AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 14, 1999
                                                       REGISTRATION NO. 333-
================================================================================
                      SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                ---------------
                                   FORM S-3
                             REGISTRATION STATEMENT
                                     UNDER
                           THE SECURITIES ACT OF 1933
                                ---------------
                              CREE RESEARCH, INC.
            (Exact name of registrant as specified in its charter)


<TABLE>
<CAPTION>
          NORTH CAROLINA                            56-1572719
<S>                                <C>
(State or other jurisdiction            (I.R.S. Employer Identification No.)
 of incorporation or organization)
</TABLE>


                              4600 SILICON DRIVE
                         DURHAM, NORTH CAROLINA 27703
                                (919) 313-5300
          (Address, including zip code and telephone number, including
            area code, of registrant's principal executive offices)

                                F. NEAL HUNTER
                     CHAIRMAN AND CHIEF EXECUTIVE OFFICER
                              CREE RESEARCH, INC.
                              4600 SILICON DRIVE
                         DURHAM, NORTH CAROLINA 27703
                                (919) 313-5300
(Name, address, including zip code and telephone number, including area code,
                             of agent for service)
                                ---------------
                                  COPIES TO:


<TABLE>
<S>                                        <C>
         GERALD F. ROACH, ESQ.                 PHILLIP P. ROSSETTI, ESQ. 
          AMY J. MEYERS, ESQ.                      HALE AND DORR LLP     
       SMITH, ANDERSON, BLOUNT,                     60 STATE STREET      
 DORSETT, MITCHELL & JERNIGAN, L.L.P.         BOSTON, MASSACHUSETTS 02109
    2500 FIRST UNION CAPITOL CENTER                  (617) 526-6000      
     RALEIGH, NORTH CAROLINA 27601           
            (919) 821-1220
</TABLE>


        APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
  As soon as practicable after this registration statement becomes effective.

  If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [ ]

  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, other than securities offered only in connection with dividend or
interest reinvestment plans, check the following box. [ ]

  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 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        REGISTRATION
     BE REGISTERED       REGISTERED(1)     PER SHARE(2)    OFFERING PRICE(2)        FEE
============================================================================================
<S>                     <C>             <C>               <C>                 <C>
Common Stock,
  $0.005 par value per
  share ............... 1,495,000       $ 41.94               $62,700,300     $ 17,430.68
============================================================================================
</TABLE>


(1) Includes 195,000 shares which the underwriters have the option to purchase
    to cover over-allotments, if any. See "Underwriting."

(2) Estimated solely for the purpose of calculating the registration fee, based
    upon the average of the high and low prices of the Common Stock on the
    Nasdaq National Market on January 13, 1999 in accordance with Rule 457(c).

                                ---------------
  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 THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
================================================================================

<PAGE>


                 Subject to Completion, Dated January 14, 1999
The information contained in this prospectus is not complete and may be
changed. These securities may not be sold until the registration statement
filed with the Securities and Exchange Commission is effective. This prospectus
is not an offer to sell these securities and it is not soliciting an offer to
buy these securities in any state where the offer or sale is not permitted.





                               1,300,000 SHARES



                                  (CREE LOGO)
                                 
 
                                 COMMON STOCK
                                $     PER SHARE
- --------------------------------------------------------------------------------
Cree Research, Inc. is offering 1,300,000 shares of common stock with this
prospectus. This is a firm commitment underwriting.

The common stock is listed on the Nasdaq National Market under the symbol
"CREE." On January 12, 1999, the last reported sale price of the common stock
on the Nasdaq National Market was $48.50 per share.

INVESTING IN THE COMMON STOCK INVOLVES CERTAIN RISKS. SEE "RISK FACTORS"
BEGINNING ON PAGE 6.




<TABLE>
<CAPTION>
                                   PER SHARE     TOTAL
                                  ----------- ----------
<S>                               <C>         <C>
  Price to the public ........... $           $
  Underwriting discount .........
  Proceeds to Cree ..............
</TABLE>


Cree has granted an over-allotment option to the underwriters. Under this
option, the underwriters may elect to purchase a maximum of 195,000 additional
shares from Cree within 30 days following the date of this prospectus to cover
over-allotments.
- --------------------------------------------------------------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF
THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.



CIBC OPPENHEIMER
          PRUDENTIAL SECURITIES INCORPORATED
                             MORGAN KEEGAN & COMPANY, INC.


                   The date of this Prospectus is     , 1999


<PAGE>
Following the prospectus cover page are color photos of certain of the Company's
products:
        Blue and green LEDs 
        Silicon carbide (SiC) wafer 
        Gemstone crystal 
        Microwave device 
        Utility substation (Photo courtesy of Carolina Power & Light) 
        Blue laser beam

In the center of the photo layout is the Cree logo over the title "Existing and
Planned Products"

Beside or beneath each photo is the following description:

        LEDS
        Cree has created high brightness blue and green LEDs through the
        combination of SiC and GaN.

        SILICON CARBIDE WAFERS
        Cree is the leading worldwide supplier of SiC wafers used by customers
        in research and development programs.

        GEMSTONE APPLICATIONS
        Cree manufactures near colorless SiC with properties similar to diamond
        for use in unique gemstones.

        MICROWAVE*
        Cree is developing devices for use in microwave applications, such as
        wireless base station transmitters.

        POWER SEMICONDUCTORS*
        Cree is developing power semiconductor devices for applications such as
        motor control and high voltage power transmission.

        LASERS*
        Cree is developing blue laser diodes designed to increase optical
        storage capability.

*Currently under development

                                       2

<PAGE>

                               TABLE OF CONTENTS




<TABLE>
<CAPTION>
                                                                                          PAGE
                                                                                         -----
<S>                                                                                      <C>
Forward-Looking Statements ...........................................................     3
Prospectus Summary ...................................................................     4
Risk Factors .........................................................................     6
Use of Proceeds ......................................................................    12
Dividend Policy ......................................................................    12
Price Range of Common Stock ..........................................................    13
Capitalization .......................................................................    14
Selected Consolidated Financial Data .................................................    15
Management's Discussion and Analysis of Financial Condition and Results of Operations     16
Business .............................................................................    25
Management ...........................................................................    34
Principal Shareholders ...............................................................    36
Certain Transactions .................................................................    38
Underwriting .........................................................................    39
Legal Matters ........................................................................    41
Experts ..............................................................................    41
Other Matters ........................................................................    41
Where You Can Find More Information ..................................................    41
Index to Financial Statements ........................................................   F-1
</TABLE>


                           -------------------------
As used in this prospectus, the terms "we," "us," "our," the "Company" and
"Cree" mean Cree Research, Inc. and its subsidiaries (unless the context
indicates a different meaning), and the term "common stock" means the Company's
common stock, $0.005 par value per share. Unless otherwise stated, all
information contained in this prospectus assumes no exercise of the
over-allotment option granted to the underwriters.

The underwriters are offering the shares subject to various conditions and may
reject all or part of any order. The shares should be ready for delivery on or
about          , 1999, against payment in immediately available funds.


                           -------------------------
                          FORWARD-LOOKING STATEMENTS


Information set forth in this prospectus under the captions "Prospectus
Summary," "Risk Factors," "Management's Discussion and Analysis of Financial
Condition and Results of Operations," "Business" and "Use of Proceeds" contains
various "forward-looking statements" within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act, which represent our
judgment concerning the future and are subject to risks and uncertainties that
could cause our actual operating results and financial positions to differ
materially. Forward-looking statements are typically identified by the use of
terms such as "may," "will," "expect," "anticipate," "estimate" and similar
words, although some forward-looking statements are expressed differently. Our
actual results could differ materially from those contained in the
forward-looking statements due to a number of factors, including fluctuations
in our operating results, production yields in our manufacturing processes,
whether we can produce commercial quantities of high brightness blue and green
LEDs, our dependence on a few customers, whether we can manage our growth
effectively, assertion of intellectual property rights by others, adverse
economic conditions and insufficient capital resources. These and other factors
that could cause actual results to differ materially from such forward-looking
statements are set forth under the caption "Risk Factors" and elsewhere in this
prospectus.


                                       3

<PAGE>

                              PROSPECTUS SUMMARY

YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED
INFORMATION REGARDING OUR COMPANY AND THE COMMON STOCK BEING SOLD IN THIS
OFFERING AND OUR FINANCIAL STATEMENTS AND ACCOMPANYING NOTES THAT APPEAR
ELSEWHERE IN THIS PROSPECTUS.


                                  THE COMPANY

We are the world leader in developing and manufacturing semiconductor materials
and electronic devices made from silicon carbide, or SiC. We use our
proprietary technology to make enabling compound semiconductors such as blue
and green light emitting diodes or LEDs, SiC crystals used in the production of
unique gemstones and SiC wafers that are sold for research and development. We
have new product initiatives based on our expertise in SiC, including microwave
transistors for use in wireless base stations and radar, blue laser diodes for
optical storage applications and high power devices for power conditioning and
switching.

Our blue and green LEDs are sold to customers who package them for use in
applications such as backlighting for automotive dashboards and liquid crystal
displays, including wireless handsets. Other applications include indoor and
outdoor electronic displays, such as video replay boards in indoor arenas.
Additionally, we recently began shipping LEDs for use in traffic signals and
miniature lighting. We have developed several generations of blue LED products,
including a more robust conductive buffer chip that is easier to build into
lamps and has a low unit price. Strategies Unlimited, an industry research
firm, has estimated that the market size for LEDs (all colors) was
approximately $1.8 billion in 1997 and has forecast that the blue and green LED
portion of the market will increase from approximately $204 million in 1998 to
approximately $430 million in 2001.

We believe that for certain applications SiC-based compound semiconductor
devices offer significant advantages over other semiconductor materials such as
silicon and gallium arsenide. In particular, the properties of SiC make it an
excellent material for extending existing semiconductor device technology where
high power, high temperature or short wavelengths are important for
performance. For example, SiC enables the manufacture of blue and green LEDs in
an easier to use, industry standard structure. SiC also permits a smaller LED
chip size that we believe is less expensive to produce than LEDs made using
other materials. In addition, SiC-based microwave transistors can operate at
significantly higher power levels than existing silicon or gallium
arsenide-based devices. This characteristic will allow wireless systems to use
fewer transistors per base station with less complex circuitry, which should
result in a lower system cost.

Many of the same physical characteristics that make SiC an excellent material
for certain semiconductor applications also make the material very difficult to
produce. Through our proprietary technology and over 10 years of development
and manufacturing experience, we have succeeded in overcoming many difficulties
in processing SiC for commercial use.

Our objective is to continue to develop SiC materials and device technology
with low unit costs. We are using our materials and process technology to
develop new microwave, power and laser diode products while continuing to
enhance our LEDs, SiC wafers and gemstone crystals. We have increased the
performance and reduced the cost of our LED chips over the last several years
by decreasing chip size, increasing wafer diameter and enhancing our epitaxial
film deposition (wafer coating) and fabrication processes.

Our principal executive offices are located at 4600 Silicon Drive, Durham,
North Carolina 27703. Our telephone number is (919) 313-5300.


                                       4

<PAGE>

                                 THE OFFERING


Common stock offered by Cree........................   1,300,000 shares

Common stock to be outstanding after the offering...   14,219,818 shares(1)

Use of proceeds.....................................   To purchase additional
                                                       manufacturing equipment
                                                       and build out the
                                                       Company's principal
                                                       manufacturing facility,
                                                       to repay indebtedness,
                                                       for research and
                                                       development, and for
                                                       working capital and
                                                       general corporate
                                                       purposes.

Nasdaq National Market symbol.......................   CREE


                  SUMMARY CONSOLIDATED FINANCIAL INFORMATION
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)




<TABLE>
<CAPTION>
                                                         YEARS ENDED                        SIX MONTHS ENDED
                                          -----------------------------------------   -----------------------------
                                            JUNE 30,      JUNE 30,       JUNE 28,      DECEMBER 28,    DECEMBER 27,
                                              1996          1997           1998            1997            1998
                                          -----------   ------------   ------------   -------------   -------------
<S>                                       <C>           <C>            <C>            <C>             <C>
STATEMENT OF INCOME DATA:
Total revenue .........................     $15,057       $ 28,973       $ 42,531       $ 20,313        $ 26,317
Gross profit ..........................       3,568          9,878         14,552          6,696          12,273
Income (loss) from operations .........        (624)         3,112          8,145          3,401           7,111
Net income ............................     $   243       $  3,542       $  6,275       $  2,640        $  5,217
                                            =======       ========       ========       ========        ========
Earnings per share:
  Basic ...............................     $  0.02       $   0.28       $   0.49       $   0.21        $   0.41
                                            =======       ========       ========       ========        ========
  Diluted .............................     $  0.02       $   0.27       $   0.47       $   0.20        $   0.39
                                            =======       ========       ========       ========        ========
Shares used in per share calculation:
  Basic ...............................      11,826         12,455         12,863         12,699          12,876
                                            =======       ========       ========       ========        ========
  Diluted .............................      12,615         13,126         13,493         13,522          13,541
                                            =======       ========       ========       ========        ========
</TABLE>




<TABLE>
<CAPTION>
                                                            DECEMBER 27, 1998
                                                      -----------------------------
                                                        ACTUAL      AS ADJUSTED (2)
                                                      ----------   ----------------
<S>                                                   <C>          <C>
BALANCE SHEET DATA:
Cash and cash equivalents .........................    $12,769         $ 61,859
Working capital ...................................     24,383           73,594
Total assets ......................................     78,103          127,193
Long term debt, including current portion .........     10,000               --
Shareholders' equity ..............................     59,989          119,079
</TABLE>


- -------------------
(1)  Based on 12,919,818 shares of common stock outstanding on December 27,
     1998. Excludes 1,984,547 shares of common stock reserved for issuance upon
     the exercise of stock options and warrants outstanding at December 27,
     1998, of which 78,513 shares were issued between December 27, 1998 and
     January 11, 1999.

(2)  Adjusted to give effect to the sale of 1,300,000 shares of common stock
     offered by Cree in this offering at an assumed public offering price of
     $48.50 per share, and the application of the net proceeds from the sale of
     the shares, after deducting the estimated underwriting discount and
     estimated offering expenses payable by Cree. See "Use of Proceeds."

                                       5

<PAGE>

                                 RISK FACTORS


YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS BEFORE DECIDING TO INVEST
IN THE SHARES. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY
ONES WE FACE. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN TO US,
THAT WE CURRENTLY DEEM IMMATERIAL OR THAT ARE SIMILAR TO THOSE FACED BY OTHER
COMPANIES IN OUR INDUSTRY OR BUSINESS IN GENERAL MAY ALSO IMPAIR OUR BUSINESS
OPERATIONS. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCURS, OUR BUSINESS,
FINANCIAL CONDITION OR RESULTS OF FUTURE OPERATIONS COULD BE MATERIALLY AND
ADVERSELY AFFECTED. IN SUCH CASE, THE TRADING PRICE OF OUR COMMON STOCK COULD
DECLINE, AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT. THIS PROSPECTUS ALSO
CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE
FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THE RISKS
FACED BY US DESCRIBED BELOW AND ELSEWHERE IN THIS PROSPECTUS. PLEASE REFER TO
"FORWARD-LOOKING STATEMENTS" ON PAGE 3.

OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY AND WE MAY NOT BE ABLE TO
MAINTAIN OUR EXISTING GROWTH RATE.

Although we have had significant revenue and earnings growth in recent
quarters, we may not be able to sustain these growth rates and we may
experience significant fluctuations in our revenue and earnings in the future.
Our operating results will depend on many factors, including the following:

  o   our ability to develop, manufacture and deliver products in a timely and
      cost-effective manner;

  o   whether we encounter low levels of usable product produced during each
      manufacturing step (our "yield");

  o   our ability to expand our production of SiC wafers and devices;

  o   demand for our products;

  o   demand for our customers' products;

  o   competition; and

  o   general industry and global economic conditions.

Our future operating results could be adversely affected by these or other
factors. If our future operating results are below the expectations of stock
market analysts or our investors, our stock price may decline.


IF WE EXPERIENCE POOR PRODUCTION YIELDS, OUR OPERATING RESULTS MAY SUFFER.

Our SiC products are very complex and are fabricated using technologies that
are highly complex. Our customers incorporate our products into high volume
applications such as automotive dashboards, wireless handsets, full color video
displays and gemstones, and they insist that our products meet exact
specifications for quality, performance and reliability.

The number of usable crystals, wafers and devices that result from our
production processes can fluctuate as a result of many factors, including the
following:

  o   impurities in the materials used;

  o   contamination of the manufacturing environment;

  o   equipment failure, power outages or variations in the manufacturing
      process;

  o   losses from broken wafers or other human error; and

  o   defects in packaging.

Because many of our manufacturing costs are fixed, if our yields decrease our
operating results would be adversely affected. For this reason, we are
constantly trying to improve our yields.

In the past, we have experienced difficulties in achieving acceptable yields on
new products, which has adversely affected our operating results. We may
experience similar problems in the future and we cannot predict when they may
occur or their severity. These problems could significantly affect our future
operating results.


IF WE ARE UNABLE TO PRODUCE ADEQUATE QUANTITIES OF OUR HIGH BRIGHTNESS BLUE AND
GREEN LEDS, OUR OPERATING RESULTS MAY SUFFER.

We are currently beginning the manufacture of commercial quantities of high
brightness blue and green LEDs, and as a result, we have incurred certain fixed
costs. We believe that high volume production of these products will be
important to our future operating results. Achieving greater


                                       6

<PAGE>

volumes requires improved production yields for these products. Successful
production of these products is subject to a number of risks, including the
following:

   o our ability to consistently manufacture these products in volumes large
     enough to cover our fixed costs and satisfy our customers' requirements;

   o our ability to improve our yields and reduce the costs associated with the
     manufacture of these products; and

   o whether these products gain market acceptance.

Our inability to produce adequate quantities of our high brightness blue and
green products would have a material adverse effect on our business, results of
operations and financial condition.


OUR OPERATING RESULTS ARE SUBSTANTIALLY DEPENDENT ON THE DEVELOPMENT OF NEW
PRODUCTS BASED ON OUR CORE SIC TECHNOLOGY.

Our future success will depend on our ability to develop new SiC solutions for
existing and new markets. We must introduce new products in a timely and
cost-effective manner and we must secure production orders from our customers.
The development of new SiC products is a highly complex process, and we have
historically experienced delays in completing the development and introduction
of new products. Products currently under development include high power radio
frequency and microwave devices, power devices, blue laser diodes and high
temperature devices. The successful development and introduction of these
products depends on a number of factors, including the following:

   o achievement of technology breakthroughs required to make commercially
     viable devices;

   o the accuracy of our predictions of market requirements and evolving
     standards;

   o acceptance of our new product designs;

   o the availability of qualified development personnel;

   o our timely completion of product designs and development;

   o our ability to develop repeatable processes to manufacture new products in
     sufficient quantities for commercial sales; and

   o acceptance of our customers' products by the market.

If any of these or other factors become problematic, we may not be able to
develop and introduce these new products in a timely or cost-efficient manner.


WE DEPEND ON A FEW LARGE CUSTOMERS.

Historically, a substantial portion of our revenue has come from large
purchases by a small number of customers. We expect that trend to continue. For
example, for fiscal 1998 our top five customers accounted for 81% of our total
revenue. For the six months ended December 27, 1998, our top five customers
accounted for 79% of our total revenue. (These percentages consider sales to a
distributor as one customer). Sales to Siemens AG during both periods accounted
for 40% of our total revenue. In addition, sales to C3 accounted for 11% of our
total revenue in fiscal 1998 and 18% of our total revenue in the six months
ended December 27, 1998. Accordingly, our future operating results depend on
the success of our largest customers and on our success in selling large
quantities of our products to them.

The concentration of our revenues with a few large customers makes us
particularly dependent on factors affecting those customers. For example, if
demand for their products decreases, they may stop purchasing our products and
our operating results will suffer. If we lose a large customer and fail to add
new customers to replace lost revenue, our operating results may not recover.


WE FACE CHALLENGES RELATING TO EXPANSION OF OUR PRODUCTION AND MANUFACTURING
FACILITY.

In order to increase production at our new facility, we must add critical new
equipment, move existing equipment and complete the remaining phases of
building out the facility. We are in the process of completing this build-out
and expect to construct additional facilities in the future. Expansion
activities such as these are subject to a number of risks, including the
following:

   o unforeseen environmental or engineering problems relating to existing or
     new facilities;

   o unavailability or late delivery of the advanced, and often customized,
     equipment used in the production of our products;

   o unavailability of funds necessary for expansion;

                                       7

<PAGE>

   o work stoppages and delays; and

   o delays in bringing production equipment on-line.

These and other risks may affect the ultimate cost and timing of the build-out
of our existing facility, as well as the construction of new facilities, which
could adversely affect our business, results of operations and financial
condition.


THE ONGOING OPERATION OF OUR MANUFACTURING FACILITY IS CRITICAL TO OUR
BUSINESS.

In November 1997, we acquired our present facilities in Durham, North Carolina,
which include a total of 172,000 square feet. The ongoing operation of this
facility is crucial to our strategy of expanding our manufacturing capacity to
meet demand for our SiC products now and in the future.

We began commercial production of products from our new facility in August
1998. We expect that production from the facility will increase throughout the
remainder of fiscal 1999 and into fiscal 2000. A number of factors will affect
the successful operation of this facility and our business, including the
following:

   o demand for our products;

   o our production yields;

   o our ability to generate revenues in amounts that cover the significant
     fixed costs of operating our facility;

   o our ability to hire, train and manage qualified production personnel; and
       

   o our inability to use all or a significant portion of our facility for
     prolonged periods of time for any reason -- for example, a fire or
     explosion caused by our use of combustible chemicals and high temperatures
     during certain of our manufacturing processes.


WE FACE SIGNIFICANT CHALLENGES MANAGING OUR RAPID GROWTH.

We are experiencing a period of significant growth that will continue to place
a great strain on our management and other resources. We have grown from 188
employees on December 31, 1996 to 297 employees on December 27, 1998 and from
revenues of $29.0 million for the fiscal year ended June  30, 1997 to $42.5
million for the fiscal year ended June  28, 1998. To manage our growth
effectively, we must continue to:

   o implement and improve operational systems;

   o maintain adequate physical plant, manufacturing facilities and equipment to
     meet customer demand;

   o add experienced senior level managers; and

   o attract and retain qualified people with experience in engineering, design,
     technical marketing and support.

We will spend substantial amounts of money in connection with our rapid growth
and may have additional unexpected costs. Our systems, procedures or controls
may not be adequate to support our operations, and we may not be able to expand
quickly enough to exploit potential market opportunities. Our future operating
results will also depend on expanding sales and marketing, research and
development, and administrative support. If we cannot attract qualified people
or manage growth effectively, our business, operating results and financial
condition could be adversely affected.


THE MARKETS IN WHICH WE OPERATE ARE HIGHLY COMPETITIVE.

The market for our products is highly competitive. Although we believe our
SiC-based LEDs offer substantial advantages, competitors currently sell blue
and green LEDs made from sapphire wafers that are brighter than the high
brightness LEDs we currently produce. In addition, we believe that other firms
(including certain of our customers) may seek to enter the blue and green LED
market in the future. For example, Siemens AG and Shin-Etsu Handotai Co. Ltd.
license certain of our LED technology, which may facilitate their entrance into
our LED markets. The market for SiC wafers is also becoming competitive as
other firms have in recent years begun offering SiC wafer products or announced
plans to do so.

Also, other firms may develop new or enhanced products that are more effective
than any that we have developed or may develop. These firms may develop
technology that produces commercial products with characteristics similar to
SiC-based products, but at a lower cost. Many existing and potential
competitors have far greater financial, marketing and other resources than we
do. We believe that present and future competitors will


                                       8

<PAGE>

aggressively pursue the development and sale of competing products. We also
expect significant competition for products we are currently developing, such
as those for use in microwave communications.

