction or a series
                  of related transactions) to or with any Interested Shareholder
                  or any Affiliate of any Interested Shareholder of any assets
                  of the Corporation or any Subsidiary when such assets have an
                  aggregate Fair Market Value of $5,000,000 or more;

                           (c) The issuance or transfer to any Interested
                  Shareholder or any Affiliate of any Interested Shareholder by
                  the Corporation or any Subsidiary (in one transaction or a
                  series of related transactions) of any equity securities of
                  the Corporation or any Subsidiary where such equity securities
                  have an aggregate Fair Market Value of $5,000,000 or more;

                           (d) The adoption of any plan or proposal for the
                  liquidation or dissolution of the Corporation;

                           (e) Any reclassification of securities (including any
                  reverse stock split), or recapitalization of the Corporation,
                  or any merger, share exchange or consolidation of the
                  Corporation with or into any of its Subsidiaries or any
                  similar transaction (whether or not with or into or otherwise
                  involving an Interested Shareholder) which has the effect,
                  directly or indirectly, of increasing the percentage of the
                  outstanding shares of any class of equity or convertible
                  securities of the Corporation or any Subsidiary which is
                  directly or indirectly owned by any Interested Shareholder or
                  any Affiliate of any Interested Shareholder; or

                           (f) Any agreement, contract or other arrangement
                  providing for any of the transactions described in this
                  definition of "Business Combination."

                  (2) A "Person" shall mean any individual, firm, corporation or
         other entity.

                  (3) "Interested Shareholder" shall mean any Person (other than
         the Corporation, any Subsidiary or a trustee holding stock for the
         benefit of the employees of the Corporation or its Subsidiaries) who or
         which, along with any Affiliates and Associates of the Interested
         Shareholder:

                           (a) Is the Beneficial Owner, directly or indirectly,
                  of more than 10% of the Voting Shares of the Corporation or a
                  Subsidiary; or

                           (b) Is an assignee of or has otherwise succeeded to
                  any share of capital stock of the Corporation or a Subsidiary
                  which was at any time within two years prior thereto
                  beneficially owned by any Interested Shareholder, and such
                  assignment or succession shall have occurred in the course of
                  a transaction or series of transactions not involving a public
                  offering within the meaning of the Securities Act of 1933.


                                      -15-


<PAGE>   16



                  A Person shall be deemed an Interested Shareholder for the
                  purpose of this definition if such Person is an Interested
                  Shareholder as of the record date for the determination of
                  shareholders entitled to notice of and to vote on any Business
                  Combination, as of the date any definitive agreement relating
                  to a Business Combination is entered into or amended so as to
                  make it less favorable to the Corporation or its shareholders
                  other than the Interested Shareholder, or immediately prior to
                  the consummation of any such Business Combination.

                  (4) A Person shall be the "Beneficial Owner" of any Voting
         Shares:

                           (a) As to which such Person or any of its Affiliates
                  and Associates, pursuant to any agreement, arrangement or
                  understanding, or otherwise, has or shares, directly or
                  indirectly, voting power, including the power to vote or
                  direct the voting of such shares, or investment power,
                  including the power to dispose or to direct the disposition of
                  such shares, or both;

                           (b) Which such Person or any of its Affiliates or
                  Associates has (i) the right to acquire (whether such right is
                  exercisable immediately or only after the passage of time),
                  pursuant to any agreement, arrangement or understanding or
                  upon the exercise of conversion rights, exchange rights,
                  warrants or options, or otherwise or (ii) the right to vote
                  pursuant to any agreement, arrangement or understanding; or

                           (c) Which are beneficially owned, directly or
                  indirectly, by any other Person with which such
                  first-mentioned Person or any of its Affiliates or Associates
                  has any agreement, arrangement or understanding for the
                  purpose of acquiring, holding, voting or disposing of any
                  shares of capital stock of the Corporation or a Subsidiary, as
                  the case may be.

                  (5) "Voting Shares" when used with respect to the Corporation
         or a Subsidiary shall mean shares of such entity having general voting
         power. For the purpose of determining whether a Person is an Interested
         Shareholder pursuant to paragraph (3) of Section V.D., the outstanding
         Voting Shares shall include shares deemed owned by a Beneficial Owner
         through application of paragraph (4) of Section V.D. but shall not
         include any other Voting Shares which may be issuable to any other
         Person pursuant to any agreement or upon exercise of conversion rights,
         warrants or options, or otherwise.

                  (6) "Affiliate" and "Associate" shall have the respective
         meanings given those terms in Rule 12b-2 of the General Rules and
         Regulations under the Securities Exchange Act of 1934, as in effect on
         June 30, 1997.

                  (7) "Subsidiary" shall mean any entity of which a majority of
         any class of equity security (as defined in Rule 3a11-1 of the General
         Rules and Regulations under the Securities Exchange Act of 1934, as in
         effect on June 30, 1997) is owned, directly or indirectly, by the
         Corporation; provided, however, that for the purposes of the definition
         of Interested Shareholder set forth in paragraph (3) of Section V.D.,
         the term "Subsidiary" shall mean only an entity of which a majority of
         each class of equity security is owned, directly or indirectly, by the
         Corporation.


                                      -16-


<PAGE>   17



                  (8) "Continuing Director" shall mean an individual who was a
         member of the Board of Directors of the Corporation on the date Section
         V of these articles was adopted by the shareholders of the Corporation,
         or a director who has been nominated by the Corporation to directly
         succeed a Continuing Director or to join the Board of Directors.

                  (9) "Fair Market Value" shall mean (i) in the case of stock,
         the highest closing sales price during the 30-day period immediately
         preceding the date in question of a share of such stock on the
         Composite Tape for New York Stock Exchange--Listed Stocks, or, if such
         stock is not quoted on the Composite Tape, on the New York Stock
         Exchange, or, if such stock is not listed on such Exchange, on the
         principal United States securities exchange registered under the
         Securities Exchange Act of 1934 on which such stock is listed, or, if
         such stock is not listed on any such exchange, as quoted in the
         NASDAQ National Market, or, if such stock is not included in such
         system, the highest closing bid quotation with respect to a share of
         such stock during the 30-day period preceding the date in question on
         the National Association of Securities Dealers, Inc. Automated
         Quotations System or any system then in use, or, if no such quotations
         are available, the fair market value on the date in question of a share
         of such stock as determined in good faith by a majority of Continuing
         Directors, and (ii) in the case of property other than cash or stock,
         the fair market value of such property on the date in question as
         determined in good faith by a majority of Continuing Directors.

         E. The Continuing Directors, by a majority vote, shall have the power
to determine for the purposes of Section V on the basis of information known to
them (1) the number of Voting Shares beneficially owned by any Person, (2)
whether a Person is an Affiliate or Associate of another, (3) whether a Person
has an agreement, arrangement or understanding with another as to the matters
referred to in paragraph (4) of Section V.D., (4) whether the assets of the
Corporation or any Subsidiary have an aggregate fair market value of $5,000,000
or more, (5) whether the consideration received for the issuance or transfer of
securities by the Corporation or any Subsidiary has an aggregate fair market
value of $5,000,000 or more and (6) such other matters with respect to which a
determination is necessary or appropriate under Section V.

         F. Nothing contained in Section V shall be construed to relieve any
Interested Shareholder from any fiduciary obligation imposed by law.


                                       VI.

          Except as otherwise provided herein (and in addition to any other vote
that may be required by law, these articles or the bylaws of the Corporation),
the affirmative vote, in person or by proxy, at any meeting called as provided
in the bylaws, of the holders of at least two-thirds in interest of the Voting
Shares of the Corporation issued and outstanding, shall be required to amend,
alter or repeal Sections II, V, VI and VII of these articles or Section 4 of
Article II and Section 2 of Article III of the bylaws, or to adopt any new
provision inconsistent with such provisions of these articles or the bylaws;
provided, however, that if at the time of any such proposed amendment,
alteration, repeal or adoption, (a) there shall exist one or more Interested
Shareholders and at least two-thirds of the Continuing Directors approve such
proposed amendment, alteration, repeal or adoption, or (b) no such Interested
Shareholder exists, and a majority of the members of the Board of Directors
approve such proposed amendment, alteration, repeal or adoption, then the
affirmative vote, in person or by proxy, at any meeting called as provided in
the

                                      -17-


<PAGE>   18


bylaws, of the holders of a majority in interest of the issued and outstanding
Voting Shares of the Corporation shall be required to approve such amendment,
alteration, repeal or adoption.

                                      VII.

                  The provisions of Articles 9 and 9A of Chapter 55 of the
General Statutes of North Carolina shall not apply to the Corporation.


                                      VIII.

                  To the full extent from time to time permitted by law, no
person who is serving or has served as a director of the Corporation shall be
personally liable in any action for monetary damages for breach of his or her
duty as a director, whether such action is brought by or in the right of the
Corporation or otherwise. Neither the amendment or repeal of this Article, nor
the adoption of any provision of these Articles of Incorporation inconsistent
with this Article, shall eliminate or reduce the protection afforded by this
Article to a director of the Corporation with respect to any matter which
occurred, or any cause of action, suit or claim, which but for this Article
would have accrued or arisen, prior to such amendment, repeal or adoption.


                                       IX.

                  The name and address of the incorporator are Sheri L.
Crockett, 2100 First Union Capitol Center, 150 Fayetteville Street Mall, Post
Office Box 831, Raleigh, NC 27602, North Carolina 27601.





                                      -18-





<PAGE>   1


                                                                     EXHIBIT 3.2



                              AMENDED AND RESTATED

                                     BYLAWS

                                       OF

                                    C3, INC.

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





                                                     Effective October 12, 1997



<PAGE>   2



                TABLE OF CONTENTS TO AMENDED AND RESTATED BYLAWS

                                       OF

                                    C3, INC.

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


                                                                           Page

ARTICLE 1 -- OFFICES.........................................................1
         Section l.  Principal and Registered Office.........................1
         Section 2.  Other Offices...........................................1

ARTICLE 2 -- MEETINGS OF SHAREHOLDERS........................................1
         Section l.  Place of Meeting........................................1
         Section 2.  Annual Meeting..........................................1
         Section 3.  Substitute Annual Meeting...............................1
         Section 4.  Special Meetings........................................1
         Section 5.  Notice of Meetings......................................1
         Section 6.  Notice of Shareholder Nominations and Proposals.........2
         Section 7.  Quorum..................................................2
         Section 8.  Shareholders' List......................................2
         Section 9.  Voting of Shares........................................3
         Section 10. Inspectors of Elections.................................3
         Section 11. Action Without Meeting..................................3

ARTICLE 3 -- BOARD OF DIRECTORS..............................................4
         Section 1.  General Powers..........................................4
         Section 2.  Number, Term and Qualification..........................4
         Section 3.  Removal.................................................4
         Section 4.  Vacancies...............................................4

ARTICLE 4 -- MEETINGS OF DIRECTORS...........................................5
         Section 1.  Annual and Regular Meetings.............................5
         Section 2.  Special Meetings........................................5
         Section 3.  Notice of Meetings......................................5
         Section 4.  Quorum..................................................5
         Section 5.  Manner of Acting........................................5
         Section 6.  Presumption of Assent...................................5
         Section 7.  Action Without Meeting..................................5
         Section 8.  Meeting by Communications Device........................6

ARTICLE 5 -- COMMITTEES......................................................6
         Section 1.  Election and Powers.....................................6
         Section 2.  Removal; Vacancies......................................6
         Section 3.  Meetings................................................6
         Section 4.  Minutes.................................................7



                                        i


<PAGE>   3



ARTICLE
 6 -- OFFICERS........................................................7
         Section 1.  Titles..................................................7
         Section 2.  Election; Appointment...................................7
         Section 3.  Removal.................................................7
         Section 4.  Vacancies...............................................7
         Section 5.  Compensation............................................7
         Section 6.  Chairman of the Board of Directors......................7
         Section 7.  President...............................................7
         Section 8.  Vice Presidents.........................................7
         Section 9.  Secretary...............................................8
         Section 10. Assistant Secretaries...................................8
         Section 11. Treasurer...............................................8
         Section 12. Assistant Treasurers....................................8
         Section 13. Controller and Assistant Controllers....................8
         Section 14. Voting Upon Stocks......................................9

ARTICLE 7 -- CAPITAL STOCK...................................................9
         Section 1.  Certificates............................................9
         Section 2.  Transfer of Shares......................................9
         Section 3.  Transfer Agent and Registrar............................9
         Section 4.  Regulations.............................................9
         Section 5.  Fixing Record Date......................................9
         Section 6.  Lost Certificates......................................10

ARTICLE 8 -- INDEMNIFICATION OF DIRECTORS AND OFFICERS......................10
         Section 1.  Indemnification Provisions.............................10
         Section 2.  Definitions............................................10
         Section 3.  Settlements............................................10
         Section 4.  Litigation Expense Advances............................10
         Section 5.  Approval of Indemnification Payments...................11
         Section 6.  Suits by Claimant......................................11
         Section 7.  Consideration; Personal Representatives and
                     Other Remedies.........................................11
         Section 8.  Scope of Indemnification Rights........................11

ARTICLE 9 -- GENERAL PROVISIONS.............................................12
         Section 1.  Dividends and other Distributions......................12
         Section 2.  Seal...................................................12
         Section 3.  Waiver of Notice.......................................12
         Section 4.  Checks.................................................12
         Section 5.  Fiscal Year............................................12
         Section 6.  Amendments.............................................12
         Section 7.  Shareholders' Agreement................................12


                                       ii


<PAGE>   4



                           AMENDED AND RESTATED BYLAWS

                                       OF

                                    C3, INC.