We expect competition to increase. This could mean lower prices for our
products, reduced demand for our products and a corresponding reduction in our
ability to recover development, engineering and manufacturing costs. Any of
these developments could have an adverse effect on our business, results of
operations and financial condition.


WE RELY ON A FEW KEY SUPPLIERS.

We depend on a limited number of suppliers for certain raw materials,
components and equipment used in manufacturing our SiC products, including key
materials and equipment used in critical stages of our manufacturing processes.
We generally purchase these limited source items with purchase orders, and we
have no guaranteed supply arrangements with such suppliers. If we were to lose
such key suppliers, our manufacturing efforts could be hampered significantly.
Although we believe our relationship with our suppliers is good, we cannot
assure you that we will continue to maintain good relationships with such
suppliers or that such suppliers will continue to exist.


IF GOVERNMENT AGENCIES OR OTHER CUSTOMERS DISCONTINUE THEIR FUNDING FOR OUR
RESEARCH AND DEVELOPMENT OF SIC TECHNOLOGY, OUR BUSINESS MAY SUFFER.

In the past, government agencies and other customers have funded a significant
portion of our research and development activities. If this support is
discontinued or reduced, our ability to develop or enhance products could be
limited and our business, results of operations and financial condition could
be adversely affected.


WE DEPEND HEAVILY ON KEY PERSONNEL.

Our success depends in part on keeping key technical and management personnel.
For example, some of the equipment used in the production of our products must
be modified before it is put to use and only a limited number of employees
possess the expertise needed to perform these modifications. Furthermore, the
number of individuals with experience in the production of SiC and related
products is limited, and our future success depends in part on retaining those
individuals who are already employees.

We must also continue to attract qualified personnel. The competition for
qualified personnel is intense, and the number of people with the experience
that we need is limited. We cannot be sure that we will be able to continue to
attract and retain other skilled personnel in the future.


LIMITATIONS ON THE PROTECTION OF OUR INTELLECTUAL PROPERTY.

Our intellectual property position is based on patents exclusively licensed to
us by North Carolina State University, also known as N.C. State, and on patents
owned by us. The licensed patents give us rights to our SiC crystal growth
process. The expiration dates on the U.S. patents we license from N.C. State
run from 2007 to 2009. We also own 43 U.S. patents relating to various aspects
of our technology and have other patent applications pending. The issued U.S.
patents we own expire between 2008 and 2016. We have obtained (or licensed from
N.C. State) a number of patents covering these same technologies in key foreign
jurisdictions.

We intend to continue to file patent applications in the future, where
appropriate, and to pursue such applications with the U.S. and foreign patent
authorities, but we cannot be sure that any other patents will be issued on such
applications or that our patents will not be contested. In the past, one of the
important patents we license from N.C. State relating to crystal growth was
subject to re-examination in the U.S. but we prevailed in the proceeding.
Currently, the corresponding European patent is being challenged, which means
that we could lose patent protection in certain European countries for this
particular method. Also, because issuance of a valid patent does not prevent
other companies from using alternative, non-infringing technology, we cannot be
sure that any of our patents (or patents issued to N.C. State or other parties
and licensed to us) will provide significant commercial protection.

In addition to patent protection, we also rely on trade secrets, technical
know-how and other unpatented proprietary information relating to our


                                       9

<PAGE>

product development and manufacturing activities. We try to protect this
information with confidentiality agreements with our employees and other
parties. We cannot be sure that these agreements will not be breached, that we
would have adequate remedies for any breach or that our trade secrets and
proprietary know-how will not otherwise become known or independently
discovered by others.


OUR OPERATIONS COULD INFRINGE UPON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS.

Particular aspects of our technology could be found to infringe the claims of
other existing or future patents. Other companies may hold or obtain patents on
inventions, or may otherwise claim proprietary rights to technology necessary
to our business. We cannot predict the extent to which we may be required to
seek licenses.


WE ARE SUBJECT TO RISKS FROM INTERNATIONAL SALES.

Sales to customers located outside the U.S. accounted for about 69% of our
revenue in fiscal 1996, about 79% of our revenue in fiscal 1997, about 74% of
our revenue in fiscal 1998 and about 62% of our revenue in the first six months
of fiscal 1999.

We expect that revenue from international sales will continue to be a
significant part of our total revenue. International sales are subject to a
variety of risks, including risks arising from currency fluctuations, the
emergence of the Euro, trading restrictions, tariffs, trade barriers and taxes.
Also, future U.S. Government or military export restrictions could limit or
prohibit sales of our products to customers in certain countries because of
their uses in military or surveillance applications.

Because all of our foreign sales are denominated in U.S. dollars, our products
become less price competitive in countries with currencies that are low or are
declining in value against the U.S. dollar. Also, we cannot be sure that our
international customers will continue to place orders denominated in U.S.
dollars. If they do not, our reported revenue and earnings will be subject to
foreign exchange fluctuations.

WE ARE SUBJECT TO STRINGENT ENVIRONMENTAL REGULATION.

We are subject to a variety of government regulations pertaining to chemical
and waste discharges and other aspects of our manufacturing process. For
example, we are responsible for the management of the hazardous materials we
use and disposal of hazardous waste resulting from our manufacturing process.
The proper handling and disposal of such hazardous material and waste requires
us to comply with certain government rules and regulations. We believe we are
in full compliance with such regulations as of the date of this prospectus, but
any failure, whether intentional or inadvertent, to comply with such
regulations could have an adverse effect on our business. In addition, these
regulations may affect our ability to expand or change our manufacturing
facility.


THE VOLATILITY OF OUR STOCK PRICE COULD AFFECT AN INVESTMENT IN OUR STOCK.

The market price of our common stock has been and may continue to be subject to
wide fluctuations. Factors affecting our stock price may include:

   o variations in operating results from quarter to quarter;

   o changes in earning estimates by analysts;

   o market conditions in the industry; and

   o general economic conditions.

Our stock price has fluctuated widely. For example, between November 1997 and
January 1998 the price of our common stock dropped from approximately $29.50 to
$13.50 per share. Between August 1998 and January 11, 1999, the price of our
common stock rose from approximately $10.50 to $53.25 per share. Consequently,
the current market price of our common stock may not be indicative of future
market prices, and you may not be able to sustain or increase the value of your
investment in our common stock.


WE FACE RISKS CONCERNING YEAR 2000 ISSUES.

We are evaluating all of our internal computers, computer equipment and other
equipment with embedded technology against Year 2000 concerns. Although we
believe our planning efforts are adequate to address our Year 2000 concerns, it
is still possible that we could experience negative consequences and material
costs caused by


                                       10

<PAGE>

undetected errors or defects in the technology used in our internal systems.
Our most significant Year 2000 risk is that the systems of other parties on
which we rely, specifically our key suppliers, will not be compliant on a
timely basis. Any disruption in delivery of supplies to us that is caused by a
third party's failure to address Year 2000 issues would affect our ability to
manufacture our products, which could result in a material adverse effect on
our business, operating results and financial condition.

At this time, we are unable to estimate the most likely worst-case effects of
the arrival of the Year 2000 and we do not have a contingency plan for any
unanticipated negative effects.


                                       11

<PAGE>

                                USE OF PROCEEDS


The Company estimates that the net proceeds from the sale of the shares of
common stock it is offering will be approximately $59.1 million. If the
underwriters fully exercise the over-allotment option, the net proceeds will be
approximately $68.1 million. For the purpose of estimating net proceeds, the
Company is assuming that the public offering price will be $48.50 per share.
"Net proceeds" is what the Company expects to receive after paying the
underwriting discount and other estimated expenses of the offering.

Cree will use the net proceeds of the offering as follows:

 o approximately $35 to $45 million of the net proceeds will be used to fund
   the build-out and expansion of the Company's facilities, as well as the
   purchase of equipment;

 o approximately $10 million of the net proceeds will be used to repay the
   outstanding balance on the Company's term loan, which has an interest rate
   of 8.0% and matures on December 10, 2011; and

 o the balance of the net proceeds, if any, will be used for general corporate
   purposes, including working capital and research and development.

The Company reserves the right to vary the use of proceeds among the categories
listed above because the Company's ability to use the proceeds in the
approximate amounts listed is dependent on a number of factors, including the
unexpected costs of equipment and other capital expenditures, the progress of
new product research and development and the continued success of the Company's
products. Pending such uses, the Company intends to invest the net proceeds
from this offering in investment grade, interest-bearing securities.


                                DIVIDEND POLICY


The Company has never declared or paid cash dividends on its common stock and
does not anticipate that it will do so in the foreseeable future. There are no
contractual restrictions in place that currently materially limit, or are
likely in the future to materially limit, the Company from paying dividends on
its common stock, but applicable state law may limit the payment of dividends.
The present policy of the Company is to retain earnings, if any, to provide
funds for the operation and expansion of its business.


                                       12

<PAGE>

                          PRICE RANGE OF COMMON STOCK


The Company's common stock has traded publicly on the Nasdaq National Market
under the symbol "CREE" since February 8, 1993, the date of the Company's
initial public offering. The following table sets forth the high and low sales
prices for the Company's common stock for the periods indicated as reported by
the Nasdaq National Market.


<TABLE>
<CAPTION>
                                                                  HIGH           LOW
                                                              ------------   -----------
<S>                                                           <C>            <C>
       FISCAL 1997
         First Quarter ....................................    $  15.750      $  8.250
         Second Quarter ...................................       14.000         8.875
         Third Quarter ....................................       15.875         9.375
         Fourth Quarter ...................................       15.125         9.500
       FISCAL 1998
         First Quarter ....................................    $  20.500      $ 11.750
         Second Quarter ...................................       29.500        15.625
         Third Quarter ....................................       19.625        13.500
         Fourth Quarter ...................................       17.625        14.000
       FISCAL 1999
         First Quarter ....................................    $  17.500      $ 10.000
         Second Quarter ...................................       47.000        13.625
         Third Quarter (through January 11, 1999) .........       53.250        41.750
</TABLE>


On January 12, 1999, the last sale price reported on the Nasdaq National Market
for the common stock was $48.50 per share. On December 27, 1998, there were
approximately 386 holders of record of the common stock.


                                       13

<PAGE>

                                CAPITALIZATION


The following table sets forth the capitalization of the Company as of December
27, 1998 on an actual and as adjusted basis to reflect the sale of 1,300,000
shares of common stock offered by the Company hereby, at an estimated offering
price of $48.50 per share, after deducting the estimated underwriting discount
and the estimated offering expenses payable by the Company and the application
of the net proceeds. See "Use of Proceeds."


<TABLE>
<CAPTION>
                                                                             DECEMBER 27, 1998
                                                                       -----------------------------
                                                                          ACTUAL      AS ADJUSTED(1)
                                                                       -----------   ---------------
                                                                              (IN THOUSANDS)
<S>                                                                    <C>           <C>
   Cash and cash equivalents .......................................    $ 12,769         $ 61,859
                                                                        ========         ========
   Long-term debt, less current portion ............................    $  9,879         $     --
   Shareholders' equity:
    Preferred stock, $0.01 par value; 3,000 shares authorized; none
      issued and outstanding .......................................          --               --
    Common stock, $0.005 par value; 30,000 shares authorized;
      12,920 shares issued and outstanding; 14,220 shares issued and
      outstanding as adjusted (1) ..................................          65               71
    Additional paid-in capital .....................................      49,583          108,667
   Retained earnings ...............................................      10,341           10,341
                                                                        --------         --------
      Total shareholders' equity ...................................      59,989          119,079
                                                                        --------         --------
       Total capitalization ........................................    $ 69,868         $119,079
                                                                        ========         ========
</TABLE>


- -------------------
(1)   Excludes 1,984,547 shares of common stock reserved for issuance upon the
   exercise of stock options and warrants outstanding at December 27, 1998, of
   which 78,513 shares were issued between December 27, 1998 and January 11,
   1999.


                                       14

<PAGE>

                     SELECTED CONSOLIDATED FINANCIAL DATA

The Company derived the statement of income data for the years ended June 30,
1996 and 1997 and June 28, 1998, and balance sheet data as of June 30, 1997 and
June 28, 1998 from the audited financial statements in this prospectus. Those
financial statements were audited by PricewaterhouseCoopers LLP, independent
accountants. The Company derived the statement of income data for the years
ended June 30, 1994 and 1995 and the balance sheet data as of June 30, 1994,
1995 and 1996 from audited financial statements that are not included in this
prospectus. The Company derived the statement of income data for the six months
ended December 28, 1997 and December 27, 1998 and balance sheet data at
December 27, 1998 from the unaudited financial statements included in this
prospectus. The Company's management believes that the unaudited historical
financial statements contain all adjustments needed to present fairly the
information included in those statements, and that the adjustments made consist
of normal recurring adjustments. Historical results are not necessarily
indicative of results of operations to be expected in the future, and the
results for the six months ended December 27, 1998 are not necessarily
indicative of results to be expected for the entire year. The following
selected consolidated financial data should be read in conjunction with the
Company's Consolidated Financial Statements and notes thereto, and with
Management's Discussion and Analysis of Financial Condition and Results of
Operations included elsewhere in this prospectus.


<TABLE>
<CAPTION>
                                                                    YEARS ENDED
                                          ----------------------------------------------------------------
                                            JUNE 30,    JUNE 30,     JUNE 30,     JUNE 30,      JUNE 28,
                                            1994(1)       1995         1996         1997          1998
                                          ----------- ------------ ----------- ------------- -------------
                                                       (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                       <C>         <C>          <C>         <C>           <C>
STATEMENT OF INCOME DATA:
Revenue:
 Product revenue, net ...................   $ 3,534     $  5,989     $ 9,689     $  19,823     $  34,891
 Contract revenue, net ..................     3,956        3,011       3,945         6,535         7,640
 License fee income .....................        --           --       1,423         2,615            --
                                            -------     --------     -------     ---------     ---------
    Total revenue .......................     7,490        9,000      15,057        28,973        42,531
Cost of revenue:                                           
 Product revenue, net ...................        --        4,244       8,411        13,388        21,727
 Contract revenue, net ..................        --        1,773       3,078         5,707         6,252
                                            -------     --------     -------     ---------     ---------
    Total cost of revenue ...............     5,923        6,017      11,489        19,095        27,979
                                            -------     --------     -------     ---------     ---------
Gross profit ............................     1,567        2,983       3,568         9,878        14,552
Operating expenses: .....................                  
 Research and development ...............       712        1,194       1,286         1,826         1,774
 Sales, general and administrative ......     1,740        2,268       2,917         4,301         4,131
Other (income) expense ..................         3           (1)        (11)          639           502
                                            -------     --------     -------     ---------     ---------
Income (loss) from operations ...........      (888)        (478)       (624)        3,112         8,145
Interest income, net ....................       457          461         867           607           730
                                            -------     --------     -------     ---------     ---------
 Income (loss) before income taxes ......      (431)         (17)        243         3,719         8,875
Income tax expense ......................        --           --          --           177         2,600
                                            -------     --------     -------     ---------     ---------
Net income (loss) .......................   $  (431)    $    (17)    $   243     $   3,542     $   6,275
                                            =======     ========     =======     =========     =========
Earnings per share:
 Basic ..................................   $ (0.04)    $   0.00     $  0.02     $    0.28     $    0.49
                                            =======     ========     =======     =========     =========
 Diluted ................................   $ (0.04)    $   0.00     $  0.02     $    0.27     $    0.47
                                            =======     ========     =======     =========     =========
Shares used in per share calculation:
 Basic ..................................    10,337       10,367      11,826        12,455        12,863
                                            =======     ========     =======     =========     =========
 Diluted ................................    10,337       10,367      12,615        13,126        13,493
                                            =======     ========     =======     =========     =========



<CAPTION>
                                               SIX MONTHS ENDED
                                          ---------------------------
                                           DECEMBER 28,  DECEMBER 27,
                                               1997          1998
                                          ------------- -------------
                                           (IN THOUSANDS, EXCEPT PER
                                                  SHARE DATA)
<S>                                       <C>           <C>
STATEMENT OF INCOME DATA:
Revenue:
 Product revenue, net ...................   $  16,369     $  23,525
 Contract revenue, net ..................       3,944         2,792
 License fee income .....................          --            --
                                            ---------     ---------
    Total revenue .......................      20,313        26,317
Cost of revenue:
 Product revenue, net ...................      10,365        11,792
 Contract revenue, net ..................       3,252         2,252
                                            ---------     ---------
    Total cost of revenue ...............      13,617        14,044
                                            ---------     ---------
Gross profit ............................       6,696        12,273
Operating expenses: .....................
 Research and development ...............         920         1,927
 Sales, general and administrative ......       1,985         2,668
Other (income) expense ..................         390           567
                                            ---------     ---------
Income (loss) from operations ...........       3,401         7,111
Interest income, net ....................         332           135
                                            ---------     ---------
 Income (loss) before income taxes ......       3,733         7,246
Income tax expense ......................       1,093         2,029
                                            ---------     ---------
Net income (loss) .......................   $   2,640     $   5,217
                                            =========     =========
Earnings per share:
 Basic ..................................   $    0.21     $    0.41
                                            =========     =========
 Diluted ................................   $    0.20     $    0.39
                                            =========     =========
Shares used in per share calculation:
 Basic ..................................      12,699        12,876
                                            =========     =========
 Diluted ................................      13,522        13,541
                                            =========     =========
</TABLE>




<TABLE>
<CAPTION>
                                                                                                
                                                                     JUNE 30,                   
                                                    -------------------------------------------   JUNE 28,   DECEMBER 27,
                                                       1994      1995       1996        1997        1998         1998
                                                    --------- --------- ----------- ----------- -----------  -------------
                                                                               (IN THOUSANDS)   
<S>                                                 <C>       <C>       <C>         <C>         <C>         <C>
BALANCE SHEET DATA:
Cash and cash equivalents .........................  $ 4,902   $ 3,748   $ 10,162    $ 10,448    $ 17,680      $ 12,769
Working capital ...................................   11,006     9,970     18,596      21,013      27,603        24,383
Total assets ......................................   20,018    20,924     43,796      50,137      72,724        78,103
Long-term debt, including current portion .........       14        --         --          --       8,667        10,000
Shareholders' equity ..............................   19,334    19,504     40,672      45,125      54,865        59,989
</TABLE>


- -------------------
(1)   During this period, the Company did not report cost of revenue by type.

                                       15

<PAGE>


                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ALL STATEMENTS, TREND ANALYSIS AND OTHER INFORMATION CONTAINED IN THE FOLLOWING
DISCUSSION RELATIVE TO MARKETS FOR OUR PRODUCTS AND TRENDS IN REVENUE, GROSS
MARGINS AND ANTICIPATED EXPENSE LEVELS, AS WELL AS OTHER STATEMENTS INCLUDING
WORDS SUCH AS "MAY," "WILL," "ANTICIPATE," "BELIEVE," "PLAN," "ESTIMATE,"
"EXPECT," AND "INTEND" AND OTHER SIMILAR EXPRESSIONS CONSTITUTE FORWARD-LOOKING
STATEMENTS. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO BUSINESS AND
ECONOMIC RISKS AND UNCERTAINTIES, AND OUR ACTUAL RESULTS OF OPERATIONS MAY
DIFFER MATERIALLY FROM THOSE CONTAINED IN THE FORWARD-LOOKING STATEMENTS.
FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT
LIMITED TO THOSE DISCUSSED IN "RISK FACTORS" AS WELL AS OTHER RISKS AND
UNCERTAINTIES REFERENCED IN THIS PROSPECTUS.


OVERVIEW

We are the world leader in developing and manufacturing semiconductor materials
and electronic devices made from SiC. We recognize product revenue at the time
of shipment or in accordance with the terms of the relevant contract. We derive
the largest portion of our revenue from the sale of blue and green LED
products. We offer LEDs at two brightness levels -- high brightness blue and
green products and standard blue products. LED devices are utilized by end
users for automotive backlighting, liquid crystal display ("LCD") backlighting
(including use in wireless handsets), indicator lamps, white light conversion
(as replacements for miniature incandescent bulbs), indoor sign and arena
displays, outdoor full color stadium displays, traffic signals and other
lighting applications. LED products represented 48% of our revenue in both
fiscal 1998 and the first six months of fiscal 1999.

The high brightness products, which were introduced to the market in September
1998 in limited quantities, are currently being integrated into our
manufacturing facility for full production. During the first six months of
fiscal 1999, margins realized on the high brightness products were
substantially lower than those derived from our standard blue LED product, as
the yield was lower than the standard product. Historically, we have
experienced low margins with many new product introductions, and we are working
to make improvements to output and yield during the second half of fiscal 1999.
We anticipate that the high brightness products will contribute greater volumes
as yield improvements are obtained.

We believe that in order to increase market demand for all of our LED products,
we must continue to substantially lower average sales prices. Historically, we
have been successful in achieving lower costs for the standard blue product.
During the remainder of fiscal 1999, we plan to focus on reducing costs through
higher production yields and from higher volumes as fixed costs are spread over
a greater number of units.

We also derive revenue from the sale of advanced materials made from SiC that
are used primarily for research and development. We also sell SiC crystals to
C3, Inc. ("C3"), which incorporates them in gemstone applications. During late
fiscal 1998 and the first six months of fiscal 1999, C3 purchased equipment
from us, which has more than doubled the capacity for the production of
crystals for C3. Sales of advanced materials made from SiC represented 34% of
our revenue in fiscal 1998 and approximately 41% during the first six months of
fiscal 1999.

The balance of our revenue, 18% for fiscal 1998 and 11% for the first six
months of fiscal 1999, is derived from government contract funding. Under
various programs, U.S. Government entities further the development of our
technology by supplementing our research and development efforts. All resulting
technology obtained through these efforts remains our property after the
completion of the contract, subject to certain license rights retained by the
government. Contract revenue includes funding of direct research and
development costs and a portion of our general and administrative expenses and
other operating expenses for contracts under which we expect funding to exceed
direct costs over the life of the contract. For contracts under which we
anticipate that direct costs will exceed amounts to be funded over the life of
the contract (i.e., certain cost-share arrangements), we report direct costs as
research and development expenses with related reimbursements recorded as an
offset to those expenses.


                                       16

<PAGE>

In September 1996, we entered into an agreement with Siemens AG ("Siemens")
under which Siemens agreed to purchase our blue LED chips. In December 1998,
this agreement was amended to provide for additional shipments of LED products,
including our high brightness LEDs, through September 1999. This contract calls
for declining prices based on an increase in the number of units shipped.
Siemens accounted for 40% of our revenue for both fiscal 1998 and the first six
months of fiscal 1999.

We also are party to certain license agreements related to our technology for
the manufacture of blue and green LEDs under which we have received one-time
license fees. Under these license agreements, our obligation to transfer the
licensed technology was completed in the year that the license fee revenue was
recognized.

On September 24, 1997, the Board of Directors changed our fiscal year from the
twelve months ending June 30, to a 52 or 53 week year ending on the last Sunday
in the month of June. Our 1998 fiscal year extended from July 1, 1997 to June
28, 1998.