                              ARTICLE 1 -- OFFICES

                  Section l. Principal and Registered Office. The principal
office of the corporation shall be located within the State of North Carolina.
The registered office of the corporation may, but need not, be the same as the
principal office.

                  Section 2. Other Offices. The corporation may have offices at
such other places, either within or without the State of North Carolina, as the
board of directors may from time to time determine.

                      ARTICLE 2 -- MEETINGS OF SHAREHOLDERS

                  Section l. Place of Meeting. Meetings of shareholders shall be
held at the principal office of the corporation, or at such other place, either
within or without the State of North Carolina, as shall be designated in the
notice of the meeting.

                  Section 2. Annual Meeting. Commencing in 1998, the annual
meeting of shareholders shall be held at 10 o'clock a.m. on the second Tuesday
of May of each year, if not a legal holiday, but if a legal holiday, then on the
next business day which is not a legal holiday, for the purpose of electing
directors of the corporation and the transaction of such other business as may
be properly brought before the meeting.

                  Section 3. Substitute Annual Meeting. If the annual meeting is
not held on the day designated by these bylaws, a substitute annual meeting may
be called in accordance with Section 4 of this Article. A meeting so called
shall be designated and treated for all purposes as the annual meeting.

                  Section 4. Special Meetings. Special meetings of the
shareholders may be called at any time by the president or the board of
directors. Unless otherwise required by the articles of incorporation or by law,
shareholders shall not be entitled to call a meeting of the shareholders of the
corporation.

                  Section 5. Notice of Meetings. At least 10 and no more than 60
days prior to any annual or special meeting of shareholders, the corporation
shall notify shareholders of the date, time and place of the meeting and, in the
case of a special or substitute annual meeting or where otherwise required by
law, shall briefly describe the purpose or purposes of the meeting. Only
business within the purpose or purposes described in the notice may be conducted
at a special meeting. Unless otherwise required by the articles of incorporation
or by law (for example, in the event of a meeting to consider the adoption of a
plan of merger or share exchange, a sale of assets other than in the ordinary
course of business or a voluntary dissolution), the corporation shall be
required to give notice only to shareholders entitled to vote at the meeting. If
an annual or special shareholders' meeting is adjourned to a different date,
time or place, notice thereof need not be given if the new date, time or place
is announced at the meeting before adjournment.

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<PAGE>   5


If a new record date for the adjourned meeting is fixed pursuant to Article 7,
Section 5 hereof, notice of the adjourned meeting shall be given to persons who
are shareholders as of the new record date. It shall be the primary
responsibility of the secretary to give the notice, but notice may be given by
or at the direction of the president or other person or persons calling the
meeting. If mailed, such notice shall be deemed to be effective when deposited
in the United States mail with postage thereon prepaid, correctly addressed to
the shareholder's address shown in the corporation's current record of
shareholders.

                  Section 6. Notice of Shareholder Nominations and Proposals.
Following the closing of a Public Offering, as such term is defined in the
corporation's articles of incorporation, nominations for election as a director
and proposals for shareholder action by a holder of any outstanding class of
shares of the corporation entitled to vote for the election of directors shall
be made in writing and be delivered or mailed to the chief executive officer of
the corporation (i) in the case of an annual meeting that is called for a date
that is within 30 days before or after the anniversary of the immediately
preceding annual meeting of shareholders, not less than 60 days nor more than 90
days prior to such anniversary date and (ii) in the case of an annual meeting
that is called for a date that is not within 30 days before or after the
anniversary date of the immediately preceding annual meeting or in the case of a
special meeting of shareholders, not later than the close of business on the
tenth day following the day on which the notice of meeting was mailed or public
disclosure of the date of the meeting was made, whichever occurs first. Such
notification shall contain a written statement of the shareholder's proposal and
of the reasons therefor, and, in the case of a director nomination, shall
contain the following information to the extent known by the notifying
shareholder: (a) the name, age and address of each proposed nominee; (b) the
principal occupation of each proposed nominee; (c) the total number of shares
that will be voted for each proposed nominee; (d) the name and residence address
of the notifying shareholder; and (e) the number of shares owned by the
notifying shareholder. Nominations or proposals not made in accordance herewith
may be disregarded by the chairman of the meeting in his discretion, and upon
his instructions all votes cast for each such nominee or for such proposal may
be disregarded.

                  Section 7. Quorum. A majority of the votes entitled to be cast
by a voting group on a matter, represented in person or by proxy at a meeting of
shareholders, shall constitute a quorum for that voting group for any action on
that matter, unless quorum requirements are otherwise fixed by a court of
competent jurisdiction acting pursuant to Section 55-7-03 of the General
Statutes of North Carolina. Once a share is represented for any purpose at a
meeting, it is deemed present for quorum purposes for the remainder of the
meeting and any adjournment thereof, unless a new record date is or must be set
for the adjournment. Action may be taken by a voting group at any meeting at
which a quorum of that voting group is represented, regardless of whether action
is taken at that meeting by any other voting group. In the absence of a quorum
at the opening of any meeting of shareholders, such meeting may be adjourned
from time to time by a vote of the majority of the shares voting on the motion
to adjourn.

                  Section 8. Shareholders' List. After a record date is fixed
for a meeting, the secretary of the corporation shall prepare an alphabetical
list of the names of all its shareholders who are entitled to notice of the
shareholders' meeting. Such list shall be arranged by voting group (and within
each voting group by class or series of shares) and shall show the address of
and number of shares held by each shareholder. The shareholders' list shall be
made available for inspection by any shareholder beginning two business days
after notice of the meeting is given for which the list was prepared and
continuing through the meeting, at the corporation's principal office or at such
other place identified in the meeting notice in the city where the meeting will
be held. The corporation shall make the shareholders' list available at the
meeting, and any shareholder or his agent or attorney is entitled to inspect the
list at any time during the meeting or any adjournment.

                                        2


<PAGE>   6



                  Section 9. Voting of Shares. Except as otherwise provided by
the articles of incorporation or by law, each outstanding share of voting
capital stock of the corporation shall be entitled to one vote on each matter
submitted to a vote at a meeting of the shareholders. Cumulative voting for
directors shall not be allowed. Action on a matter by a voting group for which a
quorum is present is approved if the votes cast within the voting group favoring
the action exceed the votes cast opposing the action, unless the vote of a
greater number is required by law or by the articles of incorporation. Voting on
all matters shall be by voice vote or by a show of hands, unless the holders of
one-tenth of the shares represented at the meeting shall demand a ballot vote on
a particular matter. Absent special circumstances, the shares of the corporation
are not entitled to vote if they are owned, directly or indirectly, by a second
corporation, domestic or foreign, and the corporation owns, directly or
indirectly, a majority of the shares entitled to vote for directors of the
second corporation, except that this provision shall not limit the power of the
corporation to vote shares held by it in a fiduciary capacity.

                  Section 10.  Inspectors of Elections.

                  (a) Appointment of inspectors of election. In advance of any
         meeting of shareholders, the board of directors may appoint any
         persons, other than nominees for office, as inspectors of election to
         act at such meeting or any adjournment thereof. If inspectors of
         election are not so appointed, the chairman of any such meeting may,
         and on the request of any shareholder or his proxy shall, appoint
         inspectors of election at the meeting. The number of inspectors shall
         be either one or three. If appointed at a meeting on the request of one
         or more shareholders or proxies, the majority of shares present shall
         determine whether one or three inspectors are to be appointed. In case
         any person appointed as inspector fails to appear or fails or refuses
         to act, the vacancy may be filled by appointment by the board of
         directors in advance of the meeting, or at the meeting by the person
         acting as chairman.

                  (b) Duties of inspectors. The inspectors of election shall
         determine the number of shares outstanding and the voting power of
         each, the shares represented at the meeting, the existence of a quorum,
         the authenticity, validity, and effect of proxies, receive votes,
         ballots, or consents, hear and determine all challenges and questions
         in any way arising in connection with the right to vote, count and
         tabulate all votes or consents, determine the result, and do such acts
         as may be proper to conduct the election or vote with fairness to all
         shareholders. The inspectors of election shall perform their duties
         impartially, in good faith, to the best of their ability and as
         expeditiously as is practical.

                  (c) Vote of inspectors. If there are three inspectors of
         election the decision, act, or certificate of a majority is effective
         in all respects as the decision, act, or certificate of all.

                  (d) Report of inspectors. On request of the chairman of the
         meeting or of any shareholder or his proxy the inspectors shall make a
         report in writing of any challenge or question or matter determined by
         them and execute a certificate of any fact found by them. Any report or
         certificate made by them is prima facie evidence of the facts stated
         herein.

                  Section 11. Action Without Meeting. Any action which the
shareholders could take at a meeting may be taken without a meeting if one or
more written consents, setting forth the action taken, shall be signed, before
or after such action, by all the shareholders who would be entitled to vote upon
the action at a meeting. The consent shall be delivered to the corporation for
inclusion in the minutes or filing with the corporate records. If by law, the
corporation is required to give its nonvoting shareholders written

                                        3


<PAGE>   7



notice of the proposed action, it shall do so at least 10 days before the action
is taken, and such notice must contain or be accompanied by the same material
that would have been required by law to be sent to nonvoting shareholders in a
notice of meeting at which the proposed action would have been submitted to the
shareholders for action.


                         ARTICLE 3 -- BOARD OF DIRECTORS

                  Section 1. General Powers. The business and affairs of the
corporation shall be managed under the direction of the board of directors
except as otherwise provided by the articles of incorporation or by a valid
shareholders' agreement.

                  Section 2. Number, Term and Qualification. The number of
directors of the corporation shall consist of one or more individuals. The
shareholders at any annual meeting may by resolution fix the number of directors
to be elected at the meeting; but in the absence of such resolution, the number
of directors elected at the meeting shall constitute the number of directors of
the corporation until the next annual meeting of shareholders, unless the number
is changed prior to such meeting by action of the shareholders. The board of
directors shall have the authority to increase or decrease by thirty percent
within any twelve-month period the number of directors. At any time that the
corporation has nine or more directors, the directors shall be divided into
three classes, as nearly equal in number as possible. The directors serving at
such time shall designate individual directors as the initial members of such
class, with the term of office of the first class to expire at the next
occurring annual meeting of shareholders, with the term of office of the second
class to expire one year thereafter, and with the term of office of the third
class to expire one year thereafter. At each annual meeting of shareholders
following the initial classification and election, directors elected to succeed
those directors whose terms expire shall be elected for a term of office to
expire at the third succeeding annual meeting of shareholders after their
election, provided, that notwithstanding the expiration of the term of the
director, the director shall continue to hold office until a successor is
elected and qualifies or until his death, resignation, removal or
disqualification or until there is a decrease in the number of directors.
Directors need not be residents of the State of North Carolina or shareholders
of the corporation.