RESULTS OF OPERATIONS

The following table shows our statement of operations data expressed as a
percentage of total revenue for the periods indicated:



<TABLE>
<CAPTION>
                                                             YEARS ENDED                    SIX MONTHS ENDED
                                                  ---------------------------------   -----------------------------
                                                   JUNE 30,    JUNE 30,    JUNE 30,    DECEMBER 28,    DECEMBER 27,
                                                     1996        1997        1998          1997            1998
                                                  ---------   ---------   ---------   -------------   -------------
<S>                                               <C>         <C>         <C>         <C>             <C>
   Revenue:
    Product revenue, net ......................      64.3%       68.4%       82.0%         80.6%           89.4%
    Contract revenue, net .....................      26.2        22.6        18.0          19.4            10.6
    License fee income ........................       9.5         9.0          --            --              --
                                                    -----       -----       -----         -----           -----
      Total revenue ...........................     100.0       100.0       100.0         100.0           100.0
   Cost of revenue:
    Product revenue, net ......................      55.9        46.2        51.1          51.0            44.8
    Contract revenue, net .....................      20.4        19.7        14.7          16.0             8.6
                                                    -----       -----       -----         -----           -----
      Total cost of revenue ...................      76.3        65.9        65.8          67.0            53.4
                                                    -----       -----       -----         -----           -----
   Gross margin ...............................      23.7        34.1        34.2          33.0            46.6
   Operating expenses:
    Research and development ..................       8.5         6.3         4.2           4.5             7.3
    Sales, general and administrative .........      19.4        14.9         9.6           9.8            10.1
    Other expense .............................        --         2.2         1.2           1.9             2.2
                                                    -----       -----       -----         -----           -----
      Income (loss) from operations ...........      (4.2)       10.7        19.2          16.8            27.0
   Interest income, net .......................       5.8         2.1         1.7           1.6             0.5
                                                    -----       -----       -----         -----           -----
      Income before income taxes ..............       1.6        12.8        20.9          18.4            27.5
   Income tax expense .........................        --         0.6         6.1           5.4             7.7
                                                    -----       -----       -----         -----           -----
      Net income ..............................       1.6%       12.2%       14.8%         13.0%           19.8%
                                                    =====       =====       =====         =====           =====
</TABLE>


     SIX MONTHS ENDED DECEMBER 27, 1998 AND DECEMBER 28, 1997

REVENUE. Revenue increased 30% from $20.3 million in the first six months of
fiscal 1998 to $26.3 million in the first six months of fiscal 1999. This
increase was attributable to an increase in product revenue of 44% from $16.4
million in the first six months of fiscal 1998 to $23.5 million in the first
six months of fiscal 1999. This rise in product revenue was a result of the
128% increase in sales of our LED products in the first six months of fiscal
1999 compared to the first six months of fiscal 1998. Growth in LED volume was
due in part to the introduction of the new high brightness devices, but mostly
was a result of


                                       17

<PAGE>

improvements in the product design of and strong demand for the standard
brightness product. This volume increase was partly offset by a 40% decline in
the average sales price of the standard blue LED chip during this same period.
We believe that in order to increase volume, we must continue to lower average
sales prices.

Revenue attributable to sales of SiC material was 84% higher in the first six
months of fiscal 1999 than in the same period of fiscal 1998 due to a
significant increase in sales to C3 for gemstone applications. During the first
six months of fiscal 1998, C3 was in initial stages of operation; therefore,
unit sales were limited. Revenue from sales of SiC wafers increased 43% in the
first six months of fiscal 1999 as compared to the first six months of fiscal
1998, due to quality improvements in wafers, along with the availability of the
larger two-inch wafer during fiscal 1999. During the first six months of fiscal
1999, sales from our displays business declined 96% over the prior year period
as we have chosen to de-emphasize this product line. Contract revenue received
from U.S. Government agencies declined 29% during the first six months of
fiscal 1999 compared to the first six months of fiscal 1998, as a significant
contract that funded optoelectronic research was exhausted in early fiscal
1999.

GROSS PROFIT. Gross margin climbed to 47% of revenue during the first six
months of fiscal 1999 as compared to 33% during the first six months of fiscal
1998. This increase is predominantly attributable to design and manufacturing
improvements that occurred over the past year resulting in significant
reductions in cost. With the introduction of the new conductive buffer LED
technology in the fourth quarter of fiscal 1998, we were able to significantly
lower costs of production due to fewer manufacturing steps required with the
new chip structure and improved yield. During the first six months of fiscal
1998, we introduced a smaller LED chip size and, in December 1997, we began to
fabricate devices on a larger two-inch wafer. As of December 1997, we were
still in the process of establishing these new manufacturing designs and had
not achieved production efficiency. In addition, the larger two-inch wafer had
not been in full production for much of the period; therefore, average die
yields during the first six months of fiscal 1998 were significantly lower.
Wafer costs for SiC material sales also declined 47% during the first six
months of fiscal 1999 over the comparative period due to more efficient
processes and improved yield.

RESEARCH AND DEVELOPMENT. Research and development expenses increased 109% in
the first six months of fiscal 1999 to $1.9 million from $0.9 million in the
first six months of fiscal 1998. Much of this increase was caused by
significantly higher costs for the initial development of the new high
brightness LED product. We anticipate that internal funding for the development
of new products will continue to grow in future periods, while we believe that
government funding for our development projects will remain constant or
decrease.

SALES, GENERAL AND ADMINISTRATIVE. Sales, general and administrative expenses
increased 34% in the first six months of fiscal 1999 to $2.7 million from $2.0
million in the first six months of fiscal 1998 due primarily to two insurance
events that were recorded in the second quarter of fiscal 1998. As a result of
the dismissal of a securities class action lawsuit in November 1997, we were
reimbursed $0.2 million for costs incurred in connection with the lawsuit. Most
of these expenses were recorded in fiscal 1997. In addition, we received a $0.2
million reimbursement of medical expenses due to a negotiated cost cap in a
partially self-funded insured health plan. As a result of our increased
profitability during the first six months of fiscal 1999 over the first six
months of fiscal 1998, the profit sharing accrual (which is based on 5% of net
income) has also grown $0.2 million. We anticipate that total sales, general
and administrative costs will increase in connection with the growth of our
business; however, we believe that as a percentage of revenue they will remain
constant or possibly decline.

OTHER (INCOME) EXPENSE. Other expense increased 45% to $0.6 million during the
first six months of fiscal 1999 from $0.4 million for the first six months of
fiscal 1998. In the first six months of fiscal 1999, we realized impairments to
leasehold costs as a result of management's decision to move equipment from our
leased facility to our new manufacturing site. This was offset somewhat by
income recognized under our equipment build-out agreement with C3. In 1998, we
sold to C3 equipment manufactured by us at cost plus a reasonable overhead
allocation. The overhead allocation was recorded as "Other income."


                                       18

<PAGE>

INTEREST INCOME, NET. Interest income, net has decreased 59% to $0.1 million in
the first six months of fiscal 1999 from $0.3 million in the first six months
of fiscal 1998 due to interest expense incurred. In November 1997, we obtained
a term loan from NationsBank to fund the acquisition and construction of our
manufacturing facility in Durham, North Carolina. While much of the interest
was capitalized during the last half of fiscal 1998, the majority of the
interest incurred in the first half of fiscal 1999 has been expensed.

INCOME TAX EXPENSE. Income tax expense for the first six months of fiscal 1999
was $2.0 million compared to $1.1 million in the first six months of fiscal
1998. This increase resulted from increased profitability during the first six
months of fiscal 1999 over fiscal 1998. Our effective tax rate during the first
six months of fiscal 1999 was 28% compared to 29% in the first six months of
fiscal 1998.


     FISCAL YEARS ENDED JUNE 28, 1998 AND JUNE 30, 1997 AND 1996

REVENUE. Revenue increased 47% from $29.0 million in fiscal 1997 to $42.5
million in fiscal 1998. A significant portion of the rise was attributable to
the 132% increase in LED volume sold pursuant to an amendment to the purchase
agreement with Siemens. This agreement and two subsequent amendments provided
$6.8 million in additional revenue in fiscal 1998 over fiscal 1997. This
significant increase in volume sold was offset by a 32% decline in our average
sales price per LED sold.

Wafer and other materials revenue increased 110% in fiscal 1998 over fiscal
1997 due to a 29% increase in wafer volume associated with greater interest in
the worldwide research community for SiC-based products, as well as revenues
from C3, which increased 89% in fiscal 1998 over fiscal 1997. C3 activity grew
as a result of the execution in July 1997 of the new supply agreement and
development agreement. Revenues for the displays business increased 37% in
fiscal 1998 over fiscal 1997 due to increased interest among customers for
indoor video displays.

Contract revenue increased 17% to $7.6 million during fiscal 1998 as compared
to fiscal 1997 as a result of a change in the mix of funding from available
contracts. Funding for fiscal 1997 included a higher amount of proceeds
recognized under two cost-share arrangements. For these arrangements, funds are
recorded as a reduction in research and development expense rather than as
contract revenue. As funds associated with these two programs were exhausted
during fiscal 1998, we shifted our resources to programs under a cost-plus or
catalog price arrangement, in which funding is recorded as contract revenue.
Therefore contract revenue was higher in fiscal 1998 than 1997.

Included in revenue for fiscal 1997 is a one-time license fee of $2.6 million.
This license fee was earned pursuant to a License and Technology Transfer
Agreement entered into in September 1996 with Shin-Etsu Handotai Co. Ltd.
("Shin-Etsu"). Pursuant to this agreement, we granted Shin-Etsu a license to
use certain epitaxial and device fabrication process technology for the
manufacture of our blue LED product. We did not record any license fee revenue
during fiscal 1998.

In fiscal 1997, our revenue of $29.0 million represented a 92% increase over
fiscal 1996 revenue of $15.1 million. The most substantial increase in revenue
occurred in the LED product line as a 70% increase in sales was recorded. Much
of this increase was attributable to higher volume stemming from the original
purchase agreement and first amendment with Siemens. Fiscal 1997 was the first
year our LEDs were incorporated into automotive backlighting applications.
During fiscal 1997, wafer sales grew 60% over fiscal 1996 due to a greater
acceptance of SiC material in the marketplace. In addition, the average sales
price per wafer was also increased during fiscal 1997 due to the availability
of higher quality premium wafer products. Revenues for the displays business
increased 76% in fiscal 1997 from fiscal 1996 due to the introduction of the
modules products in that year for indoor arena applications.

Contract revenue grew 66% to $6.5 million in fiscal 1997 over fiscal 1996 due
largely to increased funding from the U.S. Government for certain research
contracts, primarily in the areas of microwave, power, blue laser and basic
material development.

Results for fiscal 1996 include $1.4 million in one-time net license fee
revenue. This license fee was earned pursuant to a development license and
supply agreement entered into with Siemens in October 1995, under which we
granted Siemens a license to use certain technology to manufacture blue and
green LED products.


                                       19

<PAGE>

GROSS PROFIT. Our gross profit increased 47% to $14.6 million in fiscal 1998
over fiscal 1997. Our gross margin was 34% for both fiscal 1998 and fiscal
1997. License fees, which have no corresponding cost, were included in fiscal
1997 results. Without license fee revenue, gross profit would have been $7.3
million or 28% of revenue for fiscal 1997. The overall increase in gross profit
in fiscal 1998 resulted from higher revenue and lower LED and material costs
per unit. The lower LED and wafer costs were recognized due to higher
throughput, which more effectively utilized plant capacity and yield
efficiencies. The greater throughput enabled us to spread fixed cost
investments over a larger volume of product. Greater yield in LED applications
resulted from a combination of a new smaller die size and a new larger two-inch
diameter wafer and in the fourth quarter of fiscal 1998, the introduction of
the conductive buffer technology. Yield was also higher for LED and materials
due to plant processing efficiency and a higher quality of wafer materials used
in these products.

The cost of contract revenue has increased in fiscal 1998 over fiscal 1997 due
to the change in the mix of funding from available contracts. Costs for fiscal
1997 included a higher amount of expenses recognized under two cost-share
arrangements. For these arrangements, costs are recorded as research and
development expenses rather than cost of contract revenue. When funding under
these two contracts was completed in the second quarter of fiscal 1998, all
resources were shifted to cost-plus and catalog priced contracts, where
expenses are recorded as a cost of contract revenue.

In fiscal 1997 as compared to fiscal 1996, our gross margin climbed to 34% from
24%, respectively. License fee revenue, which has no corresponding cost, was
recorded in both years. Without license fees, gross margin would have been 28%
in fiscal 1997 as compared to 16% in fiscal 1996. Higher gross profit recorded
in fiscal 1997 stemmed from significantly improved yields and manufacturing
processes, as compared with fiscal 1996, when we experienced difficulty with
the ramp of LED production due to poor epitaxial yields. These processes were
corrected during the first six months of fiscal 1997.

Contract cost of revenue was significantly higher in fiscal 1997 than fiscal
1996 due largely to increased funding from the U.S. Government for certain
research contracts, primarily in the areas of microwave, power, blue laser and
basic material development.

RESEARCH AND DEVELOPMENT. Research and development costs decreased by 3% to
approximately $1.8 million in fiscal 1998 from approximately $1.8 million in
fiscal 1997 due to a reduction in work performed under two cost-share contracts
to further the blue laser research. Net costs to us for these projects were
$0.3 million and $0.7 million for fiscal 1998 and 1997, respectively. These
cost-share contracts concluded during the first half of fiscal 1998.
Additionally, research and development costs for fiscal 1997 included a
one-time write-off of $0.1 million for the closure of our Eastern European
Division, located in St. Petersburg, Russia.

Research and development spending was higher in fiscal 1997 than fiscal 1996
due to the work performed under the cost-share arrangements. These cost-share
contracts were not in place in fiscal 1996.

SALES, GENERAL AND ADMINISTRATIVE EXPENSES. Sales, general and administrative
expenses decreased 4% to $4.1 million for fiscal 1998 from $4.3 million in
fiscal 1997 due to the receipt of two one-time insurance payments. As a result
of the dismissal in November 1997 of a securities class action lawsuit filed in
October 1996, we were reimbursed $0.2 million from our insurance carrier for
costs incurred in defense of the suit. In addition, as a result of a negotiated
cost cap, we received a $0.2 million reimbursement of medical expenses that
were incurred under a partially self-funded insured health plan. As a
percentage of revenue, these costs have decreased to 10% in fiscal 1998 from
15% in fiscal 1997.

Total sales, general and administrative expenses increased 47% to $4.3 million
in fiscal 1997 from $2.9 million in fiscal 1996 due to higher costs associated
with additional sales personnel to focus the business on gaining new LED
customers, the Shin-Etsu license agreement commission fee of $0.2 million and
greater legal fees in connection with the defense of a securities class action
lawsuit.

OTHER (INCOME) EXPENSE. In fiscal 1998, other expense included a net loss
recorded on the write-down of leasehold improvements associated with a leased
facility in Durham, North Carolina and disposal of certain other fixed assets
and a write-off of $66,000 for the remaining value of goodwill associated with
the


                                       20

<PAGE>

acquisition of the Real Color Displays subsidiary. In addition, we entered into
an agreement with C3 to sell equipment manufactured by us at cost plus a
reasonable overhead allocation. The overhead allocation was recorded as "Other
income;" however, the amount was more than offset by leasehold write-offs
associated with the move to our new facility and other asset disposals. Other
expense for fiscal 1997 was higher than that recorded in fiscal 1998 as large
fixed asset write-downs were recorded as the result of a physical plant
inventory. These write-downs were greater than those recorded in fiscal 1998.

INTEREST INCOME, NET. Interest income, net increased by $0.1 million in fiscal
1998 over fiscal 1997 and decreased by $0.3 million when comparing fiscal 1997
to fiscal 1996 due to higher investable cash balances available in fiscal 1998
and fiscal 1996. Cash balances were higher in fiscal 1998 as we generated
approximately $12.1 million from operations compared to approximately $6.1
million in fiscal 1997. Also, we concluded a private equity placement in
September 1995 that increased available cash in fiscal 1996.

INCOME TAX EXPENSE. Our effective income tax rate increased to 29% for fiscal
1998 from a 5% effective rate during fiscal 1997. The lower rate for fiscal
1997 resulted from the utilization of net operating loss carryforwards. We had
no tax provision in fiscal 1996 as we generated a net operating loss for tax
purposes.


                                       21

<PAGE>

QUARTERLY RESULTS OF OPERATIONS
The following table shows unaudited quarterly results of operations in dollar
amounts and as a percentage of revenue for the periods indicated. We have
prepared this information on a basis consistent with our audited financial
statements and included all adjustments that we consider necessary for a fair
presentation of the information for the periods presented. Results of
operations for any fiscal quarter are not necessarily indicative of results for
any future period.



<TABLE>
<CAPTION>
                                                       THREE MONTHS ENDED
                                          ---------------------------------------------
                                           MARCH 31,  JUNE 30,   SEPT. 28,    DEC. 28,
                                             1997       1997       1997         1997
                                          ---------- --------- ------------ -----------
                                              (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                       <C>        <C>       <C>          <C>
Revenue:
 Product revenue, net ...................  $  5,571  $  6,940   $  8,206      $  8,164
 Contract revenue, net ..................     1,395     1,539      2,001         1,942
                                           --------  --------   --------      --------
  Total revenue .........................     6,966     8,479     10,207        10,106
Cost of revenue:
 Product revenue ........................     3,488     4,691      5,419         4,946
 Contract revenue .......................     1,244     1,245      1,653         1,600
                                           --------  --------   --------      --------
  Total cost of revenue .................     4,732     5,936      7,072         6,546
                                           --------  --------   --------      --------
Gross profit ............................     2,234     2,543      3,135         3,560
Operating expenses:                                                
 Research and development ...............       485       579        394           527
 Sales, general and administrative ......     1,079     1,252      1,140           850
 Other expense (income) .................       204       256         (6)          390
                                           --------  --------   --------      --------
  Income from operations ................       466       456      1,607         1,793
Interest income, net ....................       138       145        164           169
                                           --------  --------   --------      --------
  Income before income taxes ............       604       601      1,771         1,962
Income tax expense (benefit) ............        50      (123)       602           490
                                           --------  --------   --------      --------
 Net income .............................  $    554   $   724   $  1,169      $  1,472
                                           ========  ========   ========      ========
Earnings per share:                                                 
 Basic ..................................  $   0.04   $  0.06   $   0.09      $   0.12
                                           ========  ========   ========      ========
 Diluted ................................  $   0.04   $  0.05   $   0.09      $   0.11
                                           ========  ========   ========      ========
Shares used in per share calculation:                              
 Basic ..................................    12,326    12,455     12,609        12,789
 Diluted ................................    13,056    13,003     13,408        13,636



<CAPTION>
                                                         THREE MONTHS ENDED
                                          ------------------------------------------------
                                           MARCH 29,   JUNE 28,    SEPT. 27,    DEC. 27,
                                             1998        1998        1998         1998
                                          ---------- ----------- ------------ ------------
                                               (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                       <C>        <C>         <C>          <C>
Revenue:
 Product revenue, net ...................  $  8,929   $  9,593     $ 10,720     $ 12,805
 Contract revenue, net ..................     1,742      1,955        1,559        1,233
                                           --------   --------     --------     --------
  Total revenue .........................    10,671     11,548       12,279       14,038
Cost of revenue:
 Product revenue ........................     5,510      5,852        5,415        6,377
 Contract revenue .......................     1,430      1,573        1,207        1,045
                                           --------   --------     --------     --------
  Total cost of revenue .................     6,940      7,425        6,622        7,422
                                           --------   --------     --------     --------
Gross profit ............................     3,731      4,123        5,657        6,616
Operating expenses:
 Research and development ...............       367        487          806        1,121
 Sales, general and administrative ......     1,041      1,105        1,218        1,450
 Other expense (income) .................        31         79          269          298
                                           --------   --------     --------     --------
  Income from operations ................     2,292      2,452        3,364        3,747
Interest income, net ....................       180        217          115           20
                                           --------   --------     --------     --------
  Income before income taxes ............     2,472      2,669        3,479        3,767
Income tax expense (benefit) ............       717        790        1,113          916
                                           --------   --------     --------     --------
 Net income .............................  $  1,755   $  1,879     $  2,366     $  2,851
                                           ========   ========     ========     ========
Earnings per share:
 Basic ..................................  $   0.13   $   0.14     $   0.18     $   0.22
                                           ========   ========     ========     ========
 Diluted ................................  $   0.13   $   0.14     $   0.18     $   0.21
                                           ========   ========     ========     ========
Shares used in per share calculation:
 Basic ..................................    13,028     13,026       12,920       12,832
 Diluted ................................    13,501     13,429       13,249       13,834
</TABLE>




<TABLE>
<CAPTION>
                                                                         THREE MONTHS ENDED
                                         -----------------------------------------------------------------------------------
                                          MARCH 31,  JUNE 30,  SEPT. 28,  DEC. 28,  MARCH 29,  JUNE 28,  SEPT. 27,  DEC. 27,
                                            1997       1997      1997       1997      1998       1998      1998       1998
                                         ---------- --------- ---------- --------- ---------- --------- ---------- ---------
<S>                                      <C>        <C>       <C>        <C>       <C>        <C>       <C>        <C>
Revenue:
 Product revenue, net ..................     80.0%     81.8%      80.4%     80.8%      83.7%     83.1%      87.3%     91.2%
 Contract revenue, net .................     20.0      18.2       19.6      19.2       16.3      16.9       12.7       8.8
                                            -----     -----      -----     -----      -----     -----      -----     -----
   Total revenue .......................    100.0     100.0      100.0     100.0      100.0     100.0      100.0     100.0
Cost of revenue:
 Product revenue .......................     50.1      55.3       53.1      48.9       51.6      50.7       44.1      45.4
 Contract revenue ......................     17.9      14.7       16.2      15.8       13.4      13.6        9.8       7.4
                                            -----     -----      -----     -----      -----     -----      -----     -----
   Total cost of revenue ...............     68.0      70.0       69.3      64.7       65.0      64.3       53.9      52.8
                                            -----     -----      -----     -----      -----     -----      -----     -----
Gross profit ...........................     32.0      30.0       30.7      35.3       35.0      35.7       46.1      47.2
Operating expenses:
 Research and development ..............      7.0       6.8        3.9       5.2        3.4       4.2        6.6       8.0
 Sales, general and administrative .....     15.5      14.8       11.2       8.4        9.8       9.5        9.9      10.3
 Other expense (income) ................      2.9       3.0       (0.1)      3.9        0.3       0.8        2.2       2.1
                                            -----     -----      -----     -----      -----     -----      -----     -----
   Income from operations ..............      6.6       5.4       15.7      17.8       21.5      21.2       27.4      26.8
Interest income, net ...................      2.0       1.7        1.6       1.7        1.7       1.9        0.9       0.1
                                            -----     -----      -----     -----      -----     -----      -----     -----
   Income before income taxes ..........      8.6       7.1       17.3      19.5       23.2      23.1       28.3      26.9
Income tax expense (benefit) ...........      0.7      (1.5)       5.9       4.8        6.7       6.9        9.1       6.5
                                            -----     -----      -----     -----      -----     -----      -----     -----
 Net income ............................      7.9%      8.6%      11.4%     14.7%      16.5%     16.2%      19.2%     20.4%
                                            =====     =====      =====     =====      =====     =====      =====     =====
</TABLE>



                                       22

<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

We have funded our operations to date through sales of equity, bank borrowings
and revenue from product and contract sales. As of December 27, 1998, we had
working capital of approximately $24.4 million, including $13.7 million in cash
and cash equivalents and liquid marketable securities.

Operating activities generated $4.2 million in cash during the first six months
of fiscal 1999. This was attributable primarily to net income of $5.2 million
and other non cash expenses of $3.3 million. These amounts were partly offset
by an increase of $2.0 million in accounts receivable, a $0.9 million rise in
inventory and a $3.1 million decrease in accounts payable.

Most of the $10.4 million of cash used by investing activities in the first six
months of fiscal 1999 was related to expenditures associated with the continued
construction of our new manufacturing facility in Durham, North Carolina. We
also increased manufacturing capacity by adding new equipment to support the
epitaxial deposition and clean room fabrication processes.

The $1.2 million of cash provided by financing activities in the first six
months of fiscal 1999 related primarily to the receipt of $1.8 million and $0.7
million in proceeds from the exercise of stock warrants and stock options from
the Company's employee stock option plan, respectively. In addition, $0.6
million was received from a Director as payment of profits from a short-swing
transaction in our securities and $1.3 million was funded as the final draw
from the long term debt arrangement with NationsBank. We currently have a $10.0
million loan outstanding from NationsBank. This loan is also expected to be
paid off with proceeds from this offering. These cash proceeds were offset by a
$3.2 million cash outlay for the repurchase of our common stock. This stock was
repurchased at an average price of $13.68. The stock warrants exercised were
distributed in connection with our September 1995 private placement and have an
exercise price of $27.23. The remaining 234,575 warrants outstanding as of
December 27, 1998, will expire in September 2000.

We are currently engaged in construction activities related to a new clean room
fabrication facility. We also intend to expand our facility for new crystal
growth and test and packaging areas in calendar 1999. These additions will
allow us to consolidate all LED and wafer manufacturing facilities to one site
with improved manufacturing capabilities. In addition, in order to keep pace
with anticipated growth in LED and wafer sales and provide expanded facilities
for our new microwave product line, we anticipate a second phase of expansion
to facilities and infrastructure to begin in early fiscal 2000. We anticipate
total costs for these expenses to be between $15 and $20 million. Estimates for
equipment costs related to this expansion total between $20 and $25 million. We
plan to fund these capital projects from the proceeds of this offering. In
addition, we are in the process of purchasing a 79-acre site close to our
present facility for $1.5 million. We anticipate that internally generated cash
plus the proceeds of this offering will be sufficient to fund our capital
requirements for the next 12 months.


IMPACT OF THE YEAR 2000

     STATE OF READINESS

We have adopted a Year 2000 compliance plan and formed a team of information
technology professionals assigned to the task of identifying and resolving any
Year 2000 issues that may affect our business. Our compliance plan has four
phases: inventory, assessment, remediation and testing. We have completed an
inventory for all of our computer systems, computer related equipment and
equipment with embedded processors, as well as our products, and are in the
process of assessing those systems. We have completed this assessment with
respect to approximately 80% of our systems and expect to complete our
assessment of the remaining systems by February 1999. In addition, we have
determined that our products are of a nature that they are not subject to
failure as a result of Year 2000 issues. Although we cannot control whether and
how third parties will address the Year 2000 issue, we also are in the process
of contacting critical vendors and suppliers to assess their ability to ensure
smooth delivery of products without disruptions caused by Year 2000 problems.
In the course of our assessment, we have not yet identified any Year 2000
issues that would affect our ability to do business; however, our assessment is
not complete, and there can be no assurance that


                                       23

<PAGE>

there are no Year 2000 issues that may affect us. Once we complete the
assessment phase, we will prioritize and implement necessary repairs or
replacements to equipment and software to achieve Year 2000 compliance. We
expect to complete this phase by March 1999. The final phase will consist of a
testing program for all repairs. We anticipate that all testing will be
completed by April 1999.


     COSTS

We have not prepared estimates of costs to remediate Year 2000 problems;
however, based on currently available information, including the results of our
assessment to date and our replacement schedule for equipment, we do not
believe that the costs associated with Year 2000 compliance will have a
material adverse effect on our business, results of operations or financial
condition.


     YEAR 2000 RISKS

Although we believe that our Year 2000 compliance plan is adequate to address
Year 2000 concerns, there can be no assurance that we will not experience
negative consequences as a result of undetected defects or the non-compliance
of third parties with whom we interact. Furthermore, there can be no assurance
that there will not be a delay in, or increased costs associated with, the
implementation of corrections as the Year 2000 compliance plan is performed,
such as unexpected costs of correcting equipment that has not yet been fully
evaluated. If realized, these risks could result in an adverse effect on our
business, results of operations and financial condition.

We believe that our greatest risk stems from the potential non-compliance of
our suppliers. We depend on a limited number of suppliers for certain raw
materials, components and equipment necessary for the manufacture of our
products. Accordingly, if those suppliers are unable to process or fill our
orders or otherwise interact with us because of Year 2000 problems, we could
experience material adverse effects to our business. We are in the process of
assessing the Year 2000 status of our suppliers and are investigating
alternative sources of supply. As a consequence of our dependence on limited
sources of supply, we generally maintain a significant inventory of certain
critical materials and require suppliers to keep certain amounts of inventory
available for us; however, there can be no assurance that we will have enough
materials on hand to continue production without interruption in the event one
or more of our suppliers experiences Year 2000 problems that affect its (their)
ability to supply us. Any supply chain disruptions would affect our ability to
manufacture our products which could result in material adverse consequences to
our business, results of operations and financial condition.


     CONTINGENCIES

We have not yet developed a contingency plan to address what would happen in
the event we are unable to address the Year 2000 issue. The contingency plan is
expected to be completed after the inquiry of vendors and customers is
completed.


                                       24

<PAGE>

 
                                  BUSINESS

INTRODUCTION

Cree is the world leader in developing and manufacturing semiconductor
materials and electronic devices made from SiC. Using its proprietary compound
semiconductor technology, the Company produces LEDs for use in automotive and
LCD backlighting, indicator lamps, full color LED displays and other lighting
applications. The Company also manufactures SiC crystals used in the production
of unique gemstone products and SiC wafers sold for research directed to
optoelectronics, microwave and power applications. SiC-based compound
semiconductor devices offer significant advantages over competing products
based on silicon, gallium arsenide ("GaAs") and other materials for certain
electronic applications. The Company has new product initiatives based on SiC,
including microwave devices for wireless base stations and radar systems,
larger and clearer crystals for moissanite gemstones, blue laser diodes for
optical storage applications and power devices for power conditioning and
switching and other uses.


BACKGROUND

Most semiconductor devices are fabricated on wafers made from silicon crystals.
Silicon evolved as the dominant semiconductor material because it is relatively
easy to grow into large, single crystals and is suitable for fabricating most
electronic devices. Alternative materials, such as GaAs, have emerged to enable
the fabrication of new devices with characteristics that could not be obtained
using silicon, including certain microwave, LED, laser and other optoelectronic
devices. However, GaAs, silicon and other commercially available semiconductor
materials have certain physical and electronic characteristics that limit their
usefulness in many applications. For example, silicon and GaAs-based
semiconductors are not suitable for the fabrication of short wavelength
optoelectronic devices. In addition, the power handling capabilities of silicon
and GaAs-based microwave transistors can limit the power and performance of
microwave systems used in many commercial and military aerospace applications.
Furthermore, few silicon or GaAs devices can operate effectively at
temperatures above 400|SD F. This is a major limitation in applications such as
advanced electronic systems for high power density electric motors, jet engines
and satellites.

Substantial research and development efforts have been undertaken to explore
the properties of other potential semiconductor materials. These efforts have
identified few candidate materials that are capable of being grown as low
defect single crystals (a requirement in the production of most semiconductors)
which also possess physical and electronic properties that meaningfully
increase device performance over products fabricated from currently available
semiconductor materials. Of the few potential candidates, the properties of SiC
make it an excellent material for extending existing semiconductor device
technology where high power, high temperature or short wavelengths are
important for performance.


SIC OVERVIEW

SiC has many physical characteristics that make the material very difficult to
produce. For example, in a typical semiconductor manufacturing process, the
semiconductor material is grown in single crystal form and sliced into wafers.
The wafers are then polished and chemically etched, coated with a thin film
containing controlled levels of impurities and fabricated into devices. Because
SiC can form many different atomic arrangements and must be grown at process
temperatures above 3,500|SDF, it is difficult to grow large single crystals
that are homogeneous in structure. In addition, the high temperatures required
to grow SiC make the control of impurity levels in SiC crystals and thin films
difficult. "Micropipes," or small diameter holes, may appear in the crystals
during crystal growth, affecting the electrical integrity of the wafer and
reducing the usability of portions of the wafer for certain applications.
Furthermore, slicing and polishing SiC wafers is hindered by the intrinsic
hardness of the material. Similarly, its inherent chemical resistance makes SiC
a difficult material to etch.

Many of the same physical characteristics that make SiC difficult to produce
also make it an excellent material for certain semiconductor applications. The
following characteristics distinguish SiC from


                                       25

<PAGE>

conventional silicon and GaAs-based semiconductor materials, resulting in
significant advantages if production hurdles can be overcome:

 o WIDE ENERGY BANDGAP. Bandgap is the amount of energy required to ionize an
   electron from the valence band to the conduction band. SiC is classified as
   a "wide bandgap" semiconductor material, meaning that more energy is
   required for ionization. Electronic devices made from this material can
   operate more efficiently and at much higher temperatures than devices made
   from other common semiconductor materials.

 o HIGH BREAKDOWN ELECTRIC FIELD. The "breakdown electric field" is the amount
   of voltage per unit distance that a material can withstand and still
   effectively operate as a semiconductor device. SiC has a much higher
   breakdown electric field than silicon or GaAs. This characteristic allows
   SiC devices to operate at much higher voltage levels. Additionally, it
   allows SiC power devices to be significantly smaller while carrying the
   same as or greater power levels than comparable silicon and GaAs-based
   devices.

 o HIGH THERMAL CONDUCTIVITY. SiC is an excellent thermal conductor compared to
   other commercially available semiconductor materials. This feature enables
   SiC-based devices to operate at high power levels and still dissipate the
   excess heat generated.

 o HIGH SATURATED ELECTRON DRIFT VELOCITY. SiC has a "saturated electron drift
   velocity" higher than that of silicon or GaAs. The electron drift velocity
   is the maximum speed at which electrons can travel through a material. This
   characteristic, combined with a high breakdown electric field, allows the
   fabrication of SiC-based microwave transistors that operate at
   significantly higher power levels than current silicon and GaAs-based
   devices.

 o ROBUST MATERIAL. SiC has an extremely high melting point and is one of the
   hardest known materials in the world. SiC is also extremely resistant to
   chemical breakdown and can operate in a hostile environment. As a result, SiC
   can withstand much higher electrical pulses and is much more radiation-
   resistant than silicon or GaAs.

 o GEMOLOGICAL APPEAL. In the gemstone industry, SiC is known as moissanite.
   Its high refractive index and dispersion give it "diamond-like" sparkle or
   fire. In addition, its hardness allows superior faceting and wear
   resistance compared to many gemstone materials.


THE CREE SOLUTION

Through its proprietary technology and over 10 years of development and
manufacturing experience, Cree has succeeded in overcoming difficulties in
processing SiC for commercial use. The Company introduced its first product in
October 1989 and currently is the leading manufacturer of SiC wafers and
SiC-based blue and green LED products in the world. The Company believes that
its proprietary process techniques and the inherent attributes of SiC give
Cree's products significant advantages over competing products for certain
electronic and gemological applications. These advantages include:

 o BLUE AND GREEN LIGHT EMISSION. Cree produces high efficiency blue and green
   LEDs using gallium nitride ("GaN"), a wide bandgap material, and other
   nitrides grown on SiC substrates. The conductive properties of SiC enable
   Cree to fabricate a simpler, smaller LED chip as compared to competing blue
   and green LEDs grown using GaN and related materials on sapphire
   substrates. Cree has also demonstrated and is continuing development of
   GaN-based blue laser diodes grown on SiC. The principal advantages of SiC
   over other substrate materials for blue laser diodes are its high
   electrical and thermal conductivity and its ability to be cleaved,
   providing an excellent surface for laser light emission.

 o ENABLING SUBSTRATE PROPERTIES. The inherent attributes of SiC as a substrate
   enable researchers to work on developing new optoelectronic, microwave and
   power devices that offer significant advantages over competing products and
   which could not be produced as effectively on other substrate materials.
   The Company manufactures SiC wafers for both internal use and sale to
   external development programs to further new product development. The
   Company continues to develop larger substrates with lower defect


                                       26

<PAGE>

   densities, which should drive further device development and strengthen
   SiC's economic advantages in certain applications.

 o GEMSTONE MATERIAL PROPERTIES. Cree manufactures SiC crystals which are used
   to produce moissanite gemstones. The combination of SiC's optical
   properties (high refractive index and dispersion) and robust material
   properties give these gemstones both diamond-like sparkle or fire and
   hardness characteristics. Cree continues to develop larger and higher
   quality SiC crystals for this application.

 o HIGH POWER MICROWAVE OPERATION. The Company has demonstrated SiC microwave
   transistors that can operate at much higher voltages than silicon or GaAs
   because of SiC's high breakdown electric field, allowing much higher power
   operation at high frequencies. Higher power SiC devices can allow the
   fabrication of SiC-based microwave transmitters with less circuit
   complexity and higher total output power. These same advantages exist for
   microwave devices made using GaN on SiC substrates, which can also operate
   at much higher frequencies than SiC-only devices. The Company believes that
   initial applications for its microwave devices now under development will
   be for wireless base stations and radar systems. The high temperature
   capabilities of SiC should also enable future aerospace and defense
   applications.

 o HIGH POWER, HIGH VOLTAGE OPERATION. Cree is developing SiC power diodes and
   switches that are able to operate at higher power densities than currently
   available semiconductor materials because of the much higher breakdown
   electric field of SiC. In addition, Cree believes that its SiC power
   devices will be able to operate with lower resistive losses and lower
   switching losses than those made with silicon or GaAs.


STRATEGY

The Company's strategy is to continue to develop SiC materials and device
technology for use in enabling products and systems. The Company believes that
by supplying its customers with enabling component technology it allows them to
develop and deliver new systems that provide enhanced performance capabilities.
The Company's strategy incorporates the following key elements:

 o GROW REVENUES THROUGH MULTIPLE PRODUCT LINES. The Company has focused its
   technology on six primary product lines -- LEDs, SiC wafers, gemstone
   crystals, microwave devices, power devices and laser diodes. The Company
   generates its current product revenues primarily through the sale of blue
   and green LEDs, SiC wafers and gemstone crystals. The Company plans to
   leverage its enabling materials technology to develop products in the area
   of microwave, power and lasers while continuing to develop new and improved
   products to enhance growth in LEDs, SiC wafers and gemstone crystals.

 o EXPAND CAPACITY AND INFRASTRUCTURE. In order to meet anticipated demand for
   its existing products and to develop and fabricate new products, the
   Company has more than doubled its manufacturing capacity over the last year
   and is preparing to support additional growth over the next several years
   as needed. In November 1997, the Company acquired its present manufacturing
   facility in Durham, North Carolina, a 30-acre site with 172,000 square feet
   of manufacturing, warehouse and office space. The Company is currently in
   the process of completing the build-out of this facility to increase
   capacity, which it expects to finish in July 1999. The Company also intends
   to expand its existing facility, construct new facilities and purchase
   equipment.

 o ENHANCE COMPETITIVE VALUE OF ITS SIC PRODUCTS THROUGH TECHNOLOGICAL
   ADVANCES. The Company believes that it can make existing and future
   products more competitive than alternative non-SiC products through
   continued technological advances. In pursuing this strategy, the Company
   has increased the performance and reduced the cost of its LED chips over
   the last several years by decreasing die size, increasing wafer diameter
   and developing a conductive buffer epitaxial and fabrication process. These
   improvements have resulted in LED chip products which provide a low cost
   solution for numerous high volume applications. The Company is continuing
   SiC development activities to provide improvements in die cost, crystal
   quality and device performance.


                                       27

<PAGE>

PRODUCTS

All of Cree's products are an outgrowth of its SiC technology. Cree continually
pursues technical improvements to its existing products to lower cost and
improve quality. The following chart illustrates the Company's existing
products and user applications:



<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
        PRODUCT                                 USER APPLICATIONS
- --------------------------------------------------------------------------------------
<S>                       <C>
  Blue and green LEDs     o Backlighting, such as automotive dashboards and LCD
                            displays, including wireless handsets
                          o Large area indoor full color displays, such as arena video
                            screens
                          o Large outdoor full color displays
                          o White light products to replace miniature incandescent
                            bulbs, such as those used in automobile map lights
                          o Traffic signals
- --------------------------------------------------------------------------------------
  Wafer products          o Research and development for new semiconductor
                            applications
- --------------------------------------------------------------------------------------
  SiC crystals            o Gemstones
- --------------------------------------------------------------------------------------
</TABLE>


     BLUE AND GREEN LEDS

LEDs are solid-state chips used in miniature lamps in everyday applications
such as indicator lights on printers, computers and other equipment. LEDs
generally offer substantial advantages over small incandescent bulbs, including
longer life, lower maintenance and energy consumption, and smaller space
requirements. Groups of LEDs can make up single or multicolor electronic
displays. Prior to the introduction of Cree's blue LED product in 1989, blue
LEDs could not be produced in volumes necessary for commercialization. Since
then, Cree has developed several generations of blue LED products, including a
more robust conductive buffer chip that is easier to build into lamps and has a
lower unit price than competing products. The commercial availability of the
blue LED, together with red and green, has enabled the development of full
color LED lamps and video displays. Strategies Unlimited, an industry research
firm, has estimated that the market size for LEDs (all colors) was
approximately $1.8 billion in 1997 and has forecast that the blue and green LED
portion of the market will increase from approximately $204 million in 1998 to
approximately $430 million in 2001.

Presently, the Company's blue LED chips are used for backlighting purposes,
such as automotive dashboards and LCD displays, including wireless handsets. In
addition, they are used in office equipment indicator lighting, full color
video display technology, such as arena video replay boards, moving message
advertising and informational signs. The Company's standard blue LED products
are primarily used in indoor applications. In September 1998, the Company
introduced brighter blue and green LEDs that offer a lower cost, highly
efficient LED solution for existing applications that require a higher
brightness. For example, many municipalities throughout the U.S. have already
implemented red LEDs into their traffic signals, but have not previously used
green LEDs due to high cost or unavailability. In addition, the Company
believes that there are a large number of existing applications for green LEDs
using lower efficiency materials technology which could be replaced with Cree's
new higher efficiency green LED products.

In November 1998, Cree announced a new product line built on its existing blue
LED products for use in solid-state white light applications. By passing blue
or ultraviolet LED output through certain conversion materials such as
phosphors or polymers, blue light is converted into white light. Cree is
developing new blue and ultraviolet LEDs designed to maximize conversion
efficiency. The Company anticipates that white light LEDs initially will have
the greatest impact on the market for miniature incandescent lighting, such as
map lights, automobile trunk lights and small flashlights.


     WAFER PRODUCTS

Cree manufactures SiC wafers for sale to corporate, government and university
programs that use SiC for developing electronic components. These customers
utilize the material as the basis for research in optoelectronic, microwave and
high power devices. Each order may be sold as a bare wafer or customized


                                       28

<PAGE>

by adding epitaxial films, depending upon the nature of the customer's
development program. For the past several years, the Company has worked to
improve the quality of its wafers while increasing their size. During fiscal
1998, the Company expanded its capabilities to supply two-inch wafers while
achieving a significant improvement in wafer quality.


     SIC CRYSTALS FOR GEMSTONE APPLICATIONS

Single crystalline SiC has characteristics that are similar to diamond,
including properties relating to hardness and brilliance. Through a proprietary
process, Cree manufactures SiC crystals in near colorless form for use in
gemstones. The Company sells SiC crystals to C3, a company which was founded to
develop gemstone products from SiC crystals. C3 cuts and polishes the product
to fabricate diamond-like gemstones targeted at customers who desire affordable
high quality jewelry. During the first half of fiscal 1999, Cree significantly
expanded crystal growth capacity for C3 to meet increased volume requirements.
The potential for increasing demand depends on Cree's ability to meet C3's
requirements for color, clarity and yield. Consequently, Cree has agreed to
focus development efforts on improving its manufacturing processes to increase
crystal size and volume, as well as to develop crystals with higher quality.
Future demand also is dependent on C3's ability to cut, facet and effectively
market its gemstone products.


PRODUCTS UNDER DEVELOPMENT

The Company believes that the inherent physical characteristics of SiC make it
an excellent material for many new semiconductor applications. The Company is
dedicated to creating new applications using SiC and has products currently
under development in each of the areas described below. The following chart
illustrates the potential user applications for each area of product
development:



<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
         PRODUCT CATEGORY                           POTENTIAL USER APPLICATIONS
- --------------------------------------------------------------------------------------
<S>                                 <C>
  High power radio frequency and    o Communication systems for wireless applications, such as
    microwave devices                 PCS base stations 
                                    o Radar systems   
- --------------------------------------------------------------------------------------
  Power devices                     o Industrial motor controls
                                    o Electric vehicles
                                    o Lighting ballasts
                                    o Factory robotics
                                    o Locomotive applications
                                    o Solid-state power transmission
- --------------------------------------------------------------------------------------
  Blue and ultraviolet lasers       o High density optical storage, such as CD-ROMs and DVDs
- --------------------------------------------------------------------------------------
  High temperature devices          o Automotive and aerospace electronics
- --------------------------------------------------------------------------------------
</TABLE>


     HIGH POWER RADIO FREQUENCY AND MICROWAVE DEVICES

The Company is currently developing SiC-based high power transistors that
operate at radio and microwave frequencies. The Company believes these devices
will have applications in wireless phone base stations, high power solid-state
broadcast systems for television and radio, and radar search and detection
equipment.

Cree is continuing to develop a SiC-based device for use in base stations for
wireless systems. This device can be used for frequency band applications
beginning at 1.8 gigahertz, such as personal communications system ("PCS") base
station networks. The Company believes that SiC transistors will be superior to
current silicon and GaAs-based devices due to greater output power per
transistor. The higher output power available from SiC devices is expected to
allow wireless systems to use fewer transistors per base station resulting in
less complex circuitry and lower cost. In addition, SiC's ability to dissipate
heat more rapidly than other materials reduces the need for costly cooling
equipment. The Company currently anticipates releasing its first product
designed for use in microwave applications during fiscal 1999 for shipment in
the first half of fiscal 2000.

Cree is also developing GaN-based microwave transistors on SiC substrates that
are targeted for higher frequency applications (10 to 30 gigahertz). During
fiscal 1998, the Company reported the demonstration of GaN on SiC transistors
that, although low in total output power, operated at a power density of 6.8
watts per


                                       29

<PAGE>

millimeter at 10 gigahertz. The Company believes this power density is the
highest publicly reported for a solid-state field-effect transistor operating
at radio or microwave frequency and is substantially higher than that achieved
with equivalent silicon or GaAs-based devices. The Company does not anticipate
that a commercial device capable of emitting power at this level will be
available in the near term.


     POWER DEVICES

The Company is developing prototype high power devices that have many potential
uses. Such devices could be employed in applications involving power
conditioning as well as power switching. SiC-based power devices have the
potential to handle significantly higher power densities than existing
silicon-based devices. In addition, SiC devices are expected to operate at
significantly higher temperatures and voltages with superior switching
capabilities. These devices are expected to yield substantial power savings due
to reductions in energy losses made possible by the devices' high efficiency.
Potential applications include power drive components for electric vehicles,
lighting ballast components, industrial motor controls and power conditioning
for high voltage power transmission. The Company recently entered into a
three-year project with Kansai Electric Power Company, one of the largest power
companies in the world, for development of SiC-based devices for use in power
transmission networks.


     BLUE AND ULTRAVIOLET LASER DIODES

The Company continues to focus on the development of blue and ultraviolet laser
diodes. SiC's inherent attributes, including its natural cleavability and high
thermal conductivity, make it an excellent material for blue laser
applications. The storage capacity of optical disk drives can be increased
significantly by utilizing a laser diode capable of emitting short wavelength
light. The Company has demonstrated a laser diode fabricated from GaN and
related materials deposited on SiC substrates that emits blue light, which has
a shorter wavelength than that of the red or infrared lasers used today. The
Company believes that the shorter wavelength of blue light could potentially
result in storage capacity for optical disk drives that is significantly
greater than the capacity permitted by red light. This increased storage
capacity could lead to advances in CD-ROM data storage and audio and video
compact disc applications. Currently, the Company is the only U.S.-based
company to have demonstrated the continuous wave operation of a blue laser
diode at room temperature; however, there is still substantial work needed to
produce a blue laser suitable for commercial applications.