                  Section 3. Removal. Directors may be removed from office for
cause provided the notice of the shareholders' meeting at which such action is
to be taken states that a purpose of the meeting is removal of the director and
the number of votes cast to remove the director exceeds the number of votes cast
not to remove him. Directors may be removed from office without cause provided
the notice of the shareholders' meeting at which such action is to be taken
states that a purpose of the meeting is removal of the director and the number
of votes cast to remove the director exceeds two times the number of votes cast
not to remove him.

                  Section 4. Vacancies. Except as otherwise provided in the
articles of incorporation, a vacancy occurring in the board of directors,
including, without limitation, a vacancy resulting from an increase in the
number of directors or from the failure by the shareholders to elect the full
authorized number of directors, may be filled by a majority of the remaining
directors or by the sole director remaining in office. The shareholders may
elect a director at any time to fill a vacancy not filled by the directors. A
director elected to fill a vacancy shall be elected for the unexpired term of
his predecessor in office.



                                        4


<PAGE>   8



                       ARTICLE 4 -- MEETINGS OF DIRECTORS

                  Section 1. Annual and Regular Meetings. The annual meeting of
the board of directors shall be held immediately following the annual meeting of
the shareholders. The board of directors may by resolution provide for the
holding of regular meetings of the board on specified dates and at specified
times. Notice of regular meetings held at the principal office of the
corporation and at the usual scheduled time shall not be required. If any date
for which a regular meeting is scheduled shall be a legal holiday, the meeting
shall be held on a date designated in the notice of the meeting, if any, during
either the same week in which the regularly scheduled date falls or during the
preceding or following week. Regular meetings of the board shall be held at the
principal office of the corporation or at such other place as may be designated
in the notice of the meeting.

                  Section 2. Special Meetings. Special meetings of the board of
directors may be called by or at the request of the chairman of the board, the
president or any two directors. Such meetings may be held at the time and place
designated in the notice of the meeting.

                  Section 3. Notice of Meetings. Unless the articles of
incorporation provide otherwise, the annual and regular meetings of the board of
directors may be held without notice of the date, time, place or purpose of the
meeting. The secretary or other person or persons calling a special meeting
shall give notice by any usual means of communication to be sent at least two
days before the meeting if notice is sent by means of telephone, telecopy or
personal delivery and at least five days before the meeting if notice is sent by
mail. A director's attendance at, or participation in, a meeting for which
notice is required shall constitute a waiver of notice, unless the director at
the beginning of the meeting (or promptly upon arrival) objects to holding the
meeting or transacting business at the meeting and does not thereafter vote for
or assent to action taken at the meeting.

                  Section 4. Quorum. Except as otherwise provided in the
articles of incorporation, a majority of the directors in office shall
constitute a quorum for the transaction of business at a meeting of the board of
directors.

                  Section 5. Manner of Acting. Except as otherwise provided in
the articles of incorporation, the act of the majority of the directors present
at a meeting at which a quorum is present shall be the act of the board of
directors.

                  Section 6. Presumption of Assent. A director of the
corporation who is present at a meeting of the board of directors at which
action on any corporate matter is taken is deemed to have assented to the action
taken unless he objects at the beginning of the meeting (or promptly upon
arrival) to holding, or transacting business at, the meeting, or unless his
dissent or abstention is entered in the minutes of the meeting or unless he
shall file written notice of his dissent or abstention to such action with the
presiding officer of the meeting before its adjournment or with the corporation
immediately after adjournment of the meeting. The right of dissent or abstention
shall not apply to a director who voted in favor of such action.

                  Section 7. Action Without Meeting. Unless otherwise provided
in the articles of incorporation, action required or permitted to be taken at a
meeting of the board of directors may be taken without a meeting if the action
is taken by all members of the board. The action must be evidenced by one or
more written consents signed by each director before or after such action,
describing the action taken,

                                        5


<PAGE>   9



and included in the minutes or filed with the corporate records. Action taken
without a meeting is effective when the last director signs the consent, unless
the consent specifies a different effective date.

                  Section 8. Meeting by Communications Device. Unless otherwise
provided in the articles of incorporation, the board of directors may permit any
or all directors to participate in a regular or special meeting by, or conduct
the meeting through the use of, any means of communication by which all
directors participating may simultaneously hear each other during the meeting. A
director participating in a meeting by this means is deemed to be present in
person at the meeting.

                             ARTICLE 5 -- COMMITTEES

                  Section 1. Election and Powers. Unless otherwise provided by
the articles of incorporation or the bylaws, a majority of the board of
directors may create one or more committees and appoint two or more directors to
serve at the pleasure of the board on each such committee. To the extent
specified by the board of directors or in the articles of incorporation, each
committee shall have and may exercise the powers of the board in the management
of the business and affairs of the corporation, except that no committee shall
have authority to do the following:

                  (a) Authorize distributions.

                  (b) Approve or propose to shareholders action required to be
         approved by shareholders.

                  (c) Fill vacancies on the board of directors or on any of its
         committees.

                  (d) Amend the articles of incorporation.

                  (e) Adopt, amend or repeal the bylaws.

                  (f) Approve a plan of merger not requiring shareholder
         approval.

                  (g) Authorize or approve the reacquisition of shares, except
         according to a formula or method prescribed by the board of directors.

                  (h) Authorize or approve the issuance of, sale or contract for
         sale of shares, or determine the designation and relative rights,
         preferences and limitations of a class or series of shares, except that
         the board of directors may authorize the executive committee (or a
         senior executive officer of the corporation) to do so within limits
         specifically prescribed by the board of directors.

                  Section 2. Removal; Vacancies. Any member of a committee may
be removed at any time with or without cause, and vacancies in the membership of
a committee by means of death, resignation, disqualification or removal shall be
filled by a majority of the whole board of directors.

                  Section 3. Meetings. The provisions of Article 4 governing
meetings of the board of directors, action without meeting, notice, waiver of
notice and quorum and voting requirements shall apply to the committees of the
board and its members.


                                        6


<PAGE>   10



                  Section 4. Minutes. Each committee shall keep minutes of its
proceedings and shall report thereon to the board of directors at or before the
next meeting of the board.

                              ARTICLE 6 -- OFFICERS

                  Section 1. Titles. The officers of the corporation shall be a
president, a secretary and a treasurer and may include a chairman and vice
chairman of the board of directors, an executive vice president, one or more
vice presidents, a controller, one or more assistant secretaries, one or more
assistant treasurers, one or more assistant controllers, and such other officers
as shall be deemed necessary. The officers shall have the authority and perform
the duties as set forth herein or as from time to time may be prescribed by the
board of directors or by the president (to the extent that the president is
authorized by the board of directors to prescribe the authority and duties of
officers). Any two or more offices may be held by the same individual, but no
officer may act in more than one capacity where action of two or more officers
is required.

                  Section 2. Election; Appointment. The officers of the
corporation shall be elected from time to time by the board of directors or
appointed from time to time by the president (to the extent that the president
is authorized by the board to appoint officers).

                  Section 3. Removal. Any officer may be removed by the board at
any time with or without cause whenever in its judgment the best interests of
the corporation will be served, but removal shall not itself affect the
officer's contract rights, if any, with the corporation.

                  Section 4. Vacancies. Vacancies among the officers may be
filled and new offices may be created and filled by the board of directors, or
by the president (to the extent authorized by the board).

                  Section 5. Compensation. The compensation of the officers
shall be fixed by or at the direction of the board of directors.

                  Section 6. Chairman of the Board of Directors. The chairman of
the board of directors, if such officer is elected, shall preside at meetings of
the board of directors and shall have such other authority and perform such
other duties as the board of directors shall designate.

                  Section 7. President. The president shall be in general charge
of the affairs of the corporation in the ordinary course of its business and
shall preside at meetings of the shareholders. The president may perform such
acts, not inconsistent with applicable law or the provisions of these bylaws, as
may be performed by the president of a corporation and may sign and execute all
authorized notes, bonds, contracts and other obligations in the name of the
corporation. The president shall have such other powers and perform such other
duties as the board of directors shall designate or as may be provided by
applicable law or elsewhere in these bylaws. The president shall preside at
meetings of the board in the absence of the chairman.

                  Section 8. Vice Presidents. The executive vice president, if
such officer is elected or appointed, shall exercise the powers of the president
during that officer's absence or inability to act. In default of both the
president and the executive vice president, any other vice president may
exercise the powers of the president. Any action taken by a vice president in
the performance of the duties of the president shall be presumptive evidence of
the absence or inability to act of the president at the time the action was
taken. The vice presidents shall have such other powers and perform such other
duties as may

                                        7


<PAGE>   11



be assigned by the board of directors or by the president (to the extent that
the president is authorized by the board of directors to prescribe the authority
and duties of other officers).

                  Section 9. Secretary. The secretary shall keep accurate
records of the acts and proceedings of all meetings of shareholders and of the
board of directors and shall give all notices required by law and by these
bylaws. The secretary shall have general charge of the corporate books and
records and shall have the responsibility and authority to maintain and
authenticate such books and records. The secretary shall have general charge of
the corporate seal and shall affix the corporate seal to any lawfully executed
instrument requiring it. The secretary shall have general charge of the stock
transfer books of the corporation and shall keep at the principal office of the
corporation a record of shareholders, showing the name and address of each
shareholder and the number and class of the shares held by each. The secretary
shall sign such instruments as may require the signature of the secretary, and
in general shall perform the duties incident to the office of secretary and such
other duties as may be assigned from time to time by the board of directors or
the president (to the extent that the president is authorized by the board of
directors to prescribe the authority and duties of other officers).

                  Section 10. Assistant Secretaries. Each assistant secretary,
if such officer is elected, shall have such powers and perform such duties as
may be assigned by the board of directors or the president (to the extent the
president is authorized by the board of directors to prescribe the authority and
duties of other officers), and the assistant secretaries shall exercise the
powers of the secretary during that officer's absence or inability to act.

                  Section 11. Treasurer. The treasurer shall have custody of all
funds and securities belonging to the corporation and shall receive, deposit or
disburse the same under the direction of the board of directors. The treasurer
shall keep full and accurate accounts of the finances of the corporation, which
may be consolidated or combined statements of the corporation and one or more of
its subsidiaries as appropriate, that include a balance sheet as of the end of
the fiscal year, an income statement for that year, and a statement of cash
flows for the year unless that information appears elsewhere in the financial
statements. If financial statements are prepared for the corporation on the
basis of generally accepted accounting principles, the annual financial
statements must also be prepared on that basis. The corporation shall mail the
annual financial statements, or a written notice of their availability, to each
shareholder within 120 days of the close of each fiscal year. The treasurer
shall in general perform all duties incident to the office and such other duties
as may be assigned from time to time by the board of directors or the president
(to the extent that the president is authorized by the board of directors to
prescribe the authority and duties of other officers).

                  Section 12. Assistant Treasurers. Each assistant treasurer, if
such officer is elected, shall have such powers and perform such duties as may
be assigned by the board of directors or the president (to the extent that the
president is authorized by the board of directors to prescribe the authority and
duties of other officers), and the assistant treasurers shall exercise the
powers of the treasurer during that officer's absence or inability to act.

                  Section 13. Controller and Assistant Controllers. The
controller, if such officer is elected, shall have charge of the accounting
affairs of the corporation and shall have such other powers and perform such
other duties as the board of directors or the president (to the extent that the
president is authorized by the board of directors to prescribe the authority and
duties of other officers) shall designate. Each assistant controller shall have
such powers and perform such duties as may be assigned by the board of directors
or the president (to the extent that the president is authorized by the board of
directors to

                                        8


<PAGE>   12



prescribe the authority and duties of other officers), and the assistant
controllers shall exercise the powers of the controller during that officer's
absence or inability to act.

                  Section 14. Voting Upon Stocks. Unless otherwise ordered by
the board of directors, the president shall have full power and authority in
behalf of the corporation to attend, act and vote at meetings of the
shareholders of any corporation in which this corporation may hold stock, and at
such meetings shall possess and may exercise any and all rights and powers
incident to the ownership of such stock and which, as the owner, the corporation
might have possessed and exercised if present. The board of directors may by
resolution from time to time confer such power and authority upon any other
person or persons.

                           ARTICLE 7 -- CAPITAL STOCK

                  Section 1. Certificates. Shares of the capital stock of the
corporation shall be represented by certificates. The name and address of the
persons to whom shares of capital stock of the corporation are issued, with the
number of shares and date of issue, shall be entered on the stock transfer
records of the corporation. Certificates for shares of the capital stock of the
corporation shall be in such form not inconsistent with the articles of
incorporation of the corporation as shall be approved by the board of directors.
Each certificate shall be signed (either manually or by facsimile) by (a) the
president or any vice president and by the secretary, assistant secretary,
treasurer or assistant treasurer or (b) any two officers designated by the board
of directors. Each certificate may be sealed with the seal of the corporation or
a facsimile thereof.

                  Section 2. Transfer of Shares. Transfer of shares shall be
made on the stock transfer records of the corporation, and transfers shall be
made only upon surrender of the certificate for the shares sought to be
transferred by the record holder or by a duly authorized agent, transferee or
legal representative. All certificates surrendered for transfer or reissue
shall be canceled before new certificates for the shares shall be issued.

                  Section 3. Transfer Agent and Registrar. The board of
directors may appoint one or more transfer agents and one or more registrars of
transfers and may require all stock certificates to be signed or countersigned
by the transfer agent and registered by the registrar of transfers.

                  Section 4. Regulations. The board of directors may make rules
and regulations as it deems expedient concerning the issue, transfer and
registration of shares of capital stock of the corporation.

                  Section 5. Fixing Record Date. For the purpose of determining
shareholders entitled to notice of or to vote at any meeting of shareholders, or
entitled to receive payment of any dividend, or in order to make a determination
of shareholders for any other purpose, the board of directors may fix in advance
a date as the record date for the determination of shareholders. The record date
shall be not more than 70 days before the meeting or action requiring a
determination of shareholders. A determination of shareholders entitled to
notice of or to vote at a shareholders' meeting shall be effective for any
adjournment of the meeting unless the board of directors fixes a new record
date, which it shall do if the meeting is adjourned to a date more than 120 days
after the date fixed for the original meeting. If no record date is fixed for
the determination of shareholders, the record date shall be the day the notice
of the meeting is mailed or the day the action requiring a determination of
shareholders is taken. If no record date is fixed for action without a meeting,
the record date for determining shareholders entitled to take action without a
meeting shall be the date the first shareholder signs a consent to the action
taken.


                                        9


<PAGE>   13



                  Section 6. Lost Certificates. The board of directors must
authorize the issuance of a new certificate in place of a certificate claimed to
have been lost, destroyed or wrongfully taken, upon receipt of (a) an affidavit
from the person explaining the loss, destruction or wrongful taking, and (b) a
bond from the claimant in a sum as the corporation may reasonably direct to
indemnify the corporation against loss from any claim with respect to the
certificate claimed to have been lost, destroyed or wrongfully taken. The board
of directors may, in its discretion, waive the affidavit and bond and authorize
the issuance of a new certificate in place of a certificate claimed to have been
lost, destroyed or wrongfully taken.

             ARTICLE 8 -- INDEMNIFICATION OF DIRECTORS AND OFFICERS

                  Section 1. Indemnification Provisions. Any person who at any
time serves or has served as a director or officer of the corporation or of any
wholly owned subsidiary of the corporation, or in such capacity at the request
of the corporation for any other foreign or domestic corporation, partnership,
joint venture, trust or other enterprise, or as a trustee or administrator under
any employee benefit plan of the corporation or of any wholly owned subsidiary
thereof (a "Claimant"), shall have the right to be indemnified and held harmless
by the corporation to the fullest extent from time to time permitted by law
against all liabilities (as hereinafter defined) and litigation expenses (as
hereinafter defined) in the event a claim shall be made or threatened against
that person in, or that person is made or threatened to be made a party to, any
threatened, pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative, and whether or not brought by or on
behalf of the corporation, including all appeals therefrom (a "proceeding"),
arising out of that person's status as such or that person's activities in any
such capacity; provided, that such indemnification shall not be effective with
respect to (a) that portion of any liabilities or litigation expenses with
respect to which the Claimant is entitled to receive payment under any insurance
policy or (b) any liabilities or litigation expenses incurred on account of any
of the Claimant's activities which were at the time taken known or believed by
the Claimant to be clearly in conflict with the best interests of the
corporation.

                  Section 2. Definitions. As used in this Article, (a)
"liabilities" shall include, without limitation, (1) payments in satisfaction of
any judgment, money decree, excise tax, fine or penalty for which Claimant had
become liable in any proceeding and (2) payments in settlement of any such
proceeding subject, however, to Section 3 of this Article 8; (b) "litigation
expenses" shall include, without limitation, (1) reasonable costs and expenses
and attorneys' fees and expenses actually incurred by the Claimant in connection
with any proceeding and (2) reasonable costs and expenses and attorneys' fees
and expenses in connection with the enforcement of rights to the indemnification
granted hereby or by applicable law, if such enforcement is successful in whole
or in part; and (c) "disinterested directors" shall mean directors who are not
party to the proceeding in question.

                  Section 3. Settlements. The corporation shall not be liable to
indemnify the Claimant for any amounts paid in settlement of any proceeding
effected without the corporation's written consent. The corporation will not
unreasonably withhold its consent to any proposed settlement.

                  Section 4.  Litigation Expense Advances.

                  (a) Except as provided in subsection (b) below, any litigation
expenses shall be advanced to any Claimant within 30 days of receipt by the
secretary of the corporation of a demand therefor, together with an undertaking
by or on behalf of the Claimant to repay to the corporation such amount unless
it is ultimately determined that Claimant is entitled to be indemnified by the
corporation against such expenses.

                                       10


<PAGE>   14



The secretary shall promptly forward notice of the demand and undertaking
immediately to all directors of the corporation.

                  (b) Within 10 days after mailing of notice to the directors
pursuant to subsection (a) above, any disinterested director may, if desired,
call a meeting of all disinterested directors to review the reasonableness of
the expenses so requested. No advance shall be made if a majority of the
disinterested directors affirmatively determines that the item of expense is
unreasonable in amount; but if the disinterested directors determine that a
portion of the expense item is reasonable, the corporation shall advance such
portion.

                  (c) Without limiting the rights contained in subsection (a)
above, the board of directors may take action to advance any litigation expenses
to a Claimant upon receipt of an undertaking by or on behalf of the Claimant to
repay to the corporation such amount unless it is ultimately determined that the
Claimant is entitled to be indemnified by the corporation against such expenses.

                  Section 5. Approval of Indemnification Payments. Except as
provided in Section 4 of this Article, the board of directors of the corporation
shall take all such action as may be necessary and appropriate to authorize the
corporation to pay the indemnification required by Section 1 of this Article,
including, without limitation, making a good faith evaluation of the manner in
which the Claimant acted and of the reasonable amount of indemnity due the
Claimant. In taking any such action, any Claimant who is a director of the
corporation shall not be entitled to vote on any matter concerning such
Claimant's right to indemnification.

                  Section 6. Suits by Claimant. No Claimant shall be entitled to
bring suit against the corporation to enforce his rights under this Article
until 60 days after a written claim has been received by the corporation,
together with any undertaking to repay as required by Section 4 of this Article.
It shall be a defense to any such action that the Claimant's liabilities or
litigation expenses were incurred on account of activities described in clause
(b) of Section 1, but the burden of proving this defense shall be on the
corporation. Neither the failure of the corporation to have made a determination
prior to the commencement of the action to the effect that indemnification of
the Claimant is proper in the circumstances, nor an actual determination by the
corporation that the Claimant had not met the standard of conduct described in
clause (b) of Section 1, shall be a defense to the action or create a
presumption that the Claimant has not met the applicable standard of conduct.

                  Section 7. Consideration; Personal Representatives and Other
Remedies. Any person who during such time as this Article or corresponding
provisions of predecessor bylaws is or has been in effect serves or has served
in any of the aforesaid capacities for or on behalf of the corporation shall be
deemed to be doing so or to have done so in reliance upon, and as consideration
for, the right of indemnification provided herein or therein. The right of
indemnification provided herein or therein shall inure to the benefit of the
legal representatives of any person who qualifies or would qualify as a Claimant
hereunder, and the right shall not be exclusive of any other rights to which the
person or legal representative may be entitled apart from this Article.

                  Section 8. Scope of Indemnification Rights. The rights granted
herein shall not be limited by the provisions of Section 55-8-51 of the General
Statutes of North Carolina or any successor statute.




                                       11


<PAGE>   15



                         ARTICLE 9 -- GENERAL PROVISIONS

                  Section 1. Dividends and other Distributions. The board of
directors may from time to time declare and the corporation may pay dividends or
make other distributions with respect to its outstanding shares in the manner
and upon the terms and conditions provided by law.

                  Section 2. Seal. The seal of the corporation shall be any form
approved from time to time or at any time by the board of directors.

                  Section 3. Waiver of Notice. Whenever notice is required to be
given to a shareholder, director or other person under the provisions of these
bylaws, the articles of incorporation or applicable law, a waiver in writing
signed by the person or persons entitled to the notice, whether before or after
the date and time stated in the notice, and delivered to the corporation shall
be equivalent to giving the notice.

                  Section 4. Checks. All checks, drafts or orders for the
payment of money shall be signed by the officer or officers or other individuals
that the board of directors may from time to time designate.

                  Section 5. Fiscal Year. The fiscal year of the corporation
shall be fixed by the board of directors.

                  Section 6. Amendments. Unless otherwise provided in the
articles of incorporation or a bylaw adopted by the shareholders or by law,
these bylaws may be amended or repealed by the board of directors, except that a
bylaw adopted, amended or repealed by the shareholders may not be readopted,
amended or repealed by the board of directors if neither the articles of
incorporation nor a bylaw adopted by the shareholders authorizes the board of
directors to adopt, amend or repeal that particular bylaw or the bylaws
generally. These bylaws may be amended or repealed by the shareholders even
though the bylaws may also be amended or repealed by the board of directors. A
bylaw that fixes a greater quorum or voting requirement for the board of
directors may be amended or repealed (a) if originally adopted by the
shareholders, only by the shareholders, unless such bylaw as originally adopted
by the shareholders provides that such bylaw may be amended or repealed by the
board of directors or (b) if originally adopted by the board of directors,
either by the shareholders or by the board of directors. A bylaw that fixes a
greater quorum or voting requirement may not be adopted by the board of
directors by a vote less than a majority of the directors then in office and may
not itself be amended by a quorum or vote of the directors less than the quorum
or vote prescribed in such bylaw or prescribed by the shareholders.

                  Section 7. Shareholders' Agreement. In the event of a conflict
between these bylaws and a valid shareholders' agreement, the shareholders'
agreement shall control.



                                       12


<PAGE>   16


                  THIS IS TO CERTIFY that the above bylaws of C3, Inc. were
adopted by the board of directors of the corporation by action taken at a
meeting on and effective as of October 12, 1997.

                  This 12th day of October, 1997.