     HIGH TEMPERATURE DEVICES

In certain applications for microwave and power devices, the ability of SiC to
operate at higher temperatures than comparable silicon devices can be a major
advantage. Thus, Cree is currently developing high temperature versions of
these devices. These devices would be used for applications in high temperature
environments or environments with limited cooling or heat sinking, including
potential applications in the automotive, energy and aerospace industries. Cree
is also working on high temperature analog and digital circuits that could be
used to amplify low level sensor signals directly in a jet engine or other high
ambient temperature environment. Such devices could also find use in
applications such as down hole drilling equipment. Although Cree has developed
prototype devices, additional development work is needed to achieve commercial
viability.


RESEARCH AND DEVELOPMENT

The Company believes that its ability to maintain its position as a leading
supplier of SiC material and SiC-based semiconductor products, and to expand
the markets for such products, will depend in large part on its ability to
enhance existing products and to continue developing new products incorporating
the latest improvements in SiC technology. Accordingly, the Company is
committed to investing significant resources in research and development.

The Company continually conducts research aimed at improving the quality of its
crystals and wafers and enhancing its epitaxial film deposition (wafer coating)
process. Cree believes that these research and development efforts will benefit
all of the Company's products. The Company believes it can increase the


                                       30

<PAGE>

diameter of its wafers while lowering manufacturing costs and permitting the
development of more complex devices. The key determinants that will enable the
manufacture of more complex devices, such as power semiconductors, are the
substrate quality and wafer size. Epitaxial thickness, lower defect density and
the elimination of variation are important factors to yield improvement,
marketability and lower cost. In moving to larger wafer sizes, the Company is
focusing on how to stabilize the process to repeatedly grow larger diameter
crystals with minimal defects. The two-inch wafer size, which Cree introduced
in fiscal 1998, is considered a minimum standard for many niche fabrication
facilities. Cree also has begun development of three-inch and larger wafer
sizes.

During fiscal years 1998, 1997 and 1996, the Company spent $8.6 million, $9.7
million and $6.3 million, respectively, for direct expenditures relating to
research and development activities. Offsetting these expenditures were $8.2
million, $8.7 million and $5.9 million, respectively, of U.S. Government
funding for direct and indirect research and development expenses. In addition,
certain customers have also sponsored research activities related to the
development of new products. During fiscal years 1998 and 1997, customers spent
$3.5 million and $66,000, respectively, for product research and development
activities. In fiscal 1996, customers did not provide significant funding for
research activities.


SALES AND MARKETING

The Company actively markets its products through targeted mailings,
telemarketing, select advertising and attendance at trade shows. The Company
generally uses an executive sales approach, relying predominantly on the
efforts of senior management and a small direct sales staff for worldwide
product sales. The Company believes that this approach is preferable in view of
its current customer base and product mix, particularly since the production of
lamp and display products incorporating LED chips is concentrated among a
relatively small number of manufacturers. However, the Company departs from
this approach for sales to certain Asian countries. In Japan, the Company
markets its LED products and SiC wafers through its distributors Sumitomo
Corporation ("Sumitomo") and Shin-Etsu. The Company also uses sales
representatives to market its LED products in Hong Kong, China and Korea. The
Company sells SiC crystal materials for use in gemstone applications directly
to C3 under an exclusive supply agreement.


MANUFACTURING AND FACILITIES

The Company operates its own facilities in Durham, North Carolina. Direct
control over SiC crystal growth, wafering, epitaxial deposition, device
fabrication and test operations allows the Company to shorten its product
design and production cycles and to protect its proprietary technology and
processes. In November 1997, the Company acquired its present manufacturing
facility, a 30-acre industrial site in Durham, North Carolina, consisting of a
139,000 square foot production facility and 33,000 square feet of service and
warehouse buildings. The Company is currently in the process of completing the
build-out of this facility to increase capacity. The Company is also in the
process of purchasing a 79-acre site close to its present facility for $1.5
million. The Company anticipates that any additional expansion of capacity in
the near future will occur on these two sites.

The Company currently leases space for some of its manufacturing and research
and development facilities which occupy 21,900 square feet and 3,800 square
feet, respectively, in the same building in Durham, North Carolina. These
leases expire in December 2001 and May 1999, respectively. In addition, the
Company also leases approximately 13,200 square feet in a separate building in
Durham, North Carolina which is used for its device fabrication and test
processes. This lease expires in August 2000.

The Company's products are manufactured in a six-part process which includes:
SiC crystal growth, wafer slicing, polishing, epitaxial deposition,
fabrication, and testing and packaging. SiC crystals are grown using a
proprietary high temperature process designed to produce uniform crystals in a
single crystalline form. Crystals used for moissanite gemstones exit the
manufacturing process at this stage. Crystals used for other products are then
sliced into wafers. The wafers are polished and then processed using the
Company's proprietary epitaxial deposition technology, which essentially
consists of growing a thin layer of SiC, GaN or other material on the polished
wafer, depending on the nature of the device under production. SiC wafer


                                       31

<PAGE>

products may leave the manufacturing process either after polishing or epitaxy.
Following epitaxy, LED chips are fabricated in a clean room environment. The
final steps include testing and packaging for shipment to the customer. In
manufacturing its products the Company depends substantially on its
custom-manufactured equipment and systems, some of which is manufactured
internally and some of which the Company acquires from third parties and
customizes itself.

The Company depends on a limited number of suppliers for certain raw materials,
components and equipment used in its SiC products and LEDs, including certain
key materials and equipment used in its crystal growth, wafering, polishing,
epitaxial deposition, device fabrication and device test processes. The Company
generally purchases these limited source items pursuant to purchase orders and
has no guaranteed supply arrangements with its suppliers. In addition, the
availability of these materials, components and equipment to the Company is
dependent in part on the Company's ability to provide its suppliers with
accurate forecasts of its future requirements. The Company endeavors to
maintain ongoing communication with its suppliers to guard against
interruptions in supply and, to date, generally has been able to obtain
adequate supplies in a timely manner from its existing sources. However, any
interruption in the supply of these key materials, components or equipment
could have a significant adverse effect on the Company's operation.


COMPETITION

The semiconductor industry is intensely competitive and is characterized by
rapid technological change, price erosion and intense foreign competition. The
Company believes that it currently enjoys a favorable position in the existing
markets for SiC-based products and materials primarily as a result of its
proprietary SiC-based technology. However, the Company faces actual and
potential competition from a number of established domestic and international
compound semiconductor companies. Many of these companies have greater
engineering, manufacturing, marketing and financial resources than the Company.
 

The Company's primary competition for the blue and green LED products comes
from Nichia Chemical Industries, Ltd., Toyoda Gosei Co. Ltd. and the
Hewlett-Packard Company which currently market blue and green LED products that
are brighter than the Company's high brightness blue and green LED devices.
These companies have historically been successful in the market for outdoor
display applications because of the brightness demands of outdoor displays, as
well as the decreased price sensitivity of the outdoor display market. Cree
believes its brighter blue and green LEDs will enable it to compete
successfully in this market because they can be used in the same applications
at a lower cost than competing products.

The Company believes that it is positioned to take advantage of the larger
indoor display market because of its lower cost and the advantages of its
design. The Company believes that its approach to manufacturing blue and green
LEDs from SiC substrates offers a more cost-effective design and process than
its competitors, who use a sapphire substrate. Cree's smaller chip design
enables the diode to use less material and permits more devices to be
fabricated on each wafer processed, lowering the cost per unit. In addition,
the Company's device enables manufacturers to package the LED on the same
production line as other green and red LEDs, eliminating the need for special
equipment necessary for chips made from sapphire substrates. Furthermore,
Cree's SiC-based devices can withstand a much higher level of electrostatic
discharge ("ESD") than existing sapphire-based products and therefore are more
suitable for applications that require high ESD emission ratings, such as
automotive applications.


PATENTS AND PROPRIETARY RIGHTS

The Company has an exclusive license to 10 U.S. patents from N.C. State, and
holds 43 additional domestic patents of its own or owned jointly. In key
foreign markets, Cree holds exclusive licenses to patents issued on the N.C.
State technology and owns patents issued on Cree applications which are
counterparts to the U.S. patents. The Company also holds licenses or rights to
acquire exclusive licenses to inventions owned by N.C. State, the University of
California and Purdue Research Foundation which are subject to pending patent
applications. Cree has 25 patent applications of its own pending in the U.S.
and also has 85 foreign patent applications pending. In addition to its patent
rights, the Company relies upon proprietary know-how and


                                       32

<PAGE>

trade secrets relating to its manufacturing processes and devices and has
entered into non-disclosure agreements to protect its proprietary technology
with both employees and parties outside of the Company.

The Company earns a material amount of its revenues in overseas markets. While
the Company holds and has applied for patent protection for certain of its
technologies and products in some of these markets, there can be no assurance
that the Company's intellectual property rights will provide adequate
protection in all commercially significant markets.

THE N.C. STATE LICENSE. In 1987, the Company entered into a license agreement
with N.C. State pursuant to which the Company was granted a worldwide, fully
paid, exclusive license to manufacture, use and sell products and processes
covered by the claims of 10 U.S. patent applications filed by N.C. State
relating to SiC materials and SiC-based semiconductor devices, some of which
also have been filed in foreign countries. Ten patents were subsequently issued
with respect to eight of those applications, with expiration dates between 2007
and 2009. Twelve of the foreign filings have been issued with expiration dates
from 2006 through 2013. Included in the licensed patents are patents practiced
by the Company to grow single crystal SiC. The U.S. patent for this process
expires in 2007 and in other markets the comparable patents expire between 2006
and 2012. Under the terms of the license, the U.S. Office of Naval Research has
retained an interest in the licensed technology for certain military
applications.

CREE'S PATENTS. Since its inception, the Company has been granted 43 U.S.
patents of its own or jointly owned. These patents expire between 2008 and
2016. The Company has filed a number of these patent applications in foreign
countries, many of which have been issued. In addition, the Company has, in the
past, entered into joint research and development programs to develop new
SiC-based devices. These efforts have resulted in four jointly-owned patents,
one with Purdue University, two with General Electric Company and one with N.C.
State.

The Company intends to continue to file patent applications in the future, where
appropriate, and to pursue such applications with U.S. and foreign patent
authorities, but the Company cannot be sure that any patents will be issued on
such applications or that the Company patents will not be contested. In the
past, one of the important patents the Company licenses from N.C. State relating
to crystal growth was subject to re-examination in the U.S. but the Company
prevailed in the proceeding. Currently, the corresponding European patent is
being challenged, which means that the Company could lose patent protection in
certain European countries for this particular method. Also, because issuance of
a valid patent does not prevent other companies from using alternative,
non-infringing technology, there can be no assurance that any of the Company's
patents (or patents issued to N.C. State or other parties and licensed to the
Company) will provide significant commercial protection.

Although the Company believes that its products do not infringe on the
proprietary rights of third parties, there can be no assurance that third
parties will not assert infringement claims against the Company in the future
with respect to current or future products or that such assertion may not
require the Company to enter into royalty arrangements, prevent the Company
from selling products, or result in protracted or costly litigation.

Because of rapid technological developments in the semiconductor industry, the
patent position of any semiconductor device manufacturer, including that of the
Company, is subject to uncertainties and may involve complex legal and factual
issues. Consequently, although the Company holds certain patents, is licensed
under other patents, and is currently pursuing additional patent applications,
there can be no assurance that patents will be issued from any pending
applications or that claims allowed by any existing or future patents issued or
licensed to the Company will not be challenged, invalidated, or circumvented,
or that any rights granted under such patents will provide adequate protection
to the Company.


EMPLOYEES

As of December 27, 1998, the Company employed 297 people, including 214 in
manufacturing operations, 51 in research and development, and 32 in sales and
general administration. None of the Company's employees is represented by a
labor union or subject to collective bargaining agreements. The Company
believes relations with its employees are strong.


                                       33

<PAGE>

                                  MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The executive officers and Directors of the Company are as follows:



<TABLE>
<CAPTION>
                     NAME                        AGE                              POSITION
- ---------------------------------------------   -----   -----------------------------------------------------------
<S>                                             <C>     <C>
   F. Neal Hunter (1) .......................    36     Chairman and Chief Executive Officer
   Charles M. Swoboda .......................    32     President and Chief Operating Officer
   Calvin H. Carter, Jr., Ph.D. (2) .........    43     Executive Vice President, Director of Materials Technology
                                                        and Director
   Cynthia B. Merrell .......................    38     Chief Financial Officer and Treasurer
   John W. Palmour, Ph.D. ...................    38     Director and Director of Advanced Devices
   James E. Dykes (1)(3) ....................    61     Director
   Michael W. Haley (2)(3) ..................    60     Director
   Walter L. Robb, Ph.D (3). ................    70     Director
   Dolph W. von Arx (1)(2)(3) ...............    64     Director
</TABLE>


- -------------------
(1)   Member of Executive Committee
(2)   Member of Audit Committee
(3)   Member of Compensation Committee


MR. HUNTER, a co-founder of the Company, has served as Chairman of the
Company's Board of Directors since 1995, as the Company's Chief Executive
Officer since 1994 and as a Director since the Company's inception in 1987. Mr.
Hunter also served as President from 1994 until January 14, 1999. Prior to his
election as President and Chief Executive Officer in 1994, Mr. Hunter served as
Vice President of Marketing with responsibility for the management of the
Company's optoelectronic products and as the Company's Secretary and Treasurer.
He received a B.S. degree in mechanical engineering from N.C. State.

MR. SWOBODA became President effective January 14, 1999 and has served as Chief
Operating Officer of the Company since June 1997. Prior to becoming President,
Mr. Swoboda also held the title of Vice President since June 1997. Mr. Swoboda
joined the Company in 1993 and served as the Company's Operations Manager from
July 1996 to June 1997, as Wafer Fab Manager from April 1996 to July 1996, as
General Manager of the Company's subsidiary, Real Color Displays, Inc., from
August 1994 to April 1996 and as LED Product Manager from July 1993 to August
1994. Prior to 1993, he was employed by Hewlett-Packard Company, an electronics
company. Mr. Swoboda received a B.S. degree in electrical engineering from
Marquette University.

DR. CARTER, a co-founder of the Company, has served as a Director and Vice
President since Cree's inception. He currently holds the positions of Executive
Vice President and Director of Materials Technology. As Director of Materials
Technology, Dr. Carter is responsible for the Company's development of advanced
materials growth technology, including the growth of SiC material for
semiconductor and other applications. He previously served as Vice President,
New Product Development from 1995 to 1997 and as Director of Technology from
1987 to 1995. Dr. Carter holds B.S., M.S. and Ph.D. degrees in materials
science and engineering from N.C. State.

MS. MERRELL was named Chief Financial Officer and Treasurer effective July 1998
after serving as the Company's Interim Chief Financial Officer and Assistant
Treasurer since January 1998. Ms. Merrell joined the Company in 1996, initially
serving as its Controller. From January 1992 to November 1996 she was employed
as the controller of Kaset International, a subsidiary of The Times Mirror
Company engaged in providing training, consulting and project management
services in the field of customer relations. Ms. Merrell's prior financial
experience includes service in various capacities with Tropicana Products, Inc.
and the accounting firm of Arthur Andersen & Co. She received a B.S. degree in
accounting from the University of Florida and is licensed as a Certified Public
Accountant in Florida.


                                       34

<PAGE>

DR. PALMOUR, a co-founder of the Company, currently serves as Director of
Advanced Devices and, in that capacity, is responsible for the Company's
development of advanced SiC devices such as microwave transistors and power
devices. Dr. Palmour has served as a Director of the Company since October 1995
and previously served on the Company's Board of Directors from October 1992 to
April 1993. During the period from 1993 to 1995 that Dr. Palmour was not a
Director, he continued to be employed by the Company. Dr. Palmour received his
B.S. and Ph.D. degrees from N.C. State in the fields of materials science and
engineering.

MR. DYKES became a Director of the Company in January 1992. He served as
Executive Vice President of Thomas Group, Inc., a publicly held management
consulting group, from July 1997 through June 1998 and from 1994 to 1997 served
as President and Chief Executive Officer of Intellon Corp., a privately held
start-up company in the home automation industry. From January 1989 until his
retirement in December 1992, Mr. Dykes served as President and Chief Executive
Officer of Signetics Company, a subsidiary of North American Philips
Corporation. Mr. Dykes received a B.S. degree in electrical engineering from
the University of Florida. He is currently a director of EXAR Corporation and
Thomas Group, Inc.

MR. HALEY became a Director of the Company in April 1989. He serves as Chairman
and Chief Executive Officer of Triton Management Company based in Greensboro,
North Carolina, which previously owned and operated 60 restaurants and has been
engaged principally in investment and property management since the sale of the
restaurants in 1993 and 1996. Mr. Haley graduated from the University of North
Carolina-Chapel Hill, where he received a bachelor's degree in business
administration.

DR. ROBB became a Director of the Company in April 1993. He is currently the
President of Vantage Management, Inc., a consulting and investment firm in
Schenectady, New York. From 1986 through 1992, Dr. Robb served as a Senior Vice
President for Corporate Research and Development for General Electric Company,
a diversified technology company. From 1951 to 1986, he held various other
positions with General Electric Company. Dr. Robb received a B.S. degree from
Pennsylvania State University and M.S. and Ph.D. degrees from the University of
Illinois. All of Dr. Robb's degrees were awarded in chemical engineering. He is
currently a Director of Marquette Medical Systems, Inc., Celgene Corporation,
Neopath, Inc. and Mechanical Technology Incorporated.

MR. VON ARX became a Director of the Company in October 1991. He served as the
Non-Executive Chairman of Morrison Restaurants Inc. from January 1996 to July
1998 and is the former Chairman, President and Chief Executive Officer of
Planters LifeSavers Company, an affiliate of RJR Nabisco, Inc., where he served
in such capacities for four years prior to his retirement in 1991. Mr. von Arx
is a graduate of Washington University, where he received a bachelor's degree.
He is currently a Director of Ruby Tuesday, Inc., International Multifoods
Corporation and MacKenzie Investment Management, Inc.


                                       35

<PAGE>

                            PRINCIPAL SHAREHOLDERS


The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of December 27, 1998, except as
otherwise noted below, and as adjusted to reflect the sale of the shares
offered hereby: (i) by each person known by the Company to own beneficially
more than five percent of the Common Stock; (ii) by each Director; (iii) by
each executive officer; and (iv) by all Directors and executive officers of the
Company as a group. Except as otherwise indicated, the persons or entities
listed below have sole voting and investment power with respect to all shares
of Common Stock owned by them, except to the extent such power may be shared
with a spouse.



<TABLE>
<CAPTION>
                                                                               SHARES OF COMMON          SHARES OF COMMON
                                                                              STOCK BENEFICIALLY        STOCK BENEFICIALLY
                                                                                 OWNED PRIOR                OWNED AFTER
                                                                              TO THE OFFERING(2)          THE OFFERING(2)
                                                                           ------------------------   -----------------------
DIRECTORS AND EXECUTIVE OFFICERS(1)                                           NUMBER       PERCENT       NUMBER       PERCENT
- -----------------------------------                                        ------------   ---------   ------------   --------
<S>                                                                        <C>            <C>         <C>            <C>
   Michael W. Haley (3) ................................................      475,914         3.7%       475,914        3.3%
   Dolph W. von Arx (4) ................................................      314,160         2.4%       314,160        2.2%
   F. Neal Hunter (5) ..................................................      295,786         2.3%       295,786        2.1%
   John W. Palmour, Ph.D. (6) ..........................................      289,500         2.2%       289,500        2.0%
   Calvin H. Carter, Jr., Ph.D. (7) ....................................      256,030         2.0%       256,030        1.8%
   Walter L. Robb, Ph.D. (8) ...........................................      170,000         1.3%       170,000        1.2%
   Charles M. Swoboda (9) ..............................................       58,200           *         58,200          *
   James E. Dykes (10) .................................................       56,000           *         56,000          *
   Cynthia B. Merrell (11) .............................................       12,400           *         12,400          *
   All Directors and executive officers as a group (9 persons) .........    1,927,990        14.3%     1,927,990       13.0%
   5% SHAREHOLDERS
   ---------------                                                        
   Trustees of General Electric Pension Trust (12) .....................    1,279,967         9.9%     1,279,967        9.0%
   Freiss Associates, Inc. (13) ........................................      750,000         5.8%       750,000        5.3%
   D.L. Carlson Investment Group, Inc. (14) ............................      683,995         5.3%       683,995        4.8%
</TABLE>


- -------------------
*    Represents less than one percent.

(1)  Unless otherwise indicated, the address of the Directors and executive
     officers named above is the same as the Company's address at 4600 Silicon
     Drive, Durham, North Carolina 27703.

(2)  Based on 12,919,818 shares of common stock outstanding on December 27, 1998
     and 14,219,818 shares of common stock outstanding immediately after the
     offering. Pursuant to the rules of the Commission, certain shares of Cree's
     common stock which a person has the right to acquire within 60 days
     pursuant to the exercise of stock options and warrants are deemed to be
     outstanding for the purpose of computing beneficial ownership and the
     percentage ownership of that person but are not deemed outstanding for
     purposes of computing the percentage ownership of any other person. All
     Directors and executive officers as a group hold options to purchase an
     aggregate of 587,966 shares of common stock. Unless otherwise noted, the
     Company believes that all persons named in the table have sole voting and
     investment power with respect to all shares of common stock that are
     beneficially owned by them.

(3)  Includes options to purchase 68,000 shares of common stock. Also includes
     20,000 shares held by a charitable foundation of which Mr. Haley is a
     director. Mr. Haley holds shared voting and investment power over these
     shares but disclaims beneficial ownership.

(4)  Includes options to purchase 94,000 shares of common stock. Mr. von Arx
     disclaims voting and investment power over these shares.

(5)  Includes options to purchase 115,786 shares of common stock. 

(6)  Includes options to purchase 66,000 shares of common stock. Also includes
     10,000 shares held by Dr. Palmour's spouse. Dr. Palmour disclaims voting
     and investment power over these shares.

(7)  Includes options to purchase 54,780 shares of common stock. Also includes
     51,030 shares held by members of Dr. Carter's immediate family. Dr. Carter
     disclaims voting and investment power over these shares.

(8)  Includes options to purchase 77,000 shares of common stock. Also includes
     43,000 shares held by a trust of which Dr. Robb is a trustee. Dr. Robb
     holds shared voting and investment power over these shares but disclaims
     beneficial ownership.

(9)  Includes options to purchase 58,000 shares of common stock.

                                       36

<PAGE>

(10) Includes options to purchase 42,000 shares of common stock.

(11) Includes options to purchase 12,400 shares of common stock.

(12) Based upon a Form 13G filed with the Securities and Exchange Commission
     filed February 19,1997. Includes warrants to purchase 12,500 shares of
     common stock. Trustees of General Electric Pension Trust's address is 3003
     Summer Street, Stamford, Connecticut 06904.

(13) Based on a Form 13F filed with the Securities and Exchange Commission for
     the period ended September 30, 1998. Freiss Associates, Inc.'s address is
     3908 Kennett Pike, P.O. Box 4166, Greenville, Delaware 19807.

(14) Based on a Form 13F filed with the Securities and Exchange Commission for
     the period ended September 30, 1998. D.L. Carlson Investment Group, Inc.'s
     address is 101 N. State Street, Concord, New Hampshire 03301.


                                       37

<PAGE>

                             CERTAIN TRANSACTIONS


Pursuant to a supply agreement originally entered into in 1995 and subsequently
amended and restated, the Company has agreed to supply SiC to C3 on an
exclusive basis for use in the fabrication of gemstones, and C3 has agreed to
purchase certain of its requirements for such material from the Company. In
related development agreements executed in July 1997 and January 1998, and
subsequently amended and restated, the Company has agreed to develop improved
processes for manufacturing large volume, colorless SiC material for sale to
C3. In addition, the Company and C3 are parties to an agreement executed in
February 1996 under which the Company supplies certain electronic devices to C3
for use in gemstone testing equipment. During the fiscal year ended June 28,
1998, C3 purchased approximately $4.5 million in products and services from the
Company under these agreements.