                                         /s/ Mark W. Hahn
                                         ------------------------------------
                                         Mark W. Hahn, Secretary



                                       13






<PAGE>   1


                                                                   EXHIBIT 4.1


<TABLE>
<S>                               <C>                                                                             <C>

         [NUMBER]                                               C3 INC.                                             [SHARES]

        CTHR

                                      INCORPORATED UNDER THE LAWS OF THE STATE OF NORTH CAROLINA
                       THIS CERTIFICATE IS TRANSFERABLE IN THE CITY OF NEW YORK OR IN CHARLOTTE, NORTH CAROLINA

     COMMON STOCK                                                                                            SEE REVERSE FOR
     NO PAR VALUE                                                                                          CERTAIN DEFINITIONS

                                                                                                            CUSIP 22942P 10 9

THIS CERTIFIES THAT





IS THE OWNER OF
 

                                    FULLY PAID AND NONASSESSABLE SHARES OF THE COMMON STOCK OF


transferable on the books of the Corporation by the registered holder hereof in person or by duly authorized attorney upon surrender
of this Certificate properly endorsed.  This Certificate is not valid until countersigned by the Transfer Agent and registered by 
the Registrar.

        WITNESS the facsimile seal of the Corporation and the facsimile signatures of its duly authorized officers.


Dated:                                                                                          
                                                                                                                      
        /s/                                                                                 /s/ 

                SECRETARY                                                                               PRESIDENT

                                                      [SEAL]



COUNTERSIGNED AND REGISTERED:
        FIRST UNION NATIONAL BANK,
                (CHARLOTTE, N.C.)                                                         TRANSFER AGENT        
                                                                                           AND REGISTRAR
        
                                                                                                             
                                                                                    AUTHORIZED SIGNATURE
</TABLE>


<PAGE>   2

                                    C3, INC.

        THE CORPORATION IS AUTHORIZED TO ISSUE COMMON STOCK, NO PAR
VALUE, AND PREFERRED STOCK, NO PAR VALUE. PURSUANT TO THE CORPORATION'S
ARTICLES OF INCORPORATION, THE BOARD OF DIRECTORS MAY DETERMINE THE RELATIVE
RIGHTS, PREFERENCES AND LIMITATIONS OF THE PREFERRED STOCK
 OR ANY CLASS THEREOF
OR ANY SERIES OF ANY SUCH CLASS. UPON REQUEST, THE CORPORATION WILL FURNISH TO
ANY SHAREHOLDER WITHOUT CHARGE INFORMATION IN WRITING REGARDING THE
DESIGNATIONS, RELATIVE RIGHTS, PREFERENCES AND LIMITATIONS APPLICABLE TO THE
COMMON STOCK AND PREFERRED STOCK, INCLUDING THE AUTHORITY OF THE BOARD OF
DIRECTORS TO DETERMINE THE RELATIVE RIGHTS, PREFERENCES AND LIMITATIONS OF THE
PREFERRED STOCK.

        The following abbreviations, when used in the inscription on the face
of this Certificate, shall be construed as though they were written out in full
according to applicable laws or regulations:



<TABLE>
        <S>                                             <C>
        TEN COM -- as tenants in common                 UNIF GIFT MIN ACT -- _____________ Custodian for ___________
        TEN ENT -- as tenants by the entireties                                 (Cust)                     (Minor)
        JT TEN  -- as joint tenants with right of                            under Uniform Gifts to Minors
                   survivorship and not as tenants                           Act __________________
                   in common                                                           (State)
</TABLE>


   Additional abbreviations may also be used though not in the above list.


For value received, __________________ hereby sell, assign and transfer unto

PLEASE INSERT SOCIAL SECURITY OR OTHER
   IDENTIFYING NUMBER OF ASSIGNEE
[                                    ]

_______________________________________________________________________________
(PLEASE PRINT OR TYPE NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE)

_______________________________________________________________________________

_______________________________________________________________________________

________________________________________________________________________ shares
of the Common Stock represented by the within Certificate and do hereby 
irrevocably constitute and appoint ___________________________________________,
Attorney to transfer the said stock on the books of the within-named
Corporation with full power of substitution in the premises.

Dated:
            __________________________

Signature:
            __________________________

          
          _______________________________________
  NOTICE: THE SIGNATURE TO THIS ASSIGNMENT
          MUST CORRESPOND WITH THE NAME(S) AS WRITTEN
          UPON THE FACE OF THE CERTIFICATE IN
          EVERY PARTICULAR, WITHOUT ALTERATION OR
          ENLARGEMENT OR ANY CHANGE WHATEVER.
                                     

          SIGNATURE(S) GUARANTEED:
                                     ________________________________________
                                     THE SIGNATURE(S) SHOULD BE GUARANTEED BY
                                     AN ELIGIBLE GUARANTOR INSTITUTION
                                     (BANKS, STOCKBROKERS, SAVINGS AND LOAN
                                     ASSOCIATIONS AND CREDIT UNIONS WITH
                                     MEMBERSHIP IN AN APPROVED SIGNATURE
                                     GUARANTEE MEDALLION PROGRAM), PURSUANT
                                     TO S.E.C. RULE 17Ad-15.



KEEP THIS CERTIFICATE IN A SAFE PLACE. IF IT IS LOST, STOLEN, MUTILATED OR
DESTROYED, THE CORPORATION WILL REQUIRE A BOND OF INDEMNITY AS A CONDITION TO
THE ISSUANCE OF A REPLACEMENT CERTIFICATE.





<PAGE>   1

                                                                       EXHIBIT 5

[WOMBLE CARLYLE SANDRIDGE & RICE, PLLC LETTERHEAD]

                                                              Deborah H. Hartzog
                                                     Direct Dial: (919) 484-2311
                                                      Direct Fax: (919) 484-2361
                                                      E-mail: d_hartzog@wcsr.com

November 5, 1997


C3, Inc.
3800 Gateway Boulevard
Suite 310
Morrisville, NC  27560

         Re:      Registration Statement on Form S-1
                  File No. 333-36809
Gentlemen:

         We are acting as counsel to C3, Inc. (the "Company") in connection with
the registration under the Securities Act of 1933, as amended (the "Act"), of
2,750,000 shares (the "Primary Shares") of the Company's common stock, no par
value (the "Common Stock"), warrants issued to the representative of the
underwriters to purchase 275,000 shares of Common Stock (the "Warrants") and
275,000 shares of Common Stock issuable upon exercise of the Warrants (the
"Warrant Shares"). We have assisted the Company in the preparation of a
Registration Statement on Form S-1, filed with the Securities and Exchange
Commission (the "Commission") on September 30, 1997, Amendment No. 1 thereto,
filed with the Commission on October 3, 1997, and Amendment No. 2 thereto, filed
with the Commission on November 5, 1997 (the "Registration Statement"). We are
providing this opinion pursuant to the requirements of Item 16(a) of Form S-1
and Item 601(b)(5) of Regulation S-K under the Act.

         We have
 reviewed and are familiar with the Registration Statement, the
records relating to the organization of the Company, including its articles of
incorporation and bylaws and all amendments thereto, and all records of all
proceedings taken by the Board of Directors and shareholders of the Company
pertinent to the rendering of this opinion.

         Based on the foregoing, it is our opinion that:

         1. The Primary Shares, when sold as described in the Registration
         Statement, will be duly authorized, validly issued, fully paid and
         nonassessable.

         2. The Warrants, when issued as described in the Registration
         Statement, will be duly authorized and validly issued.

         3. The Warrant Shares, when issued and sold in accordance with the
         terms of the Warrants, will be duly authorized, validly issued, fully
         paid and nonassessable.

         We hereby consent to the filing of this opinion with the Commission as
Exhibit 5 to the Registration Statement and to the use of our name in the
Registration Statement under the caption "Legal Matters" in the prospectus
included as a part thereof. In giving this consent, we do not admit that we are
within the category of persons whose consent is required by Section 7 of the Act
or other rules and regulations of the Commission thereunder.

                                Very truly yours,

                                WOMBLE CARLYLE SANDRIDGE & RICE,
                                A Professional Limited Liability Company



                                By: /s/ Deborah H. Hartzog
                                   -------------------------------------
                                        Deborah H. Hartzog



<PAGE>   1


                                                                   EXHIBIT 10.12


       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.










               DEVELOPMENT AGREEMENT, DATED JUNE 6, 1997, BETWEEN
                        CREE RESEARCH, INC. AND C3, INC.




<PAGE>   2



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


                              DEVELOPMENT AGREEMENT


         This DEVELOPMENT AGREEMENT (the "Agreement") is entered into effective
as of the 6th day of June, 1997 by and between Cree Research, Inc. ("Cree") and
C3, Inc. ("C3").


                                    Recitals

         WHEREAS, Cree and C3 are parties to an Exclusive Supply Agreement dated
September 15, 1995 as amended July 10, 1996 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 desire to enter into an agreement whereby Cree
shall perform certain research and development activities directed to improving
the colorless material available for purchase under the Exclusive Supply
Agreement; and

         WHEREAS, Cree and C3 shall simultaneously with the execution of this
Agreement enter into an Amended and Restated Exclusive Supply
 Agreement (as thus
amended and restated, the "Supply Agreement"); and

         WHEREAS, Cree and C3, in entering into this Agreement and the amendment
and restatement of the Supply 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") according to the proposal
attached hereto as Exhibit A.

                  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.


                                        1


<PAGE>   3



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 require only that each boule
contain a certain volume of SiC material of which a specified percentage (the
"Percentage") 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 volume specifications are expressed in terms of the
diameter and height of each boule, but any equivalent volume is acceptable.
The specifications change over time, as the Date column indicates.

                       Specifications and Timetable Chart

            Date            Diameter          Height            %G-J Grade
            ----            --------          ------            ----------
         1/1/1998            *****            *****                  *****
         7/1/1998            *****            *****                  *****
         7/1/1999            *****            *****                  *****
         7/1/2000            *****            *****                  *****
         7/1/2001            *****            *****                  *****

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 Cree will use its best commercially reasonable efforts to
develop by October 31, 1997 a process that yields, an aggregate of at least
***** SiC boules per month each of which has a ***** height of material 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 (it being understood that
while such 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).

                  1.5 Cree agrees to report to C3 the progress of the
development services provided pursuant to this Agreement at monthly progress
meetings. 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.



                                        2


<PAGE>   4



                  1.6 In April of each year, Cree and C3 shall consult on
appropriate development goals for the following year. Before May 1 of each year,
Cree shall submit to C3 a development plan for the next twelve months beginning
July 1 which shall include a budget and a description of the scope of
development activities in a format and with a level of detail similar to the
proposal attached hereto as Exhibit A with the addition of specific tasks and
goals listed on a quarterly basis. Plans submitted under this paragraph shall
set forth Cree's then current expectations for carrying on development
activities under this Agreement for the period covered by the plan, in the
manner determined by Cree to maximize the development progress toward the year's
goals. Cree may substitute resources and personnel from those set out in the
development plans provided that Cree reasonably determines such substitutions
are in the best interest of maintaining or enhancing progress toward the then
current development goals. If Cree succeeds in reaching goals more quickly than
anticipated, Cree will consult with C3 to determine other development goals
important to high yields of gemstone quality SiC material.

                  1.7 All SiC boules produced pursuant to this Agreement,
including SiC boules that do not meet the Specifications, 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 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 considered as "in use for production" for
purposes of the Supply Agreement. All SiC boules delivered hereunder will 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.

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

                  1.9 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.

                  1.10 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);




                                        3


<PAGE>   5



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


                           (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 certain overhead
         allocations).

                  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 the proposal attached hereto as Exhibit A.

                  2.3 If, prior to January 1, 1998, Cree has not developed a
Repeatable Process for producing SiC boules that meet the Specifications for
January 1, 1998, C3 shall have the option to reduce its funding obligations
herein (that is, the amount applicable under clause (ii) of Section 2.2) by 50%
by giving notice to Cree; provided, that such option, if not sooner exercised by
C3, shall expire at 11:59 p.m. eastern time on January 10, 1998. If C3 exercises
its option to reduce its funding obligations pursuant to this Section 2.3, such
reduction shall be effective January 1, 1998.