The Company and C3 are also parties to an agreement executed in May 1998 under
which C3 purchased certain equipment constructed by the Company which the
Company retains for use in manufacturing SiC crystals for sale to C3. The
purchase price of the equipment was based on the Company's costs plus a
reasonable allocation of overhead, subject to an agreed maximum price of $3.4
million. Under the terms applicable to the purchase, C3 is obligated to
transfer title to the equipment to the Company once it is fully depreciated.

Certain of the Company's Directors and executive officers own approximately
169,000 shares of C3 common stock, representing less than 2.3% of C3's
outstanding common stock. In addition, C. Eric Hunter and Jeff N. Hunter,
brothers of Cree's Chairman and Chief Executive Officer, F. Neal Hunter,
beneficially own approximately 18% of the outstanding common stock of C3. Jeff
Hunter is the Chairman and Chief Executive Officer of C3. The Company also owns
less than 1% of the outstanding shares of common stock of C3.


                                       38

<PAGE>

                                 UNDERWRITING


The Company has entered into an underwriting agreement with the underwriters
named below. CIBC Oppenheimer Corp., Prudential Securities Incorporated and
Morgan Keegan & Company, Inc. are acting as representatives of the
underwriters.

The underwriting agreement provides for the purchase of a specific number of
shares of common stock by each of the underwriters. The underwriters'
obligations are several, which means that each underwriter is required to
purchase a specified number of shares, but is not responsible for the
commitment of any other underwriter to purchase shares. Subject to the terms
and conditions of the underwriting agreement, each underwriter has severally
agreed to purchase the number of shares of common stock set forth opposite its
name below:



<TABLE>
<CAPTION>
UNDERWRITER                                        NUMBER OF SHARES
- -----------                                        ----------------
<S>                                               <C>
   CIBC Oppenheimer Corp. .....................
   Prudential Securities Incorporated .........
   Morgan Keegan & Company, Inc. ..............
       Total ..................................
                                                  -----------------
                                                  =================
</TABLE>


This is a firm commitment underwriting. This means that the underwriters have
agreed to purchase all of the shares offered by this prospectus (other than
those covered by the over-allotment option described below) if any are
purchased. Under the underwriting agreement, if an underwriter defaults in its
commitment to purchase shares, the commitments of non-defaulting underwriters
may be increased or the underwriting agreement may be terminated, depending on
the circumstances.

The representatives have advised Cree that the underwriters propose to offer the
shares directly to the public at the public offering price that appears on the
cover page of this prospectus. In addition, the representatives may offer some
of the shares to certain securities dealers at such price less a concession of 
$    per share. The underwriters may also allow, and such dealers may reallow, a
concession not in excess of $    per share to certain other dealers. After the
shares are released for sale to the public, the representatives may change the
offering price and other selling terms at various times.

The Company has granted the underwriters an over-allotment option. This option,
which is exercisable for up to 30 days after the date of this prospectus,
permits the underwriters to purchase a maximum of 195,000 additional shares
from the Company to cover over-allotments. If the underwriters exercise all or
part of this option, they will purchase shares covered by the option at the
public offering price that appears on the cover page of this prospectus, less
the underwriting discount. If this option is exercised in full, the total price
to public will be $     , and the total proceeds to the Company will be $     .
The underwriters have severally agreed that, to the extent the over-allotment
option is exercised, they will each purchase a number of additional shares
proportionate to the underwriter's initial amount reflected in the foregoing
table.


                                       39

<PAGE>

The following table provides information regarding the amount of the discount
to be paid to the underwriters by the Company:


                              TOTAL
              -------------------------------------
                                      EXERCISE OF
                WITHOUT EXERCISE       WITH FULL
 PER SHARE     OF OVER-ALLOTMENT     OVER-ALLOTMENT
- -----------   -------------------   ---------------




The Company estimates that its total expenses of the offering, excluding the
underwriting discount, will be approximately $650,000.

The Company has agreed to indemnify the underwriters against certain
liabilities, including liabilities under the Securities Act of 1933.

The Company and its officers and directors have agreed to a 90-day "lock up"
with respect to        shares of common stock and certain other Company
securities that they beneficially own, including securities that are
convertible into shares of common stock and securities that are exchangeable or
exercisable for shares of common stock. This means that, subject to certain
exceptions, for a period of 90 days following the date of this prospectus, the
Company and such persons may not offer, sell, pledge or otherwise dispose of
these securities without the prior written consent of CIBC Oppenheimer Corp.

Rules of the Securities and Exchange Commission may limit the ability of the
underwriters to bid for or purchase shares before the distribution of the
shares is completed. However, the underwriters may engage in the following
activities in accordance with the rules:

 o Stabilizing transactions -- The representatives may make bids or purchases
   for the purpose of pegging, fixing or maintaining the price of the shares,
   so long as stabilizing bids do not exceed a specified maximum.

 o Over-allotments and syndicate covering transactions -- The underwriters may
   create a short position in the shares by selling more shares than are set
   forth on the cover page of this prospectus. If a short position is created
   in connection with the offering, the representatives may engage in
   syndicate covering transactions by purchasing shares in the open market.
   The representatives may also elect to reduce any short position by
   exercising all or part of the over-allotment option.

 o Penalty bids -- If the representatives purchase shares in the open market in
   a stabilizing transaction or syndicate covering transaction, they may
   reclaim a selling concession from the underwriters and selling group
   members who sold those shares as part of this offering.

 o Passive market making -- Market makers in the shares who are underwriters or
   prospective underwriters may make bids for or purchases of shares, subject
   to certain limitations, until the time, if ever, at which a stabilizing bid
   is made.

Stabilization and syndicate covering transactions may cause the price of the
shares to be higher than it would be in the absence of such transactions. The
imposition of a penalty bid might also have an effect on the price of the
shares if it discourages resales of the shares.

Neither the Company nor the underwriters make any representation or prediction
as to the effect that the transactions described above may have on the price of
the shares. These transactions may occur on the Nasdaq National Market or
otherwise. If such transactions are commenced, they may be discontinued without
notice at any time.


                                       40

<PAGE>

                                 LEGAL MATTERS


Certain legal matters in connection with this offering will be passed upon for
the Company by Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P.,
2500 First Union Capitol Center, Raleigh, North Carolina 27601. Certain legal
matters in connection with this offering will be passed upon for the
Underwriters by Hale and Dorr LLP, 60 State Street, Boston, Massachusetts
02109.


                                    EXPERTS


The consolidated balance sheets as of June 30, 1997 and June 28, 1998, and the
consolidated statements of operations, cash flow and shareholders equity for the
two years in the period ended June 30, 1997, and for the year ended June 28,
1998, included in this prospectus have been included herein in reliance on the
report of PricewaterhouseCoopers LLP, independent accountants, given on the
authority of that firm as experts in accounting and auditing.


                                 OTHER MATTERS


In September 1998, the Company retained Ernst & Young LLP as its independent
public accountants and dismissed the Company's former auditors. In connection
with its audits for the two most recent fiscal years prior to dismissal and
through the date of its dismissal, there were no disagreements with the former
auditors on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure which disagreements, if
not resolved to the satisfaction of the former auditors, would have caused it
to make reference to the subject matter of the disagreement in connection with
its report on the financial statements of the Company for such periods. The
former auditors' reports on the Company's financial statements contained no
adverse opinion or disclaimer of opinion and were not qualified or modified as
to uncertainty, audit scope or accounting principles. Prior to retaining Ernst
& Young LLP, the Company had not consulted with Ernst & Young LLP on any
accounting, auditing or reporting matter.


                      WHERE YOU CAN FIND MORE INFORMATION

The Company has filed a registration statement on Form S-3 with the Securities
and Exchange Commission in connection with this offering. In addition, the
Company files annual, quarterly and current reports, proxy statements and other
information with the Securities and Exchange Commission. You may read and copy
the registration statement and any other documents filed by the Company at the
Securities and Exchange Commission's Public Reference Room at 450 Fifth Street,
N.W., Washington, D.C. 20549. Please call the Securities and Exchange
Commission at 1-800-SEC-0330 for further information on the Public Reference
Room. The Company's Securities and Exchange Commission filings are also
available to the public at the Securities and Exchange Commission's Internet
site at "http://www.sec.gov".

This prospectus is part of the registration statement and does not contain all
of the information included in the registration statement. Whenever a reference
is made in this prospectus to any contract or other document of the Company,
the reference may not be complete and you should refer to the exhibits that are
a part of the registration statement for a copy of the contract or document.

The Securities and Exchange Commission allows the Company to "incorporate by
reference" into this prospectus the information the Company files with it,
which means that the Company can disclose important information to you by
referring you to those documents. Information incorporated by reference is part
of this prospectus. Later information filed with the Securities and Exchange
Commission will update and supersede this information.


                                       41

<PAGE>

The Company incorporates by reference the documents listed below and any future
filings made with the Securities and Exchange Commission under Sections 13(a),
13(c), 14 or 15(d) of the Securities Exchange Act of 1934 until this offering
is completed:

     o Annual Report on Form 10-K for the year ended June 28, 1998, as amended
       by Form 10-K/A.

     o Quarterly Report on Form 10-Q for the quarter ended September 27, 1998.

     o Current Report on Form 8-K dated September 21, 1998, as amended by Form
       8-K/A on September 30, 1998.

     o The description of the Company's common stock contained in its
       registration statement on Form 8-A filed with the Commission under
       Section 12 of the Securities Exchange Act of 1934.

You may request a copy of these filings, at no cost, by contacting the Company
at:

      Cree Research, Inc.
      4600 Silicon Drive
      Durham, North Carolina 27703
      Attention: Investor Relations Manager
      Telephone: (919) 313-5300
 

                                       42

<PAGE>

                              CREE RESEARCH, INC.
                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS




<TABLE>
<CAPTION>
                                                                                              PAGE
                                                                                             -----
<S>                                                                                          <C>
   INTERIM FINANCIAL STATEMENTS -- UNAUDITED
    Consolidated Balance Sheets as of June 28, 1998 (audited) and December 27, 1998 ......    F-2
    Consolidated Statements of Income for the six months ended December 28, 1997 and
     December 27, 1998 ...................................................................    F-3
    Consolidated Statements of Cash Flow for the six months ended December 28, 1997 and
      December 27, 1998 ..................................................................    F-4
    Consolidated Statements of Shareholders' Equity for the year ended June 28, 1998
     (audited) and for the six months ended December 27, 1998 ............................    F-5
    Notes to Consolidated Financial Statements ...........................................    F-6
   ANNUAL FINANCIAL STATEMENTS
    Report of Independent Accountants ....................................................   F-12
    Consolidated Balance Sheets as of June 30, 1997 and June 28, 1998 ....................   F-13
    Consolidated Statements of Operations for the years ended June 30, 1996 and 1997, and
      June 28, 1998 ......................................................................   F-14
    Consolidated Statements of Cash Flow for the years ended June 30, 1996 and 1997, and
      June 28, 1998 ......................................................................   F-15
    Consolidated Statements of Shareholders' Equity for the years ended June 30, 1996 and
      1997, and  June 28, 1998 ...........................................................   F-16
    Notes to Consolidated Financial Statements ...........................................   F-17

</TABLE>


 

                                      F-1

<PAGE>

                              CREE RESEARCH, INC.
                          CONSOLIDATED BALANCE SHEETS
                                 (IN THOUSANDS)




<TABLE>
<CAPTION>
                                                                                  JUNE 28,    DECEMBER 27,
                                                                                    1998          1998
                                                                                 ---------   -------------
                                                                                              (UNAUDITED)
<S>                                                                              <C>         <C>
   ASSETS
   Current assets:
    Cash and cash equivalents ................................................    $17,680       $12,769
    Marketable securities ....................................................        657           905
    Accounts receivable, net .................................................     10,479        12,110
    Inventories ..............................................................      2,543         3,402
    Deferred income tax ......................................................      1,952           264
    Prepaid expenses and other current assets ................................      1,347           691
                                                                                  -------       -------
      Total current assets ...................................................     34,658        30,141
    Property and equipment, net ..............................................     36,476        44,972
    Patent and license rights, net ...........................................      1,525         1,641
    Other assets .............................................................         65         1,349
                                                                                  -------       -------
      Total assets ...........................................................    $72,724       $78,103
                                                                                  =======       =======
   LIABILITIES AND SHAREHOLDERS' EQUITY
   Current liabilities:
    Accounts payable, trade ..................................................    $ 5,595       $ 4,097
    Current maturities of long term debt .....................................         17           121
    Accrued salaries and wages ...............................................        391           550
    Other accrued expenses ...................................................      1,052           990
                                                                                  -------       -------
      Total current liabilities ..............................................      7,055         5,758
   Long term liabilities:
    Long term debt ...........................................................      8,650         9,879
    Deferred income tax ......................................................      2,154         2,477
                                                                                  -------       -------
      Total long term liabilities ............................................     10,804        12,356
   Shareholders' equity:
    Preferred stock, par value $0.01; 2,750 shares authorized at June 28, 1998
      and 3,000 shares authorized at December 27, 1998; none issued and
      outstanding ............................................................         --            --
    Common stock, $0.005 par value; 14,500 shares authorized at June 28,
      1998 and 30,000 shares authorized at December 27, 1998; shares issued
      and outstanding 12,989 and 12,920 at June 28, 1998 and December 27,
      1998, respectively .....................................................         65            65
    Additional paid-in-capital ...............................................     49,676        49,583
    Retained earnings ........................................................      5,124        10,341
                                                                                  -------       -------
      Total shareholders' equity .............................................     54,865        59,989
                                                                                  -------       -------
       Total liabilities and shareholders' equity ............................    $72,724       $78,103
                                                                                  =======       =======
</TABLE>


   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                      F-2

<PAGE>

                              CREE RESEARCH, INC.
                       CONSOLIDATED STATEMENTS OF INCOME
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)




<TABLE>
<CAPTION>
                                                        SIX MONTHS ENDED
                                                  -----------------------------
                                                   DECEMBER 28,    DECEMBER 27,
                                                       1997            1998
                                                  -------------   -------------
                                                           (UNAUDITED)
<S>                                               <C>             <C>
   Revenue:
    Product revenue, net ......................     $ 16,369        $ 23,525
    Contract revenue, net .....................        3,944           2,792
                                                    --------        --------
      Total revenue ...........................       20,313          26,317
   Cost of revenue:
    Product revenue ...........................       10,365          11,792
    Contract revenue ..........................        3,252           2,252
                                                    --------        --------
      Total cost of revenue ...................       13,617          14,044
                                                    --------        --------
   Gross profit ...............................        6,696          12,273
   Operating expenses:
    Research and development ..................          920           1,927
    Sales, general and administrative .........        1,985           2,668
    Other expense .............................          390             567
                                                    --------        --------
      Income from operations ..................        3,401           7,111
   Interest income, net .......................          332             135
                                                    --------        --------
      Income before income taxes ..............        3,733           7,246
   Income tax expense .........................        1,093           2,029
                                                    --------        --------
      Net income ..............................     $  2,640        $  5,217
                                                    ========        ========
   Earnings per share:
      Basic ...................................     $   0.21        $   0.41
                                                    ========        ========
      Diluted .................................     $   0.20        $   0.39
                                                    ========        ========
   Shares used in per share calculation:
      Basic ...................................       12,699          12,876
                                                    ========        ========
      Diluted .................................       13,522          13,541
                                                    ========        ========
</TABLE>


   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                      F-3

<PAGE>

                              CREE RESEARCH, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOW
                                 (IN THOUSANDS)



<TABLE>
<CAPTION>
                                                                                  SIX MONTHS ENDED
                                                                            -----------------------------
                                                                             DECEMBER 28,    DECEMBER 27,
                                                                                 1997            1998
                                                                            -------------   -------------
<S>                                                                         <C>             <C>
                                                                                      (UNAUDITED)
   Operating activities:
    Net income ..........................................................     $  2,640        $   5,217
    Adjustments to reconcile net income to net cash provided by operating
      activities:
      Depreciation and amortization .....................................        2,067            2,341
      Loss on disposal of property, equipment and patents ...............          320              951
      Amortization of patent rights .....................................           50               56
      Amortization and write off of goodwill ............................           86               --
      Proceeds from sale of marketable trading securities ...............           --              489
      Purchase of marketable trading securities .........................       (1,500)            (232)
      Gain on marketable trading securities .............................           --             (116)
      Changes in operating assets and liabilities:
      Accounts receivable ...............................................       (2,258)          (1,964)
      Inventories .......................................................        1,161             (859)
      Prepaid expenses and other assets .................................          148            1,004
      Accounts payable, trade ...........................................         (783)          (3,073)
      Accrued expenses ..................................................          889              420
                                                                            ----------        ---------
      Net cash provided by operating activities .........................        2,820            4,234
                                                                            ----------        ---------
   Investing activities:
    Purchase of property and equipment ..................................       (5,704)         (10,380)
    Proceeds from sale of property and equipment ........................          340              189
    Purchase of patent rights ...........................................         (200)            (194)
                                                                            ----------        ---------
       Net cash used in investing activities ............................       (5,564)         (10,385)
                                                                            ----------        ---------
   Financing activities:
    Proceeds from issuance of long-term debt ............................        3,259            1,333
    Net proceeds from issuance of common stock ..........................        2,139            2,527
    Receipt of Section 16(b) common stock profits .......................           --              594
    Repurchase of common stock ..........................................           --           (3,214)
                                                                            ----------        ---------
       Net cash provided by financing activities ........................        5,398            1,240
                                                                            ----------        ---------
   Net increase (decrease) in cash and cash equivalents .................        2,654           (4,911)
   Cash and cash equivalents:
    Beginning of period .................................................       10,448           17,680
                                                                            ----------        ---------
    End of period .......................................................     $ 13,102        $  12,769
                                                                            ==========        =========
   Supplemental disclosure of cash flow information:
    Cash paid for interest, net of amounts capitalized ..................     $     --        $     275
                                                                            ==========        =========
    Cash paid for income taxes ..........................................     $    219        $   1,396
                                                                            ==========        =========
</TABLE>


The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                      F-4

<PAGE>

                              CREE RESEARCH, INC.
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
      YEAR ENDED JUNE 28, 1998 AND THE SIX MONTHS ENDED DECEMBER 27, 1998
                                 (IN THOUSANDS)



<TABLE>
<CAPTION>
                                                             COMMON    ADDITIONAL                               TOTAL
                                                             STOCK      PAID-IN     RETAINED     TREASURY   SHAREHOLDERS'
                                                           PAR VALUE    CAPITAL     EARNINGS      STOCK        EQUITY
                                                          ----------- ----------- ------------ ----------- --------------
<S>                                                       <C>         <C>         <C>          <C>         <C>
Balance at June 30, 1997 -- (audited) ...................    $62       $ 46,214     $ (1,151)   $     --      $ 45,125
Common stock options exercised for cash, 217
 shares .................................................      1          1,693           --          --         1,694
Common stock warrants exercised for cash, 331
 shares .................................................      2          1,240           --          --         1,242
Purchase of common stock for the treasury, 82
 shares .................................................     --             --           --      (1,262)       (1,262)
Retirement of 82 treasury shares ........................     --         (1,262)          --       1,262
Income tax benefits from stock option exercises .........     --          1,791           --          --         1,791
Net income ..............................................     --             --        6,275          --         6,275
                                                             -----     --------     --------    --------      --------
Balance at June 28, 1998 -- (audited) ...................     65         49,676        5,124          --        54,865
Common stock options exercised for cash, 100
 shares .................................................      1            745           --          --           746
Common stock warrants exercised for cash, 72
 shares .................................................     --          1,781           --          --         1,781
Receipt of Section 16(b) common stock profits ...........     --            594           --          --           594
Purchase and retirement of 235 treasury shares ..........     (1)        (3,213)          --          --        (3,214)
Net income ..............................................     --             --        5,217          --         5,217
                                                             -----     --------     --------    --------      --------
Balance at December 27, 1998 -- (unaudited) .............    $65       $ 49,583     $ 10,341    $     --      $ 59,989
                                                             =====     ========     ========    ========      ========
</TABLE>


The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                      F-5

<PAGE>

                              CREE RESEARCH, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


BASIS OF PRESENTATION

The consolidated balance sheet as of December 27, 1998, the consolidated
statements of income for the six months ended December 28, 1997 and December
27, 1998, the consolidated statements of cash flow for the six months ended
December 28, 1997 and December 27, 1998, and the consolidated statement of
shareholders' equity for the six months ended December 27, 1998 have been
prepared by the Company and have not been audited. In the opinion of
management, all normal and recurring adjustments necessary to present fairly
the financial position, results of operations and cash flows at December 27,
1998, and all periods presented, have been made.

Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested that these condensed financial
statements be read in conjunction with the financial statements and notes
thereto included elsewhere herein. The results of operations for the period
ended December 27, 1998 are not necessarily indicative of the operating results
that may be attained for the entire fiscal year.


ACCOUNTING POLICIES

     FISCAL YEAR

The Company's fiscal year is a 52 or 53 week period ending on the last Sunday
in the month of June. Accordingly, all quarterly reporting reflects a 13 week
period in fiscal 1999. In fiscal 1998, the Company changed its fiscal year from
the twelve months ending June 30, to the 52 week period ending on the last
Sunday in the month of June. The Company's current fiscal year will extend from
June 29, 1998 to June 27, 1999.


     INVESTMENTS

Investments are accounted for in accordance with Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" ("SFAS 115"). This statement requires certain securities to
be classified into three categories:

       (1) Securities Held-to-Maturity -- Debt securities that the entity has
   the positive intent and ability to hold to maturity are reported at
   amortized cost.

       (2) Trading Securities -- Debt and equity securities that are bought and
   held principally for the purpose of selling in the near term are reported
   at fair value, with unrealized gains and losses included in earnings.

       (3) Securities Available-for-Sale -- Debt and equity securities not
   classified as either securities held-to-maturity or trading securities are
   reported at fair value with unrealized gains and losses excluded from
   earnings and reported as a separate component of stockholders' equity.

The Company's short-term investments are comprised of equity securities that
are classified as trading securities, which are carried at their fair value
based upon quoted market prices of those investments at December 27, 1998, with
net realized and unrealized gains and losses included in net earnings.

As of December 27, 1998, short-term investments consist of common stock
holdings in C3, the majority of which were purchased in November 1997 and
September 1998. The Company's CEO has, through a binding agreement, promised to
indemnify the Company for losses of up to $450,000 for the net difference
between the aggregate cash consideration paid by Cree for the shares of C3
common stock and the cash proceeds received by Cree upon the sale of C3 common
shares. This indemnity covers losses that may result from the sale of shares
purchased in November 1997 and September 1998 below the purchase price paid,
offset by gains realized on shares acquired directly from C3 in January 1997
(see below). Payment of this obligation is due within ten days after receipt by
the CEO of the Company's written demand made pursuant to a vote of the majority
of the members of the Board of Directors other than the CEO. Realized losses on
shares of C3


                                      F-6

<PAGE>

                              CREE RESEARCH, INC.
     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

stock sold by the Company were $254,000 and $46,000, for fiscal 1998 and 1999,
respectively. At December 27, 1998, a net unrealized gain, including shares
acquired directly from C3 (see below), of $383,000 was recognized to bring the
valuation of shares held to market. Therefore, the Company recorded
approximately $116,000 of other income in the six months ended December 27,
1998. Approximately $32,000 of net losses were recorded to other income
(expense) in fiscal 1998. Since the net unrealized gain on shares held exceeded
realized losses on shares sold, there was no receivable recorded from the CEO
as of December 27, 1998.