                  2.4 If, prior to January 1, 1998, Cree produces from *****
crystal growers, in a 30-day period, an aggregate of at least ***** SiC boules
that meet the Specifications for January 1, 1998, C3 shall pay Cree the sum of
two hundred thousand dollars ($200,000) 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


                                        4


<PAGE>   6



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


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

                  3. Term 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 June 30, 2002.

                  3.2 C3 shall have the option to terminate this Agreement prior
         to June 30, 2002 under the following conditions:

                           (i) If, prior to January 1, 1998, Cree does not
         produce from ***** crystal growers, in a 30-day period, an aggregate of
         at least ***** SiC boules having an average volume of ***** height and
         ***** diameter (or equivalent), with a minimum ***** height, comprised
         of material 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 (it being understood that while such
         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), C3 shall have the option of
         terminating this Agreement by giving notice to Cree; provided, that
         such option to terminate, if not sooner exercised by C3, shall expire
         at 11:59 p.m. eastern time on January 10, 1998.

                           (ii) During each year beginning July 1, 1998 through
         the year beginning July 1, 2001 (the "Subject Years"), if Cree does not
         develop by July 1 of each Subject Year a Repeatable Process for
         producing SiC boules that meet the initial applicable Specifications
         for such Subject Year, C3 shall have the option of terminating the
         Agreement by giving notice to Cree; 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 applicable deadline for establishing the Repeatable
         Process.

                           (iii) If the price charged to C3 for an SiC boule
         ordered under the Supply Agreement as a standard product meeting the
         Specifications noted below (as more specifically defined in Section
         1.3) exceeds the amount shown for such Specifications below, C3 may
         terminate this Agreement at any time by giving notice to Cree:


                                        5


<PAGE>   7



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


                  Diameter            Height           %G-J Grade         Price
                  --------            ------           ----------         -----
                   *****              *****               *****           *****
                   *****              *****               *****           *****
                   *****              *****               *****           *****
                   *****              *****               *****           *****
                   *****              *****               *****           *****

If C3 exercises its option to terminate this Agreement pursuant to Section
3.2(i) or 3.2(ii), 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 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 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


                                        6


<PAGE>   8



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 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


                                        7


<PAGE>   9



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.
2810 Meridian Parkway, Suite 144           P.O. Box 13533
Durham, North Carolina 27713               Research Triangle Park, NC 27709-3533
Attention: President                       Attention: President
Fax No. (919) 361-5415                     Fax No.: (919) 468-0486



                                        8


<PAGE>   10




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


                                                                       EXHIBIT A


                            A Proposal Submitted to:

                                    C3, INC.
                                 P.O. Box 13533
                      Research Triangle Park, NC 27009-3533


                                    entitled:


     DEVELOPMENT OF COLORLESS SILICON CARBIDE BOULE MANUFACTURING TECHNOLOGY


                                       by:


                               CREE RESEARCH, INC.
                              2810 Meridian Parkway
                                Durham, NC 27713
                               Tel: (919) 361-5709



                           7 Month Proposed Cost: *****
                          12 Month Proposed Cost: *****






         COMPANY PROPRIETARY 

"The information contained in this document
is confidential and proprietary to Cree
Research, Inc. and shall not be duplicated,
used or disclosed -- in whole or in part
without the prior written consent of the
Company."




<PAGE>   11




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


Use or disclosure of proposal data is subject to the restriction on the Cover
Page of this proposal.
- ----------------------------------

A. PERSONNEL

         ***** at Cree Research, has over 20 years of experience in materials
research and development of elemental and compound semiconductors, ranging from
silicon through gallium arsenide to silicon carbide. *****'s work in silicon
carbide has focused primarily on the development of ***** crystals and
substrates for microwave and power device applications, with special emphasis on
polytype uniformity, uniformity of electrical properties (conducting through
semi-insulating), and low crystalline defect density. In addition to SiC,*****'s
work covers materials problems related to the growth of ***** for
microelectronic device applications including microwave power MMICs, high
voltage power switching, infrared imaging, and VLSI. His experience in
semiconductor crystal growth covers growth of silicon carbide by ***** methods;
growth of silicon by ***** techniques; and growth of *****. ***** has authored
or co-authored over 60 papers and presentations. ***** will be the Principal
Investigator on this program and will devote 100% of his time to the effort.

         ***** at Cree Research, has over 17 years of experience in research
related to silicon carbide, and is also *****. He has been ***** on all of
Cree's funded research contracts (totaling >$25M). ***** has extensive
experience in SiC crystal growth, thin film deposition, doping, and material
characterization and developed the first commercially viable SiC boule growth
process. Since joining Cree, he has increased the diameter of SiC bulk crystals
from ***** to *****, increased crystal thickness by ***** and improved the
crystal quality by orders of magnitude. Much of the progress has been made
possible by the combination of a ***** project which was completed in ***** and
an ongoing ***** funded program on which he is PI. He was also co-PI on a *****
contract which demonstrated the first *****, increased the *****. He is Program
Manager on another ***** funded program which will soon lead to the release of
***** based on *****. In addition to the ***** funded programs at *****, *****
was co-PI on a ***** sponsored grant on ***** as well as other grants related to
SiC for structural applications. He was also co-PI and program manager on an
***** funded program on the growth and characterization of *****. ***** is
co-inventor on 7 issued U.S. patents, 2 pending U.S. patent applications, and 1
issued foreign patent and has 70 publications on SiC and other electronic
materials.

         ***** at Cree Research is responsible for the development of silicon
carbide bulk crystal growth processes. He has over 25 years of experience in
research related to growth technology and characterization of wide bandgap
semiconductor crystals and epitaxial layers including SiC, AIN, SiC-AIN, and
GaN. Before joining Cree Research in *****, he was a professor at *****. He
investigated thermodynamics and kinetics of crystal growth processes for SiC and
SiC-AIN crystals, both pure and doped. Based on this research, he developed a
new method for bulk SiC and SiC-AIN crystal growth with controlled polytype
structures in *****. This ***** method is the basis for all known SiC boule
growth programs. He also was a consultant of the R&D team at ***** for *****
technology (***** preparation and ***** growth by a ***** method). In *****, he
was Consultant-Professor of ***** and Guest-Professor of the *****. Since
joining Cree Research, he has increased the diameter of SiC bulk crystals and
has determined the primary reasons for formation of micropipe defects in SiC
boules. His has 21 patents and his results are published in more than 100
articles and 5 books/monographs.




<PAGE>   12




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


Use or disclosure of proposal data is subject to the restriction on the Cover
Page of this proposal.
- ----------------------------------

         ***** at Cree, has over 9 years of experience in the SiC field. His
initial work began with UHV ion-assisted e-beam deposition processes and surface
analytical studies on the interfacial chemistry of various materials grown on
SiC. Traveling abroad as a visiting scientist in *****, he conducted materials
studies on SiC for power device work sponsored by *****. His research there
focused on ***** analysis of SiC bulk material and growth of CVD films. Upon
returning to the U.S. he worked as a SiC crystal growth research scientist at
*****. In ***** he joined Cree Research as a *****, where he has worked between
development and production to successfully guide the ***** Departments through
a ***** expansion and an order of magnitude improvement in production material
quality. ***** has authored or co-authored over 20 articles and presentations.






<PAGE>   13




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


Use or disclosure of proposal data is subject to the restriction on the Cover
Page of this proposal.
- ----------------------------------

B. BUDGET

NOTE: CREE RESERVES THE RIGHT TO ADJUST THE SPENDING AS IT DEEMS APPROPRIATE IN
ORDER TO MEET TILE OBJECTIVES OF THE DEVELOPMENT PROGRAM AND WITHIN THE TOTAL
AMOUNT OF THE BUDGET.


<TABLE>
<CAPTION>
                                                                                                                 MONTHLY
                                                                                                                 STARTING
               JUN-97        JUL-97        AUG-97        SEP-97        OCT-97        NOV-97        DEC-97        JAN-98

<S>            <C>           <C>           <C>           <C>           <C>           <C>           <C>           <C>
EQUIPMENT
COSTS
*****          *****         *****         *****         *****         *****         *****         *****         *****
*****          *****         *****         *****         *****         *****         *****         *****         *****
*****          *****         *****         *****         *****         *****         *****         *****         *****

PEOPLE COSTS

C3             *****         *****         *****         *****         *****         *****         *****         *****
Focused
Team

Cree           *****         *****         *****         *****         *****         *****         *****         *****
Resources

OTHER PROCESSING
Analytical     *****         *****         *****         *****         *****         *****         *****         *****
Wafering       *****         *****         *****         *****         *****         *****         *****         *****
Polishing      *****         *****         *****         *****         *****         *****         *****         *****

Total          *****         *****         *****         *****         *****         *****         *****         *****

</TABLE>



EQUIPMENT - The equipment is outlined above and the cost reflects a *****
margin. Please note that ***** will be used until September.

C3 FOCUSED TEAM - This team will be led by ***** and will include a dedicated
***** which will be hired for this program.

CREE RESOURCES - These resources will support the C3 development effort on a
part time basis. This team will work under the direction of ***** and include
*****. In addition, ***** will provide equipment design support.




<PAGE>   14



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


Use or disclosure of proposal data is subject to the restriction on the Cover
Page of this proposal.
- ----------------------------------

C.       MILESTONES/GOALS

The goals and milestones for the proposed program are listed below in Table 1.

5 YEAR DEVELOPMENT PLAN (TABLE 1)



<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
DATE                    MILESTONE                                       DEMONSTRATION
- --------------------------------------------------------------------------------------------------------------------------
<S>                     <C>                                             <C>
January 1, 1998         ***** Diameter Crystal, ***** Height,           ***** crystals (per the milestone specification) 
                        ***** Yield, GHIJ grade material                from ***** system in a single month
- --------------------------------------------------------------------------------------------------------------------------
July 1, 1998            ***** Diameter Crystal,*****  Height,           ***** crystals (per the milestone specification)
                        ***** Yield, GHIJ grade material                from ***** system in a single month
- --------------------------------------------------------------------------------------------------------------------------
July 1, 1999            ***** Diameter Crystal, ***** Height,           ***** crystals (per the milestone specification)
                        ***** Yield, GHIJ grade material                from ***** system in a single month
- --------------------------------------------------------------------------------------------------------------------------
July 1, 2000            ***** Diameter Crystal, ***** Height,           ***** crystals (per the milestone specification)
                        ***** Yield, GHIJ grade material                from ***** system in a single month
- --------------------------------------------------------------------------------------------------------------------------
July 1, 2001            ***** Diameter Crystal, ***** Height,           ***** crystals (per the milestone specification)
                        ***** Yield, GHIJ grade material                from ***** system in a single month
- --------------------------------------------------------------------------------------------------------------------------

</TABLE>








<PAGE>   1

   
                                                                   EXHIBIT 10.15

                             1996 STOCK OPTION PLAN



                                       OF



                                    C3, INC.

                          (AS AMENDED OCTOBER 27, 1997)
    



<PAGE>   2

   


                             1996 STOCK OPTION PLAN
                                       OF
                                    C3, INC.
                          (AS AMENDED OCTOBER 27, 1997)


1. PURPOSE

         This plan (the "plan") is intended to encourage and enable selected key
employees, directors and independent contractors in the service of C3, Inc. (the
"Corporation") to acquire or to increase their holdings of common stock of the
Corporation (the "shares") in order to promote a closer identification of their
interests with those of the Corporation and its shareholders, thereby further
stimulating their efforts to enhance the efficiency, soundness, profitability,
growth and shareholder value of the Corporation. This purpose will be carried
out through the granting of incentive stock options ("incentive options") and
nonqualified stock options ("nonqualified options"). Incentive options and
nonqualified options shall be referred to herein collectively as "options." To
the extent that any option is designated as an incentive stock option and such
option does not qualify as an incentive stock option, it shall constitute a
nonqualified stock option.

2. ADMINISTRATION OF THE PLAN

                  (a) The plan shall be administered by the Board of Directors
         of the Corporation (the
 "Board"). Notwithstanding the foregoing, the
         Board, in its sole discretion, may delegate all of any part of its
         authority to administer the plan to a committee of the board which
         shall be comprised of no fewer than the minimum number of "non-employee
         directors," as such term is defined in Rule 16b-3 promulgated under the
         Securities Exchange Act of 1934, as amended, as may be required by Rule
         16b-3. In the event of such delegation, references to the "Board"
         include references to such committee.

                  (b) Any action of the Board may be taken by a written
         instrument signed by all of the members of the Board and any action so
         taken by written consent shall be as fully effective as if it had been
         taken by a majority of the members at a meeting duly held and called.
         Subject to the provisions of the plan, the Board shall have full and
         final authority, in its discretion, to take any action with respect to
         the plan including, without limitation, the following: (i) to determine
         the individuals to receive options, the nature of each option as an
         incentive option or nonqualified option, the times when options shall
         be granted, the number of shares to be subject to each option, the
         option price (determined in accordance with Paragraph 6), the option
         period, the time or times when each option shall be exercisable and the
         other terms, conditions, restrictions and limitations of an option;
         (ii) to prescribe the form or forms of the agreements evidencing any
         options granted under the plan; (iii) to establish, amend and rescind
         rules and regulations for the administration of the plan; and (iv) to
         construe and interpret the plan, the rules and regulations, and the
         agreements evidencing options granted under the plan, and to make all
         other determinations deemed necessary or advisable for administering
         the plan. In addition, the Board shall have authority, in its sole
         discretion, to accelerate the date that any option which was not
         otherwise exercisable shall become exercisable in whole or in part,
         without any obligation to accelerate such date with respect to any
         other options granted to any recipient.

    



<PAGE>   3

   


3. EFFECTIVE DATE

         The effective date of the plan shall be June 1, 1996. The Plan was
amended and restated October 27, 1997. Options may be granted under the plan on
and after the effective date, but not after May 31, 2006.

4. SHARES OF STOCK SUBJECT TO THE PLAN

         Both incentive options and nonqualified options, as designated by the
Board, may be granted under the plan. As amended, the number of shares of stock
that may be issued and sold pursuant to options shall not exceed in the
aggregate 777,450 shares of authorized but unissued shares of the Corporation.
The Corporation hereby reserves sufficient authorized shares to provide for the
exercise of options granted hereunder. Any shares subject to an option which,
for any reason, expires or is terminated unexercised as to such shares may again
be subject to an option granted under the plan.

5. ELIGIBILITY

         An option may be granted only to an individual who satisfies the
following eligibility requirements on the date the option is granted:

                  (a) The individual is either (i) a key employee of the
         Corporation or a related corporation, (ii) a member of the Board, or
         (iii) an independent contractor providing services to the Corporation
         or a related corporation. For this purpose, an individual shall be
         considered to be an "employee" only if there exists between the
         individual and the Corporation or a related corporation the legal and
         bona fide relationship of employer and employee. In determining whether
         such a relationship exists, the regulations of the United States
         Treasury Department relating to the determination of the employment
         relationship for the purpose of collection of income tax on wages at
         the source shall be applied. Also, for this purpose, a "key employee"
         is an employee of the Corporation or a related corporation whom the
         Board determines is in a position to affect materially the profits of
         the Corporation or a related corporation by reason of the nature and
         extent of such employee's duties, responsibilities, personal
         capabilities, performance and potential.

                  (b) With respect to the grant of an incentive option, the
         individual as an employee does not own, immediately before the time
         that the incentive option is granted, stock possessing more than ten
         percent of the total combined voting power of all classes of stock of
         the Corporation or a related corporation; provided, that an individual
         owning more than ten percent of the total combined voting power of all
         classes of stock of the Corporation or a related corporation may be
         granted an incentive option if the price at which such option may be
         exercised is greater than or equal to 110 percent (110%) of the fair
         market value of the shares on the date the option is granted and the
         period of the option does not exceed five years. For this purpose, an
         individual will be deemed to own stock which is attributed to him under
         Section 424(d) of the Internal Revenue Code of 1986, as amended (the
         "Code").



                                       -2-

    


<PAGE>   4

   

                  (c) The individual, being otherwise eligible under this
         Paragraph 5, is selected by the Board as an individual to whom an
         option shall be granted (an "optionee").

6. OPTION PRICE

         The price per share at which an option may be exercised (the "option
price") shall be established by the Board at the time the option is granted and
shall be set forth in the terms of the agreement evidencing the grant of the
option; provided that, in the case of an incentive option, the option price
shall be equal to or greater than the fair market value per share of the shares
on the date the option is granted. For this purpose, the following rules shall 
apply:

                  (a) An option shall be considered to be granted on the date
         that the Board acts to grant the option, or on any later date specified
         by the Board as the effective date of the option.

                  (b) The fair market value of the shares shall be determined in
         good faith by the Board in accordance with the applicable provisions of
         Section 20.2031-2 of the Federal Estate Tax Regulations, or in any
         other manner consistent with the Code and accompanying regulations;
         provided, that if the shares are listed for trading on the New York
         Stock Exchange or American Stock Exchange or included in the NASDAQ
         National Market System, fair market value shall be the closing sales
         price of the shares on the New York Stock Exchange or the American
         Stock Exchange (as applicable) or as reported in the NASDAQ National
         Market System on the date immediately preceding the date the option is
         granted, or, if there is no transaction on such date, then on the
         trading date nearest preceding the date the option is granted for which
         closing price information is available; and, provided further, if the
         shares are quoted on the NASDAQ System but are not included in the
         NASDAQ National Market System, the fair market value shall be the mean
         between the high bid and low asked quotations in the NASDAQ System on
         the date immediately preceding the date the option is granted for which
         such information is available.

                  (c) In no event shall there first become exercisable by an
         optionee in any one calendar year incentive stock options granted by
         the Corporation or any related corporation with respect to shares
         having an aggregate fair market value (determined at the time an option
         is granted) greater than $100,000.

7. OPTION PERIOD AND LIMITATIONS ON THE RIGHT TO EXERCISE OPTIONS

                  (a) The period during which an option may be exercised (the
         "option period") shall be determined by the Board when the option is
         granted and shall not extend more than ten years from the date on which
         the option is granted. An option shall be exercisable on such date or
         dates, during such period, for such number of shares, and subject to
         such conditions as shall be determined by the Board and set forth in
         the agreement evidencing such option, subject to the rights granted
         herein to the Board to accelerate the time when options may be
         exercised. Any option or portion thereof not exercised before the
         expiration of the option period shall terminate.




                                       -3-

    


<PAGE>   5

   


                  (b) An option may be exercised by giving written notice of at
         least ten days to the Secretary of the Corporation at the Corporation's
         principal office. Such notice shall specify the number of shares to be
         purchased pursuant to an option and the aggregate purchase price to be
         paid therefor, and shall be accompanied by payment of such purchase
         price. Such payment shall be in the form of (i) cash, (ii) certified
         check, (iii) shares of common stock owned by the optionee at the time
         of exercise, (iv) shares of common stock withheld upon exercise, (v)
         delivery of written notice of exercise to the Corporation and delivery
         to a broker of written notice of exercise and irrevocable instructions
         to promptly deliver to the Corporation the amount of sale or loan
         proceeds to pay the option price, or (vi) a combination of the
         foregoing methods, as elected by the optionee. Shares tendered or
         withheld in payment upon the exercise of an option shall be valued at
         their fair market value on the date of exercise, as determined by the
         Board by applying the provisions of Paragraph 6(b).

                  (c) No option granted to an optionee who was an employee at
         the time of grant shall be exercised unless the optionee is, at the
         time of exercise, an employee as described in Paragraph 5(a), and has
         been an employee continuously since the date the option was granted,
         subject to the following:

                           (i) An option shall not be affected by any change in
                  the terms, conditions or status of the optionee's employment,
                  provided that the optionee continues to be an employee of the
                  Corporation or a related corporation.

                           (ii) The employment relationship of an optionee shall
                  be treated as continuing intact for any period that the
                  optionee is on military or sick leave or other bona fide leave
                  of absence, provided that the period of such leave does not
                  exceed ninety days, or, if longer, as long as the optionee's
                  right to reemployment is guaranteed either by statute or by
                  contract. The employment relationship of an optionee shall
                  also be treated as continuing intact while the optionee is not
                  in active service because of disability. For purposes of this
                  Paragraph 7(c)(ii), "disability" shall mean the inability of
                  the optionee to engage in any substantial gainful activity by
                  reason of any medically determinable physical or mental
                  impairment which can be expected to result in death, or which
                  has lasted or can be expected to last for a continuous period
                  of not less than twelve months. The Board shall determine
                  whether an optionee is disabled within the meaning of this
                  paragraph.

                           (iii) If the employment of an optionee is terminated
                  because of disability within the meaning of subparagraph (ii),
                  or if the optionee dies while he is an employee or dies after
                  the termination of his employment because of disability, the
                  option may be exercised only to the extent exercisable on the
                  date of the optionee's termination of employment or death
                  while employed (the "termination date"), except that the Board
                  may in its discretion accelerate the date for exercising all
                  or any part of the option which was not otherwise exercisable
                  on the termination date. The option must be exercised, if at
                  all, prior to the first to occur of the following, whichever
                  shall be applicable: (A)



                                       -4-

    



<PAGE>   6


   

                  the close of the period of twelve months next succeeding the
                  termination date; or (B) the close of the option period. In
                  the event of the optionee's death, such option shall be
                  exercisable by such person or persons as shall have acquired
                  the right to exercise the option by will or by the laws of
                  intestate succession.

                           (iv) If the employment of the optionee is terminated
                  for any reason other than disability (as defined in
                  subparagraph (ii)) or death, his option may be exercised to
                  the extent exercisable on the date of such termination of
                  employment, except that the Board may in its discretion
                  accelerate the date for exercising all or any part of the
                  option which was not otherwise exercisable on the date of such
                  termination of employment. The option must be exercised, if at
                  all, prior to the first to occur of the following, whichever
                  shall be applicable: (A) the close of the period of 90 days
                  next succeeding the termination date; or (B) the close of the
                  option period. If the optionee dies following such termination
                  of employment and prior to the earlier of the dates specified
                  in (A) or (B) of this subparagraph (iv), the optionee shall be
                  treated as having died while employed under subparagraph (iii)
                  immediately preceding (treating for this purpose the
                  optionee's date of termination of employment as the
                  termination date). In the event of the optionee's death, such
                  option shall be exercisable by such person or persons as shall
                  have acquired the right to exercise the option by will or by
                  the laws of intestate succession.

                  (d) Unless the individual option agreement with an optionee
         provides otherwise, no option granted to a non-employee member of the
         Board (a "director") or an independent contractor shall be exercised
         unless the individual either (i) is, at the time of exercise, a
         director or independent contractor (as applicable) and has been in
         service continuously since the date the option was granted, or (ii) 
         was, within ninety days prior to the time of exercise, a director or
         independent contractor (as applicable) and, prior to such termination
         from service, had been a director or independent contractor
         continuously since the date the option was granted; provided, that if
         the individual's service as a director or independent contractor is
         terminated because of death, the option shall be exercisable by such
         person or persons who shall have acquired the right to exercise the
         option by will or the laws of intestate succession, and such option
         shall be exercisable at any time prior to the earlier of: (A) the close
         of the period ending twelve months after the death of the director, or
         (B) the close of the option period.

                  (e) An optionee or his legal representative, legatees or
         distributees shall not be deemed to be the holder of any shares subject
         to an option unless and until certificates for such shares are issued
         to him or them under the plan.

                  (f) Nothing in the plan shall confer upon the optionee any
         right to continue in the employment or service of the Corporation or a
         related corporation, or to interfere in any way with the right of the
         Corporation or a related corporation to terminate the optionee's
         employment or service at any time.




                                       -5-

    


<PAGE>   7

   

8. NONTRANSFERABILITY OF OPTIONS AND SHARES

         Except to the extent, if any, as may be permitted by the Code or other
applicable law, an option shall not be transferable (including by pledge or
hypothecation) other than by will or the laws of intestate succession, and an
option shall be exercisable during the optionee's lifetime only by him.