In addition to the shares of C3 purchased in November 1997 and September 1998,
the Company acquired 24,601 shares of C3 common stock in January 1997. These
shares were issued pursuant to an option C3 granted to the Company in 1995. The
option gave the Company the right to acquire, for an aggregate consideration of
$500, one percent of the outstanding common stock of C3. C3 retained the right
to waive the consideration and issue the stock at any time, which it elected to
do in January 1997. The shares issued pursuant to the option are restricted
securities within the meaning of Rule 144 under the Securities Act of 1933,
which permits the sale of such securities without registration if certain
conditions are met. The shares first became eligible for sale under Rule 144 in
the third quarter of fiscal 1998.


     LONG TERM DEBT

The Company obtained a term loan from a commercial bank of up to $10,000,000 to
finance the purchase and upfit of a production facility and service and
warehouse buildings in November 1997. As of December 27, 1998 the entire
$10,000,000 loan was outstanding, including a current portion of $121,000 and a
long term amount of $9,879,000. The loan, which is collateralized by the
purchased property, accrues interest at a fixed rate of 8% and carries
customary covenants, including the maintenance of a minimum tangible net worth
and other requirements. Accrued interest is due monthly until May 1999, at
which time the outstanding principal balance will be amortized over twenty
years until 2011, when the loan balance becomes due.

During the six months ended December 27, 1998, the Company capitalized interest
on funds used to construct property, plant and equipment in connection with the
facility. Interest capitalized for the six months ended December 27, 1998 was
$118,000.


     INVENTORIES

Inventories are stated at the lower of cost or market, with cost determined
using the first-in, first-out (FIFO) method. Inventories consist of the
following:



<TABLE>
<CAPTION>
                                 JUNE 28,    DECEMBER 27,
                                   1998          1998
                                ---------   -------------
                                     (IN THOUSANDS)
<S>                             <C>         <C>
   Raw materials ............    $  999         $1,338
   Work-in-progress .........       752          1,220
   Finished goods ...........       792            844
                                 ------         ------
    Total Inventory .........    $2,543         $3,402
                                 ======         ======
</TABLE>


     RESEARCH AND DEVELOPMENT ACCOUNTING POLICY

The U.S. Government provides funding for several of the Company's current
research and development efforts. The contract funding may be based on a
cost-plus or a cost-share arrangement. The amount of funding under each
contract is determined based on cost estimates that include direct costs, plus
an allocation for research and development, general and administrative and cost
of capital expenses. Cost-plus funding is determined based on actual costs plus
a set percentage margin. For cost-share contracts, the actual costs are


                                      F-7

<PAGE>

                              CREE RESEARCH, INC.
     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

divided between the U.S. Government and the Company based on the terms of the
contract. The government's cost share is then paid to the Company. Activities
performed under these arrangements include research regarding silicon carbide
and gallium nitride materials. The contracts typically require submission of a
written report to document the results of such research.

The revenue and expense classification for contract activity is determined
based on the nature of the contract. For contracts where the Company
anticipates that funding will exceed direct costs over the life of the
contract, funding is reported as contract revenue and all direct costs are
reported as costs of contract revenue. For contracts under which the Company
anticipates that direct costs will exceed amounts to be funded over the life of
the contract, costs are reported as research and development expenses and
related funding as an offset of those expenses. The following table details
information about contracts for which direct expenses exceed funding by period
as included in research and development expenses:



<TABLE>
<CAPTION>
                                                SIX MONTHS ENDED
                                          -----------------------------
                                           DECEMBER 28,    DECEMBER 27,
                                               1997            1998
                                          -------------   -------------
                                                 (IN THOUSANDS)
<S>                                       <C>             <C>
Net R&D costs .........................        $281             $0
Government funding ....................         598              0
                                               ----             --
  Total direct costs incurred .........        $879             $0
                                               ====             ==
</TABLE>


As of December 27, 1998, all funding under contracts where the Company
anticipates that direct costs will exceed amounts to be funded has been
exhausted. Therefore, the Company anticipates that all future funding under
existing contracts will be reflected as contract revenue while direct costs
will be reported as contract cost of revenue.


     SIGNIFICANT SALES CONTRACT

In September 1996, the Company entered into a Purchase Agreement with Siemens
AG ("Siemens"), pursuant to which Siemens agreed to purchase LED chips made
with the Company's gallium nitride-on-silicon carbide technology. In April 1997
and December 1997, contract amendments were executed that provided for enhanced
product specifications requested by Siemens and larger volume requirements,
respectively.

In September 1998, the Company and Siemens further amended the contract to
extend the Purchase Agreement with respect to shipments to be made on or after
June 29, 1998. The third amendment obligates the Company to ship, and Siemens
to purchase, stipulated quantities of both conductive buffer and new high
brightness LED chips and silicon carbide wafers through fiscal 1999. The
agreement also limits Siemen's right to defer shipments to 30% of scheduled
quantities for items to be shipped in more than 24 weeks after initial notice
and 10% of scheduled quantities for items to be shipped in more than 12 weeks.
In both cases, Siemens would be required to accept all product within 90 days
of the original shipment date. Additionally, the amendment provides for higher
per unit prices early in the contract with reductions in unit prices being
available as the cumulative volume shipped increases.

In December 1998, the Company and Siemens further amended the contract to
include greater quantities of conductive buffer LED chips to be shipped during
fiscal 1999 and extend the contract for these shipments through September 1999.
This amendment also provides for higher per unit prices early in the contract
with reductions in unit prices being available as the cumulative volume shipped
increases. As was the case with the third amendment, these higher prices were
negotiated by the Company to offset higher per unit costs expected earlier in
the contract.


                                      F-8

<PAGE>

                              CREE RESEARCH, INC.
     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

     INCOME TAXES

The Company has established an estimated tax provision based upon an effective
rate of 28%. The estimated tax rate was based on tax reduction strategies being
implemented by the Company. The estimated effective rate was based upon
projections of income for the fiscal year and the Company's ability to utilize
remaining net operating loss carryforwards and other tax credits. However, the
actual effective rate may vary depending upon actual pre-tax book income for
the year or other factors.

Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between financial statement carrying
amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates in
effect for the year in which those temporary differences are expected to be
recovered or settled.

The actual income tax expense attributable to earnings for the six months ended
December 27, 1998 differed from the amounts computed by applying the statutory
U.S. Federal tax rate of 35% to pretax earnings as a result of the following:



<TABLE>
<CAPTION>
                                                                AMOUNT       PERCENT
                                                              ----------   ----------
                                                                  (IN THOUSANDS)
<S>                                                           <C>          <C>
   Federal income tax provision at statutory rate .........     $2,536         35.0%
   State tax provision ....................................        174          2.4
   Decrease in income tax expense resulting from:
      Foreign sales corporation ...........................       (306)        (4.2)
      State tax incentives ................................       (167)        (2.3)
      Research and development credits ....................        (85)        (1.2)
      Change in valuation allowance .......................       (123)        (1.7)
                                                                ------         ----
   Income tax expense .....................................     $2,029         28.0%
                                                                ======         ====
 
</TABLE>


The following are the components of the provision for income taxes for the six
months ended December 27, 1998 (in thousands):



<TABLE>
<S>                                   <C>
   Current:
    Federal .......................    $1,182
    State .........................       175
                                       ------
   Total current portion ..........     1,357
   Deferred:
    Federal .......................       782
    State .........................      (110)
                                       ------
   Total deferred portion .........       672
                                       ------
   Net provision ..................    $2,029
                                       ======
</TABLE>


                                      F-9

<PAGE>

                              CREE RESEARCH, INC.
     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are as follows:



<TABLE>
<CAPTION>
                                                            JUNE 28,     DECEMBER 27,
                                                              1998           1998
                                                           ----------   -------------
                                                                 (IN THOUSANDS)
                                                                 --------------
<S>                                                        <C>          <C>
   Deferred tax assets:
   Net operating loss carryforwards ....................     $1,304        $  948
   Research tax credits ................................        169            92
   Compensation accruals ...............................         62            70
   Inventory capitalization ............................        120           130
   Bad debt allowance ..................................         56            64
   Alternative minimum tax .............................        261           158
   Foreign tax credit ..................................        270           153
   State incentive credits .............................         --           165
                                                             ------        ------
   Total gross deferred tax assets .....................      2,242         1,780
   Less valuation allowance ............................       (290)         (167)
                                                             ------        ------
   Net deferred tax asset ..............................      1,952         1,613
   Deferred tax liabilities:
   Property and equipment, due to depreciation .........      2,154         2,477
                                                             ------        ------
   Gross deferred tax liabilities ......................      2,154         2,477
                                                             ------        ------
   Net deferred tax asset (liability) ..................     $ (202)       $ (864)
                                                             ======        ======
</TABLE>


The net change in the total valuation allowance for the six months ended
December 27, 1998 was $123,000. The primary reason for the reduction in the
valuation allowance for the six months ended December 27, 1998 was the
implementation of tax strategies to utilize these assets. Realization of
deferred tax assets associated with the NOL carryforwards is dependent upon the
Company generating sufficient taxable income prior to their expiration.
Although realization is not assured for the remaining deferred tax assets,
management believes it is more likely than not that they will be realized
through future taxable earnings. However, the net deferred tax assets could be
reduced in the future if management's estimates of taxable income during the
carryforward period are significantly reduced.

As of December 27, 1998, the Company has net operating loss carryforwards for
federal purposes of $3,493,000 and $2,346,000 for state purposes. The
carryforward expiration period is 2011 to 2013 for Federal tax purposes and
from 2000 to 2003 for state purposes. The Company anticipates that each of
these carryforwards will be utilized by the end of the current fiscal year.


EARNINGS PER SHARE

The Company presents earnings per share in accordance with Statement of
Financial Accounting Standards, "Earnings Per Share," ("SFAS 128"). SFAS 128
required the Company to change its method of computing, presenting and
disclosing earnings per share information. All prior period data presented has
been restated to conform to the provisions of SFAS 128.


                                      F-10

<PAGE>

                              CREE RESEARCH, INC.
     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

The following computation reconciles the differences between the basic and
diluted presentations:



<TABLE>
<CAPTION>
                                                                   SIX MONTHS ENDED
                                                             -----------------------------
                                                              DECEMBER 28,    DECEMBER 27,
                                                                  1997            1998
                                                             -------------   -------------
                                                                 (IN THOUSANDS, EXCEPT
                                                                    PER SHARE DATA)
<S>                                                          <C>             <C>
   Net income ............................................     $  2,640        $  5,217
   Weighted average common shares ........................       12,699          12,876
                                                               --------        --------
   Basic earnings per common share .......................     $   0.21        $   0.41
                                                               ========        ========
 
   Net income ............................................     $  2,640        $  5,217
   Diluted weighted average common shares:
   Common shares outstanding .............................       12,699          12,876
   Dilutive effect of stock options and warrants .........          823             665
                                                               --------        --------
   Total diluted weighted average common shares ..........       13,522          13,541
                                                               --------        --------
   Diluted earnings per common share .....................     $   0.20        $   0.39
                                                               ========        ========
</TABLE>


Potential common shares that would have the effect of increasing diluted income
per share are considered to be antidilutive. In accordance with SFAS No. 128,
these shares were not included in calculating diluted income per share. As of
December 27, 1998, there were no potential shares considered to be
antidilutive. For the six months ended December 28, 1997, there were 300,000
shares that were not included in calculating diluted income per share because
their effect was antidilutive.


NEW ACCOUNTING PRONOUNCEMENTS

In fiscal 1999, the Company adopted Statement of Financial Accounting Standards
No.130, "Reporting Comprehensive Income," ("SFAS 130"), which establishes
standards for reporting and display of Comprehensive income and its components
in a full set of general-purpose financial statements. SFAS 130 only impacts
financial statement presentation as opposed to actual amounts recorded. Other
comprehensive income includes all nonowner changes in equity that are excluded
from net income. This Statement has no financial statement impact for an
enterprise that has no items of other comprehensive income in any period
presented. During the six months ended December 28, 1997 and December 27, 1998,
the Company had no items of other comprehensive income.

In fiscal 1999, the Company adopted Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information,"
("SFAS 131"). SFAS 131 changes the way public companies report segment
information in annual financial statements and also requires those companies to
report selected segment information in interim financial statements to
shareholders. SFAS 131 also establishes standards for related disclosures about
products and services, geographic areas, and major customers. The application
of the new rules does not have a significant impact on the Company's financial
statements.

In June 1998, the Financial Accounting Standards Board issued Statement No.133,
"Accounting for Derivative Instruments and Hedging Activities," ("SFAS 133")
which is required to be adopted in years beginning after June 15, 1999. Because
of the Company's minimal use of derivatives, management does not anticipate
that the adoption of the new Statement will have a significant effect on
earnings or the financial position of the Company.


                                      F-11

<PAGE>

 
                      REPORT OF INDEPENDENT ACCOUNTANTS


July 22, 1998


BOARD OF DIRECTORS AND SHAREHOLDERS
CREE RESEARCH, INC.


In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, cash flows and shareholders' equity,
present fairly, in all material respects, the financial position of Cree
Research, Inc. and subsidiaries at June 30, 1997 and June 28, 1998, and the
results of their operations and their cash flows for the two years in the period
ended June 30, 1997, and for the year ended June 28, 1998 in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.




PRICEWATERHOUSECOOPERS LLP

Raleigh, North Carolina


                                      F-12

<PAGE>

                              CREE RESEARCH, INC.
                          CONSOLIDATED BALANCE SHEETS
                                 (IN THOUSANDS)




<TABLE>
<CAPTION>
                                                                                      JUNE 30,     JUNE 28,
                                                                                        1997         1998
                                                                                    -----------   ---------
<S>                                                                                 <C>           <C>
 ASSETS
 Current assets:
  Cash and cash equivalents .....................................................    $ 10,448      $17,680
  Marketable securities .........................................................          --          657
  Accounts receivable, net ......................................................       7,694       10,479
  Inventories ...................................................................       3,949        2,543
  Deferred income tax ...........................................................       1,830        1,952
  Prepaid expenses and other current assets .....................................         466        1,347
                                                                                     --------      -------
    Total current assets ........................................................      24,387       34,658
  Property and equipment, net ...................................................      24,333       36,476
  Patent and license rights, net ................................................       1,267        1,525
  Other assets ..................................................................         150           65
                                                                                     --------      -------
    Total assets ................................................................    $ 50,137      $72,724
                                                                                     ========      =======
 LIABILITIES AND SHAREHOLDERS' EQUITY
 Current liabilities:
  Accounts payable, trade .......................................................    $  2,248      $ 5,595
  Current maturities of long term debt ..........................................          --           17
  Accrued salaries and wages ....................................................         292          391
  Other accrued expenses ........................................................         834        1,052
                                                                                     --------      -------
    Total current liabilities ...................................................       3,374        7,055
 Long term liabilities:
  Long term debt ................................................................          --        8,650
  Deferred income tax ...........................................................       1,638        2,154
                                                                                     --------      -------
    Total long term liabilities .................................................       1,638       10,804
 Shareholders' equity:
  Preferred stock, par value $0.01; 2,750 shares authorized; none issued and
    outstanding .................................................................          --           --
  Common stock, $0.005 par value; 14,500 shares authorized; shares issued and
    outstanding 12,523 at June 30, 1997 and 12,989 at June 28, 1998 .............          62           65
  Additional paid-in-capital ....................................................      46,214       49,676
  Retained earnings (deficit) ...................................................      (1,151)       5,124
                                                                                     --------      -------
    Total shareholders' equity ..................................................      45,125       54,865
                                                                                     --------      -------
     Total liabilities and shareholders' equity .................................    $ 50,137      $72,724
                                                                                     ========      =======
</TABLE>


The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                      F-13

<PAGE>

                              CREE RESEARCH, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)




<TABLE>
<CAPTION>
                                                 JUNE 30,     JUNE 30,       JUNE 28,
                                                   1996         1997           1998
                                                ---------   ------------   ------------
<S>                                             <C>         <C>            <C>
Revenue:
  Product revenue, net ......................    $ 9,689      $ 19,823       $ 34,891
  Contract revenue, net .....................      3,945         6,535          7,640
  License fee income ........................      1,423         2,615             --
                                                 -------      --------       --------
   Total revenue ............................     15,057        28,973         42,531
Cost of revenue:
  Product revenue, net ......................      8,411        13,388         21,727
  Contract revenue, net .....................      3,078         5,707          6,252
                                                 -------      --------       --------
   Total cost of revenue ....................     11,489        19,095         27,979
                                                 -------      --------       --------
Gross profit ................................      3,568         9,878         14,552
Operating expenses:
  Research and development ..................      1,286         1,826          1,774
  Sales, general and administrative .........      2,917         4,301          4,131
  Other (income) expense ....................        (11)          639            502
                                                 -------      --------       --------
   Income (loss) from operations ............       (624)        3,112          8,145
Interest income, net ........................        867           607            730
                                                 -------      --------       --------
   Income before income taxes ...............        243         3,719          8,875
Income tax expense ..........................         --           177          2,600
                                                 -------      --------       --------
   Net income ...............................    $   243      $  3,542       $  6,275
                                                 =======      ========       ========
   Earnings per share:
     Basic ..................................    $  0.02      $   0.28       $   0.49
                                                 =======      ========       ========
     Diluted ................................    $  0.02      $   0.27       $   0.47
                                                 =======      ========       ========
   Shares used in per share calculation:
     Basic ..................................     11,826        12,455         12,863
                                                 =======      ========       ========
     Diluted ................................     12,615        13,126         13,493
                                                 =======      ========       ========
</TABLE>


The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                      F-14

<PAGE>

                              CREE RESEARCH, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOW
                                 (IN THOUSANDS)



<TABLE>
<CAPTION>
                                                                             JUNE 30,       JUNE 30,      JUNE 28,
                                                                               1996           1997          1998
                                                                          -------------   -----------   -----------
<S>                                                                       <C>             <C>           <C>
Operating activities:
  Net income ..........................................................     $    243       $  3,542      $   6,275
  Adjustments to reconcile net income to net cash provided by (used in)
   operating activities:
   Depreciation and amortization ......................................        1,765          3,356          4,217
   Loss (gain) on disposal of property and equipment ..................           (8)           631            719
   Loss on write off of patents .......................................           --            141             17
   Amortization of patent rights ......................................          126            108            102
   Amortization and write off of goodwill .............................           41             41             86
   Purchase of marketable trading securities ..........................           --             --         (1,500)
   Proceeds from sale of marketable trading securities ................           --             --            421
   Loss on marketable trading securities ..............................           --             --             32
   Deferred income taxes ..............................................           --           (192)           394
   Tax benefits associated with stock options .........................           --             96          1,791
   Changes in assets and liabilities:
     Accounts receivable ..............................................       (3,258)          (891)        (2,398)
     Inventories ......................................................       (1,549)          (723)         1,406
     Deferred cost on research contracts ..............................           81             --             --
     Prepaid expenses and other assets ................................           49           (262)          (882)
     Accounts payable, trade ..........................................          714           (226)         1,092
     Accrued expenses .................................................          160            476            320
                                                                            ----------     --------      ---------
     Net cash provided by (used in) operating activities ..............       (1,636)         6,097         12,092
                                                                            ----------     --------      ---------
Investing activities:
  Maturity of investment securities ...................................        2,124          1,787             --
  Purchase of property and equipment ..................................      (14,740)        (8,115)       (15,287)
  Proceeds from sale of assets ........................................           52             13            463
  Purchase of patent rights ...........................................         (310)          (310)          (377)
                                                                            ----------     --------      ---------
     Net cash used in investing activities ............................      (12,874)        (6,625)       (15,201)
                                                                            ----------     --------      ---------
Financing activities:
  Proceeds from issuance of long-term debt ............................           --             --          8,667
  Net proceeds from issuance of common stock ..........................       20,924            926          2,936
  Repurchase of common stock ..........................................           --           (112)        (1,262)
                                                                            ----------     --------      ---------
     Net cash provided by financing activities ........................       20,924            814         10,341
                                                                            ----------     --------      ---------
Net increase in cash and cash equivalents .............................        6,414            286          7,232
Cash and cash equivalents:
  Beginning of year ...................................................        3,748         10,162         10,448
                                                                            ----------     --------      ---------
  End of year .........................................................     $ 10,162       $ 10,448      $  17,680
                                                                            ==========     ========      =========
Supplemental disclosure of cash flow information:
  Cash paid for interest, net of amounts capitalized ..................     $      5       $     --      $      74
                                                                            ==========     ========      =========
  Cash paid for income taxes ..........................................     $     --       $    300      $     336
                                                                            ==========     ========      =========
</TABLE>


The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                      F-15

<PAGE>

                              CREE RESEARCH, INC.
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
             YEARS ENDING JUNE 30, 1996 AND 1997 AND JUNE 28, 1998
                                 (IN THOUSANDS)




<TABLE>
<CAPTION>
                                              COMMON    ADDITIONAL                                              TOTAL
                                              STOCK      PAID-IN     RETAINED      UNEARNED      TREASURY   SHAREHOLDERS'
                                            PAR VALUE    CAPITAL     EARNINGS    COMPENSATION     STOCK        EQUITY
                                           ----------- ----------- ------------ -------------- ----------- --------------
<S>                                        <C>         <C>         <C>          <C>            <C>         <C>
Balance at June 30, 1995 .................     $52      $ 24,427     $ (4,936)       $ (2)      $    (38)     $ 19,503
Common stock options
  exercised for cash, 122 shares .........       1           412           --          --             --           413
Common stock warrants
  exercised for cash, 665 shares .........       3         2,916           --          --             --         2,919
Compensation expense
  for common stock options ...............      --            --           --           2             --             2
Proceeds from sale of 1,079 shares
  of common stock and 300
  common stock warrants,
  net of issuance costs of $625 ..........       5        17,587           --          --             --        17,592
Net income ...............................      --            --          243          --             --           243
                                               ---      --------     --------        ----       --------      --------
Balance at June 30, 1996 .................      61        45,342       (4,693)         --            (38)       40,672
Common stock options exercised
  for cash, 52 shares ....................      --           160           --          --             --           160
Common stock warrants exercised
  for cash, 203 shares ...................       1           766           --          --             --           767
Purchase of common stock for
  the treasury, 10 shares ................      --            --           --          --           (112)         (112)
Retirement of 20 treasury shares .........      --          (150)          --          --            150            --
Income tax benefits from stock
  option exercises .......................      --            96           --          --             --            96
Net income ...............................      --            --        3,542          --             --         3,542
                                               ---      --------     --------        ----       --------      --------
Balance at June 30, 1997 .................      62        46,214       (1,151)         --             --        45,125
Common stock options exercised
  for cash, 217 shares ...................       1         1,693           --          --             --         1,694
Common stock warrants exercised
  for cash, 331 shares ...................       2         1,240           --          --             --         1,242
Purchase of common stock for
  the treasury, 82 shares ................      --            --           --          --         (1,262)       (1,262)
Retirement of 82 treasury shares .........      --        (1,262)          --          --          1,262            --
Income tax benefits from stock
  option exercises .......................      --         1,791           --          --             --         1,791
Net income ...............................      --            --        6,275          --             --         6,275
                                               ---      --------     --------        ----       --------      --------
Balance at June 28, 1998 .................     $65      $ 49,676     $  5,124        $ --       $     --      $ 54,865
                                               ===      ========     ========        ====       ========      ========
</TABLE>


The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                      F-16

<PAGE>

                              CREE RESEARCH, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1. NATURE OF BUSINESS

Cree Research, Inc. ("the Company" or "Cree"), a North Carolina corporation,
develops, manufactures and markets silicon carbide-based semiconductor devices.
Revenues are primarily derived from the sale of blue light emitting diodes
("LEDs"), silicon carbide ("SiC") based materials and full-color LED based
electronic displays and modules. The Company markets its blue LED chip products
principally to customers who incorporate them into packaged lamps for resale to
original equipment manufacturers. The Company also sells SiC material products
to corporate, government and university research laboratories. In addition, the
Company is engaged in a variety of research programs related to the advancement
of SiC process technology and the development of electronic devices that take
advantage of SiC's unique physical and electronic properties. These research
projects are primarily funded by Federal government agencies and departments.
The Company recovers the costs of a majority of its research and development
efforts from revenues on these contracts with agencies of the Federal
government.