9. DILUTION OR OTHER ADJUSTMENTS

         If there is any change in the outstanding shares of common stock of the
Corporation as a result of a merger, consolidation, reorganization, stock
dividend, stock split to holders of shares that is distributable in shares, or
other change in the capital stock structure of the Corporation, the Board shall
make such adjustments to options, to the number of shares reserved for issuance
under the plan, and to any provisions of this plan or an agreement as the Board
deems equitable to prevent dilution or enlargement of options or otherwise
advisable to reflect such change.

10. WITHHOLDING

         The Corporation shall require a recipient of shares of common stock to
pay to the Corporation in cash the amount of any tax or other amount required by
any governmental authority to be withheld and paid over by the Corporation to
such authority for the account of such recipient. Notwithstanding the foregoing,
the recipient may satisfy such obligation in whole or in part, and any other
local, state or federal income tax obligations relating to such award, by
electing (the "Election") to have the Corporation withhold shares of common
stock from the shares to which the recipient is entitled. The number of shares
to be withheld shall have a fair market value (determined in accordance with
Paragraph 6(b)) as of the date that the amount of tax to be withheld is
determined (the "Tax Date") as nearly equal as possible to (but not exceeding)
the amount of such obligations being satisfied. Each Election must be made in
writing to the Board prior to the Tax Date.

11. CERTAIN DEFINITIONS

         For purposes of the plan, the following terms shall have the meaning
indicated:

                  (a) "Related corporation" means any parent, subsidiary or
         predecessor of the Corporation.

                  (b) "Parent" or "parent corporation" shall mean any
         corporation (other than the Corporation) in an unbroken chain of
         corporations ending with the Corporation if, at the time that the
         option is granted, each corporation other than the Corporation owns
         stock possessing fifty percent or more of the total combined voting
         power of all classes of stock in another corporation in the chain.

                  (c) "Subsidiary" or "subsidiary corporation" means any
         corporation (other than the Corporation) in an unbroken chain of
         corporations beginning with the Corporation if, at the time



                                       -6-

    


<PAGE>   8

   


         that the option is granted, each corporation other than the last
         corporation in the unbroken chain owns stock possessing fifty percent
         or more of the total combined voting power of all classes of stock in
         another corporation in the chain.

                  (d) "Predecessor" or "predecessor corporation" means a
         corporation which was a party to a transaction described in Section
         424(a) of the Code (or which would be so described if a substitution or
         assumption under that section had occurred) with the Corporation, or a
         corporation which is a parent or subsidiary of the Corporation, or a
         predecessor of any such corporation.

                  (e) In general, terms used in the plan shall, where
         appropriate, be given the meaning ascribed to them under the provisions
         of the Code applicable to incentive stock options.

12. STOCK OPTION AGREEMENT

         The grant of any option under the plan shall be evidenced by the
execution of an agreement (the "Agreement") between the Corporation and the
optionee. Such Agreement shall set forth the date of grant of the option, the
option price, the option period, the designation of the option as an incentive
option or nonqualified option, and the time or times when and the conditions
upon the happening of which the option shall become exercisable. Such Agreement
shall also set forth the restrictions, if any, with respect to which the shares
to be purchased thereunder shall be subject and such other terms and conditions
as the Board shall determine which are consistent with the provisions of the
plan and applicable law and regulations.

13. RESTRICTIONS ON SHARES

         The Corporation may impose such restrictions on any shares acquired
upon exercise of options granted under the plan as it may deem advisable,
including, without limitation, restrictions pursuant to any agreements between
the Corporation and the optionee and restrictions necessary to ensure compliance
with the Securities Act of 1933, as amended, and any blue sky or securities laws
applicable to such shares. The Corporation may cause a restrictive legend to be
placed on any certificate issued pursuant to the exercise of an option in such
form as may be prescribed from time to time by applicable laws and regulations
or as may be advised by legal counsel.

14. AMENDMENT OR TERMINATION

         The plan may be amended or terminated by action of the Board; provided,
that:

                  (a) Any amendment that would (i) materially increase the
         aggregate number of shares which may be issued under the plan (subject
         to Paragraph 9 herein) or (ii) materially change the requirements for
         eligibility to receive options under the plan shall be made only with
         the approval of the shareholders of the Corporation.

                  (b) No option shall be adversely affected by a subsequent
         amendment or termination of the plan.



                                       -7-

    


<PAGE>   9


   

                  (c) No option shall be amended (i) without the consent of the
         optionee, and (ii) if the option is an incentive option, without the
         opinion of legal counsel to the Corporation that such amendment will
         not constitute a "modification" within the meaning of Section 424 of
         the Code if the Board determines such an opinion is necessary.

15. SHAREHOLDER APPROVAL

         The plan shall be submitted to the shareholders of the Corporation for
approval by a majority of the shares of common stock of the Corporation that are
entitled to vote thereon, which approval must occur, if at all, within twelve
months following the effective date of the plan. All options granted prior to
shareholder approval of the plan shall be conditional upon such approval, and no
option shall be exercisable prior to such approval.

16. APPLICABLE LAW

         Except as otherwise provided herein, the plan shall be construed and
enforced according to the laws of the State of North Carolina.

         IN WITNESS WHEREOF, this 1996 Stock Option Plan of C3, Inc., as
amended, has been executed in behalf of the Corporation as of the 27th day of
October, 1997.

                                      C3, INC.


                                      By  /s/ Jeff N. Hunter
                                          ---------------------------
                                              Jeff N. Hunter
                                              President



Attest:

/s/ Mark W. Hahn
- --------------------------------
    Mark W. Hahn
    Secretary


[Corporate Seal]



                                       -8-

    


<PAGE>   10


   

                           1996 STOCK OPTION AGREEMENT
                                       OF
                                    C3, INC.



         THIS AGREEMENT, made the ______ day of ____________, 19__, between C3,
INC., a North Carolina corporation (the "Corporation"), and
__________________________ (the "Optionee");

                                R E C I T A L S :

         In furtherance of the purposes of the 1996 Stock Option Plan of C3,
Inc., as amended (the "plan"), the Corporation and the Optionee hereby agree as
follows:

         1. The rights and duties of the Corporation and the Optionee under this
Agreement shall in all respects be subject to and governed by the provisions of
the plan, a copy of which is attached to this Agreement and the terms of which
are incorporated herein by reference.

         2. The Corporation hereby grants to the Optionee pursuant to the plan,
as a matter of separate inducement and agreement in connection with his
employment with or service to the Corporation or related corporation, and not in
lieu of any salary or other compensation for his services, the right and option
(the "option") to purchase all or any part of an aggregate of _______________
(_________) shares (the "shares") of the common stock of the Corporation, at the
purchase price of _____________________________ Dollars ($__________) per share.
The option to purchase ________________ (________) of the shares shall be
designated as an incentive option. The option to purchase ______________________
(_______) of the shares shall be designated as a nonqualified option. To the
extent that any option is designated as an incentive option and such option does
not qualify as an incentive option, it shall be treated as a nonqualified
option. Except as otherwise provided in the plan, the option will expire if not
exercised in full before ______________, ______.

         3. The option shall become exercisable on the date or dates set forth
on Schedule A attached hereto. To the extent that an option which is exercisable
is not exercised, such option shall accumulate and be exercisable by the
Optionee in whole or in part at any time prior to expiration of the option. Upon
the exercise of an option in whole or in part, the Optionee shall pay the option
price to the Corporation in accordance with the provisions of Paragraph 7 of the
plan, and the Corporation shall as soon thereafter as practicable deliver to the
Optionee a certificate or certificates for the shares purchased.

         4. Nothing contained in this Agreement or the plan shall require the
Corporation or a related corporation to continue the employment or service of
the Optionee for any particular period of time, nor shall it require the
Optionee to remain in the employment of or in service to the Corporation or such
related corporation for any particular period of time. Except as otherwise
expressly provided in the plan, all rights of the Optionee under the plan with
respect to the unexercised portion of his option shall terminate upon
termination of the employment or service of the Optionee with the Corporation or
a related corporation.

         5. This option shall not be transferable (including by pledge or
hypothecation) other than by will or the laws of intestate distribution, and
this option shall be exercisable during the Optionee's lifetime only by the
Optionee.


    


<PAGE>   11


   

         6. This Agreement shall be binding upon and shall inure to the benefit
of the parties hereto and their respective executors, administrators,
next-of-kin, successors and assigns. This paragraph shall not be construed to
authorize any transfer in violation of Paragraph 5.

         7. This Agreement may be modified or amended only by the written
agreement of the parties hereto.

         8. This Agreement shall be construed and enforced according to the laws
of the State of North Carolina.

         IN WITNESS WHEREOF, this Agreement has been executed in behalf of the
Corporation and by the Optionee on the day and year first above written.


                                       C3, INC.


                                       By:
                                            ----------------------------
                                                ----------
                                                President

Attest:


- --------------------------------
        -------------
        Secretary


[Corporate Seal]



                                                 OPTIONEE

                                                 ________________________(SEAL)




                                       -2-

    


<PAGE>   12

   

                           1996 STOCK OPTION AGREEMENT
                                       OF
                                    C3, INC.


                                   SCHEDULE A





Date option granted: __________________, 19__
Date option expires: __________________, 19__
Number of shares subject to option: _______ shares
Option price (per share): $________



Date Installment             Number of Shares                 Incentive or
First Exercisable             in Installment              Nonqualified Option
- -----------------             --------------              -------------------


    




<PAGE>   1

                                                                    EXHIBIT 23.2



INDEPENDENT AUDITORS' CONSENT

We consent to the use in this Amendment No. 2 to Registration Statement 
No. 333-36809 of C3, Inc. of our report dated March 11, 1997, except for 
Note 9, as to which the date is September 25, 1997, appearing in the
Prospectus, which is a part of this Registration Statement, and to the reference
to us under the headings "Selected Financial Data" and "Experts" in such
Prospectus.


/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP

Raleigh, North Carolina
November 5, 1997






<TABLE> <S> <C>

<ARTICLE> 5
       
<S>                             <C>                     <C>
<PERIOD-TYPE>                   YEAR                   9-MOS
<FISCAL-YEAR-END>                          DEC-31-1996             DEC-31-1997
<PERIOD-START>                             JAN-01-1996             JAN-01-1997
<PERIOD-END>                               DEC-31-1996             SEP-30-1997
<CASH>                                       1,167,458               4,737,864
<SECURITIES>                                         0                       0
<RECEIVABLES>                                        0                       0
<ALLOWANCES>                                         0                       0
<INVENTORY>                                          0                  17,911
<CURRENT-ASSETS>                             1,174,458               4,875,196
<PP&E>                                          14,081                  94,380
<DEPRECIATION>                                   2,352                       0
<TOTAL-ASSETS>                               1,226,134               5,085,048
<CURRENT-LIABILITIES>                           12,855                 469,962
<BONDS>                                              0                       0
<PREFERRED-MANDATORY>                                0                       0
<PREFERRED>                                    593,271               5,574,647
<COMMON>                                     1,029,803               1,095,803
<OTHER-SE>                                    (409,795)             (2,055,364)
<TOTAL-LIABILITY-AND-EQUITY>                 1,226,134               5,085,048
<SALES>                                              0                       0
<TOTAL-REVENUES>                                     0                       0
<CGS>                                                0                       0
<TOTAL-COSTS>                                        0                       0
<OTHER-EXPENSES>                               286,684               1,277,983
<LOSS-PROVISION>                                     0                       0
<INTEREST-EXPENSE>                                   0                       0
<INCOME-PRETAX>                               (382,608)             (1,754,569)
<INCOME-TAX>                                         0                       0
<INCOME-CONTINUING>                           (382,608)             (1,754,569)
<DISCONTINUED>                                       0                       0
<EXTRAORDINARY>                                      0                       0
<CHANGES>                                            0                       0
<NET-INCOME>                                  (382,608)             (1,754,569)
<EPS-PRIMARY>                                        0                       0
<EPS-DILUTED>                                    (0.14)                  (0.41)
        

</TABLE>