2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES


     PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of Cree Research,
Inc., and its wholly-owned subsidiaries, Real Color Displays, Inc. ("RCD"),
Cree Research FSC, Inc. and Cree Technologies, Inc. All material intercompany
accounts and transactions have been eliminated in consolidation.


     CHANGE IN FISCAL YEAR

On September 24, 1997, the Board of Directors of Cree Research, Inc. changed
the Company's fiscal year from the twelve months ending June 30, to a 52 or 53
week year ending on the last Sunday in the month of June. Accordingly, all
quarterly reporting reflected a 13 week period in fiscal 1998, except that the
period ended September 28, 1997, which commenced July 1, 1997, reflected the
results of twelve weeks and five days. The Company's 1998 fiscal year extended
for the period from July 1, 1997 to June 28, 1998.


     ESTIMATES

The preparation of these 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 the
disclosure of contingent assets and liabilities, at June 30, 1997 and June 28,
1998, and the reported amounts of revenues and expenses during the years ended
June 30, 1996 and 1997 and June 28, 1998. Actual amounts could differ from
those estimates.


     REVENUE RECOGNITION

The Company recognizes product revenue at the time of shipment or in accordance
with the terms of the relevant contract. Revenue from government contracts is
recorded on the percentage-of-completion method as expenses per contract are
incurred. License fee income is recognized when the transfer of licensed
technology is completed.

Contract revenue represents reimbursement by various U.S. Government entities
to aid in the furthering of the development of the Company's technology by
supplementing the Company's research and development efforts. Any resulting
technology obtained by the Company through these efforts remain the property of
the Company after the completion of the contract, subject to certain license
rights obtained by the government. Contract revenue includes funding of direct
research and development costs and a portion of the Company's general and
administrative expenses and other operating expenses for contracts under which
funding is expected to exceed direct costs over the life of the contract. The
specific reimbursement provisions of the contracts, including the portion of
the Company's general and administrative expenses and other operating expenses
that are reimbursed, vary by contract. Such reimbursements are recorded as
contract revenue. For


                                      F-17

<PAGE>

                              CREE RESEARCH, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

contracts under which the Company anticipates that direct costs will exceed
amounts to be funded over the life of the contract (i.e., certain cost share
arrangements), the Company reports direct costs as research and development
expenses with related reimbursements recorded as an offset to those expenses.

In September 1996, the Company entered into a license and supply agreement with
Shin-Etsu Handotai Co. LTD. ("Shin-Etsu") and other parties to use certain LED
fabrication technology and has agreed to supply silicon carbide wafers required
to manufacture the licensed product. The license agreement provides for payment
of a license fee and royalties based on a percentage of sales of products made
using the licensed technology. The license fee was payable in installments
which totaled $2,700,000. As of June 28, 1998, all license fees have been
received. The Company also has recorded a short-term accrued expense of
$186,000 payable in the first quarter of fiscal 1999 to the third party that
brokered the license agreement. Substantially all of the Company's obligations
to transfer the licensed technology were performed during fiscal 1997, and the
net present value of the license fee payments and commission were recognized.
In October 1995, the Company also entered into an agreement to license its
technology for the joint development and manufacture of LEDs using Cree's
technology to Siemens AG License fees are payable in installments totaling
$1,500,000. As of June 28, 1998, all fees have been received. The Company's
obligation to transfer the licensed technology was substantially completed
during fiscal 1996, and the net present value of the license fee payments was
recorded as revenue at that time.


     CASH AND CASH EQUIVALENTS

Cash and cash equivalents consist of unrestricted cash accounts and highly
liquid investments with an original maturity of three months or less when
purchased.


     MARKETABLE SECURITIES

Investments are accounted for in accordance with Statement of Financial
Accounting Standards No. 115 (SFAS No. 115) "Accounting for Certain Investments
in Debt and Equity Securities." This statement requires certain securities to
be classified into three categories:

      (a) Securities Held-to-Maturity -- Debt securities that the entity has
   the positive intent and ability to hold to maturity are reported at
   amortized cost.

      (b) Trading Securities -- Debt and equity securities that are bought and
   held principally for the purpose of selling in the near term are reported
   at fair value, with unrealized gains and losses included in earnings.

      (c) Securities Available-for-Sale -- Debt and equity securities not
   classified as either securities held-to-maturity or trading securities are
   reported at fair value with unrealized gains or losses excluded from
   earnings and reported as a separate component of stockholders' equity.

The Company's short-term investments are comprised of equity securities that
are classified as trading securities, which are carried at their fair value
based upon quoted market prices of those investments at June 28, 1998, with net
realized and unrealized gains and losses included in net earnings.

As of June 28, 1998, short-term investments consist of common stock holdings in
C3 a portion of which were purchased in November 1997. The Company's CEO has,
through a binding agreement, promised to indemnify the Company for losses of up
to $300,000, plus the lesser of $100,000 or the net difference between the per
share selling price and $9.375 per share for all shares of C3 common stock sold
by Cree. This indemnity covers losses that may result from the sale of shares
purchased in November 1997 below the purchase price paid, offset by gains
realized on shares acquired directly from C3 in January 1997 (see below).
Payment of this obligation is due within ten days after receipt by the CEO of
the Company's written


                                      F-18

<PAGE>

                              CREE RESEARCH, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

demand made pursuant to a vote of the majority of the members of the Board of
Directors. At June 28, 1998, the Company had recorded a $390,000 receivable
from the CEO (included in net accounts receivable) based upon this agreement
for the net realized and unrealized losses on this investment. Realized losses
on shares of C3 stock sold by the Company during fiscal 1998 totaled $254,000,
and unrealized losses offset by the unrealized gain on shares acquired from C3
directly (see below) were $168,000 at June 28, 1998. Approximately $32,000 of
losses on the investment in C3 stock is included in other income (expense) for
fiscal 1998.

In addition to the shares of C3 purchased in November 1997, the Company
acquired 24,601 shares of C3 common stock in January 1997. These shares were
issued pursuant to an option C3 granted to the Company in 1995. The option gave
the Company the right to acquire, for an aggregate consideration of $500, one
percent of the outstanding common stock of C3. C3 retained the right to waive
the consideration and issue the stock at any time, which it elected to do in
January 1997. The shares issued pursuant to the option are restricted
securities within the meaning of Rule 144 under the Securities Act of 1933,
which permits the sale of such securities without registration if certain
conditions are met. The shares first became eligible for sale under Rule 144 in
the third quarter of fiscal 1998.


     INVENTORIES

Inventories are stated at the lower of cost or market, with cost being
determined under the first-in, first-out (FIFO) method. Inventories consists of
the following:



<TABLE>
<CAPTION>
                                 JUNE 30,    JUNE 28,
                                   1997        1998
                                ---------   ---------
                                   (IN THOUSANDS)
<S>                             <C>         <C>
   Raw materials ............    $1,559      $  999
   Work-in-progress .........     1,374         752
   Finished goods ...........     1,016         792
                                 ------      ------
                                 $3,949      $2,543
                                 ======      ======
</TABLE>


     PROPERTY AND EQUIPMENT

Property and equipment are recorded at cost and depreciated on a straight-line
basis over the estimated useful lives of the assets, which range from three to
20 years. Leasehold improvements are amortized over the life of the related
lease. Expenditures for repairs and maintenance are charged to expense as
incurred. The costs of major renewals and betterments are capitalized and
depreciated over their estimated useful lives. The cost and related accumulated
depreciation of the assets are removed from the accounts upon disposition and
any resulting gain or loss is reflected in operations.

During the first quarter of fiscal 1996, the Company changed its previous
estimate on the useful lives of some of its manufacturing equipment from five
to nine years. The change in estimate was based on the Company's experience
with similar fixed assets. The net adjustment increased net income
approximately $280,000, or $0.02 per share, for fiscal 1996.

The Company has entered into an agreement with C3 to sell crystal growth
equipment manufactured by the Company to C3 at cost plus a reasonable overhead
allocation. As a result of this transaction, the Company has recognized the
overhead allocation as "other operating income."

In November 1997, the Company purchased real property consisting of
approximately 30 acres of land with a production facility of approximately
139,000 square feet and a total of approximately 33,000 square feet of service
and warehouse buildings. This property is located in Durham, North Carolina, in
the vicinity of the Research Triangle Park. The purchase price of the land and
buildings was $3,000,000. The Company moved


                                      F-19

<PAGE>

                              CREE RESEARCH, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

most of its sales and administrative personnel to this facility in January
1998. The Company anticipates it will relocate several other operations to this
facility over the next few quarters. All areas, with the exception of certain
crystal growth and wafer fabrication assets, are expected to relocate during
fiscal 1999.

The Company assesses the realizability of the carrying value of its investment
in property and equipment whenever events or changes in circumstance indicate
that an impairment may have occurred in accordance with the provisions of
Statement of Financial Accounting Standards No. 121 ("SFAS No. 121"),
"Accounting for Impairment of Long Lived Assets and Assets to be Disposed of."
As of June 28, 1998, the Company has not recorded any impairment in the
carrying value of its property and equipment.


     PATENT AND LICENSE RIGHTS

Patent rights reflect costs incurred to enhance and maintain the Company's
intellectual property position. License rights reflect costs incurred to use
the intellectual property of others. Both are amortized on a straight line
basis. During fiscal 1997, the Company changed its previous estimate of the
useful lives of patents from 17 years beginning at the date of patent issue to
20 years from the date of patent application to conform to a legislative
amendment made to the U.S. patent laws which became effective in June 1995.
This change in estimate had no material impact to net income or earnings per
share, since the average period of time between patent application and issue is
generally about three years. Amortization expense was $126,000, $108,000 and
$102,000, for the years ended June 30, 1996 and 1997 and June 28, 1998,
respectively. Total accumulated amortization for patents was approximately
$460,000 and $560,000 at June 30, 1997 and June 28, 1998, respectively.


     GOODWILL

Goodwill represented the amount by which the costs to acquire the net assets of
the Real Color Displays subsidiary exceeded their related fair value at
acquisition. Based on a review of undiscounted cash flows of the subsidiary
anticipated over the remaining amortization period, the Company determined that
goodwill had been impaired. As a result, the Company wrote off the remaining
$66,000 carrying value of such goodwill in the second quarter of fiscal 1998.
As required by generally accepted accounting principles, this charge was
included in the results of operations.


     RESEARCH AND DEVELOPMENT POLICY

The Company partners with the Federal government in many of its current
research and development efforts. By entering into contracts, the Company has
most of its research and product development costs funded by the U.S.
Government. The contract funding may be based on a cost-plus or a cost-share
arrangement. Pursuant to each contract, the amount of funding is determined
based on cost estimates that include direct costs, plus an allocation for
research and development, general and administrative and a cost of capital
expense. Cost-plus funding is determined based on actual costs plus a set
percentage margin. For the cost-share contracts, the actual costs are divided
between the U.S. Government and the Company based on the terms of the contract.
The government's cost share is then funded to the Company. Activities performed
under both of these arrangements include research regarding silicon carbide and
gallium nitride materials. The contracts typically require the submission of a
written report that documents the results of such research.

Funding on contracts under which the Company anticipates that funding will
exceed direct costs over the life of the contract is recorded as contract
revenue and related costs are reported as a cost of contract revenue. For
contracts under which the Company anticipates that direct costs will exceed
amounts to be funded over the life of the contract, direct costs are shown as
research and development expenses and related funding as an offset of those
expenses. The following table details information about contracts for which
direct expenses exceed funding by period as reflected in the statements of
operations:


                                      F-20

<PAGE>

                              CREE RESEARCH, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)



<TABLE>
<CAPTION>
                                                             YEARS ENDED
                                                  ---------------------------------
                                                   JUNE 30,    JUNE 30,    JUNE 28,
                                                     1996        1997        1998
                                                  ---------   ---------   ---------
                                                           (IN THOUSANDS)
<S>                                               <C>         <C>         <C>
   Net research and development costs .........    $  368      $  671        $276
   Government funding .........................     1,918       2,186         601
                                                   ------      ------        ----
      Total direct costs incurred .............    $2,286      $2,857        $877
                                                   ======      ======        ====
</TABLE>


As of June 28, 1998, all funding under contracts where the Company anticipates
that direct costs will exceed amounts to be funded has been exhausted.
Therefore, the Company anticipates that all future funding under existing
contracts will be reflected as contract revenue while direct costs will be
reported as contract cost of revenue.


     INTEREST CAPITALIZATION

During the year ended June 28, 1998, the Company capitalized interest on funds
used to construct property, plant and equipment in connection with the newly
acquired facility. Interest capitalized during fiscal 1998 was $128,000.


     CREDIT RISK, MAJOR CUSTOMERS AND MAJOR SUPPLIERS

Financial instruments which potentially subject the Company to a concentration
of credit risk consist principally of cash equivalents and accounts receivable.
The Company's cash equivalents consist of U.S. Treasury bills, government
agency bonds and commercial paper. Certain bank deposits may at times be in
excess of the FDIC insurance limit.

The Company sells its products to manufacturers and researchers worldwide and
generally requires no collateral. The Company maintains reserves for potential
credit losses, and such losses, in the aggregate, have generally been within
management's expectations. The Company presently derives primarily all of its
contract revenues from contracts with the U.S. Department of Defense.
Approximately 33% and 18%, respectively, of the Company's accounts receivable
balance at June 30, 1997 and June 28, 1998 was due from the Department of
Defense. In addition, the Company had amounts due from Siemens totaling 19% and
37%, of accounts receivable balances at June 30, 1997 and June 28, 1998,
respectively, and amounts due from C3 totaling 1% and 23%, of accounts
receivable balances at June 30, 1997 and June 28, 1998, respectively.

The Company has derived its product revenue from sales primarily in the United
States, the Far East and Europe as follows:



<TABLE>
<CAPTION>
                                        YEARS ENDED
                             ---------------------------------
                              JUNE 30,    JUNE 30,    JUNE 28,
                                1996        1997        1998
                             ---------   ---------   ---------
<S>                          <C>         <C>         <C>
   United States .........       31%         21%         26%
   Far East ..............       27%         33%         15%
   Europe ................       38%         44%         58%
   Other .................        4%          2%          1%
</TABLE>


One customer accounted for 46% and 51% of product revenue for fiscal 1997 and
1998, respectively. Another customer accounted for 2% and 13% of product
revenue for fiscal 1997 and 1998, respectively. In addition, two customers
accounted for 32% of product revenue in fiscal 1996. The Department of Defense
accounted for 97%, 99% and 93% of contract revenues during fiscal 1996, 1997
and 1998, respectively.


                                      F-21

<PAGE>

                              CREE RESEARCH, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company depends on single or limited source suppliers for a number of raw
materials and components used in its SiC wafer products and LEDs. Any
interruption in the supply of these key materials or components could have a
significant adverse effect on the Company's operations.


     PER SHARE DATA

Basic earnings per common share is computed using the weighted average number
of shares outstanding. Diluted earnings per common share is computed using the
weighted average number of shares outstanding adjusted for the incremental
shares attributed to outstanding options to purchase common stock.

Incremental shares of 789,000, 670,000 and 631,000 in 1996, 1997 and 1998,
respectively, were used in the calculation of diluted earnings per common
share.


     ACCOUNTING FOR STOCK BASED COMPENSATION

In accordance with Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, no compensation is recorded for stock options or
other stock-based awards that are granted to employees with an exercise price
equal to or above the common stock price on the grant date. Compensation
related to performance share grants is recognized from the grant date until the
performance conditions are satisfied, based on the market price of the
Company's common stock.

In October, 1995, the Financial Accounting Standards Board ("FASB") issued
Statement No. 123 ("FAS 123"), "Accounting for Stock Based Compensation." This
Statement establishes fair value as the measurement basis for equity
instruments issued in exchange for goods or services and stock-based
compensation plans. Fair value may be measured using quoted market prices,
option-pricing models or other reasonable estimation methods. FAS 123 permits
the Company to choose between adoption of the fair value based method or
disclosing pro forma net income information. The Statement is effective for
transactions entered into after December 31, 1995. The Company will continue to
account for stock-based compensation in accordance with Accounting Principles
Board Opinion No. 25, as amended, and provide only the pro forma disclosures
required by FAS 123.


3. ACCOUNTS RECEIVABLE

The following is a summary of accounts receivable:



<TABLE>
<CAPTION>
                                                JUNE 30, 1997     JUNE 28, 1998
                                               ---------------   --------------
                                                        (IN THOUSANDS)
<S>                                            <C>               <C>
   Trade receivables .......................        $5,210           $ 8,971
   Other short term receivables ............         2,700             1,659
                                                    ------           -------
                                                     7,910            10,630
   Allowance for doubtful accounts .........           216               151
                                                    ------           -------
   Current receivables .....................         7,694            10,479
   Long term receivables ...................            54                56
                                                    ------           -------
      Total accounts receivable ............        $7,748           $10,535
                                                    ======           =======
</TABLE>



                                      F-22

<PAGE>

                              CREE RESEARCH, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes the changes in the Company's allowance for
doubtful accounts for the years ended June 30, 1996 and 1997, and June 28,
1998:


                        ALLOWANCE FOR DOUBTFUL ACCOUNTS:
                                (In thousands)



<TABLE>
<CAPTION>
                              BALANCE AT    CHARGES TO         DEDUCTIONS         BALANCE AT
YEARS                         BEGINNING      COST AND         (WRITE-OFFS           END OF          
ENDED                         OF PERIOD      EXPENSES       CHARGED TO RESERVE)     PERIOD
- -----                         ---------      --------       -------------------     ------
<S>                          <C>           <C>           <C>                     <C>
   June 30, 1996 .........       $ 22          203                (175)              $ 50
   June 30, 1997 .........       $ 50          190                 (24)              $216
   June 28, 1998 .........       $216           50                (115)              $151
</TABLE>


4. PROPERTY AND EQUIPMENT

The following is a summary of property and equipment:



<TABLE>
<CAPTION>
                                                          JUNE 30, 1997     JUNE 28, 1998
                                                         ---------------   --------------
                                                                  (IN THOUSANDS)
<S>                                                      <C>               <C>
   Office equipment and furnishings ..................      $    909         $   1,372
   Land and buildings ................................            --             3,501
   Machinery and equipment ...........................        22,312            28,136
   Construction in progress ..........................         2,669             9,074
   Leasehold improvements ............................         5,420             4,697
                                                            --------         ---------
                                                              31,310            46,780
   Accumulated depreciation and amortization .........        (6,977)          (10,304)
                                                            --------         ---------
      Total property and equipment ...................      $ 24,333         $  36,476
                                                            ========         =========
</TABLE>


Depreciation and amortization of property and equipment totaled $1,765, $3,356
and $4,217 for the year ended June 30, 1996 and 1997, and June 28, 1998,
respectively.


5. SHAREHOLDERS' EQUITY

The Board of Directors is authorized to issue 1,250,000 and 1,500,000 shares of
Class A Voting and Class B Non-Voting preferred stock, respectively, each with
a par value of $0.01 per share, at its discretion. This preferred stock may be
issued in one or more series with the number of shares, designation, relative
rights, preferences and limitations to be determined by resolution of the Board
of Directors.


6. STOCK OPTIONS AND STOCK WARRANTS

As permitted by FAS 123, "Accounting For Stock-Based Compensation," the Company
has elected to follow Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" and related interpretations and amendments in
accounting for its employee stock option plans.

The Company's Amended and Restated Equity Compensation Plan has authorized the
grant of options for up to 2,540,000 shares of the Company's common stock. All
options granted have ten year terms and vest and become fully exercisable
within five years. The Company had granted 96,000 options with a ten year term
for shares of the Company's common stock under the Stock Option Plan for
Non-Employee Directors (Directors Formula Plan). This Plan was terminated in
November 1997 and all 96,000 options granted under this plan are now fully
vested. The Company's current stock plans provide for grants of options with
exercise prices equal to or exceeding fair market value on the date of grant.


                                      F-23

<PAGE>

                              CREE RESEARCH, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Pro forma information regarding net income and earnings per share is required
by Statement 123, and has been determined as if the Company had accounted for
its employee stock options under the fair value method of the Statement. The
fair value of these options was estimated at the date of grant using a Black-
Scholes option pricing model with weighted average risk free rates of interest
of 6.7% and 5.6%, for the years ended June 30, 1997 and June 28, 1998,
respectively. The volatility factor of the expected market price of the
Company's common stock is .748 and the weighted-average expected life of the
options was seven years for executives and directors and five years for other
employees.

For purposes of pro-forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information is as follows:



<TABLE>
<CAPTION>
                                                                          YEARS ENDED
                                                             -------------------------------------
                                                              JUNE 30,     JUNE 30,      JUNE 28,
                                                                1996         1997          1998
                                                             ---------   -----------   -----------
                                                             (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                          <C>         <C>           <C>
   Net income, as reported ...............................    $  243       $ 3,542       $ 6,275
                                                              ======       =======       =======
   Pro forma net income, as adjusted for FAS 123 .........    $  243       $ 1,418       $ 4,405
                                                              ======       =======       =======
   Pro forma earnings per share:
      Basic ..............................................    $ 0.02       $  0.11       $  0.34
                                                              ======       =======       =======
      Diluted ............................................    $ 0.02       $  0.11       $  0.33
                                                              ======       =======       =======
</TABLE>


The following table details the number of stock options outstanding and their
related exercise prices as of June 28, 1998:




<TABLE>
<CAPTION>
 NUMBER OF OPTIONS OUTSTANDING AS OF JUNE 28,
                      1998
- -----------------------------------------------
  EXERCISE       NUMBER OF     WEIGHTED-AVERAGE
    PRICE         OPTIONS      CONTRACTUAL LIFE
- ------------   ------------   -----------------
<S>            <C>            <C>
  $   0.42          5,497          2 years
  $   3.13          8,000          6 years
  $   3.63        250,200          5 years
  $   3.75         13,317          3 years
  $   4.00         78,700          6 years
  $   4.38          6,000          6 years
  $   6.82          6,700          5 years
  $   7.38          6,000          6 years
  $   9.38         26,600          9 years
  $  10.25         14,500          9 years
  $  11.19         16,800          8 years
  $  12.98        409,100          9 years
  $  14.38        203,400          7 years
  $  15.75         48,000          8 years
  $  16.38         43,500         10 years
  $  17.75         19,000         10 years
  $  18.75         40,000          9 years
  $  19.38         10,000         10 years
                  -------
                1,205,314
                =========
</TABLE>


                                      F-24

<PAGE>

                              CREE RESEARCH, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)



<TABLE>
<CAPTION>
                                                                        TOTAL OPTION ACTIVITY
                                                ---------------------------------------------------------------------
                                                    JUNE 30, 1996           JUNE 30, 1997           JUNE 28, 1998
                                                ---------------------   ---------------------   ---------------------
                                                                (IN THOUSANDS, EXCEPT PER SHARE DATA)
                                                             WEIGHTED                WEIGHTED                WEIGHTED
                                                             AVERAGE                 AVERAGE                 AVERAGE
                                                 OPTIONS      PRICE      OPTIONS      PRICE      OPTIONS      PRICE
                                                ---------   ---------   ---------   ---------   ---------   ---------
<S>                                             <C>         <C>         <C>         <C>         <C>         <C>
   Outstanding -- beginning of year .........      769       $ 4.23        632      $  4.39         927     $  4.76
   Granted ..................................       --       $   --        381      $ 13.56         542     $ 13.98
   Exercised ................................      122       $ 3.39         52      $  3.08         217     $  7.80
   Forfeited ................................       15       $ 4.36         34      $  8.05          47     $  8.67
                                                   ---                     ---                    -----
   Outstanding -- end of year ...............      632       $ 4.39        927      $  4.76       1,205     $ 10.19
   Exercisable at end of year ...............      439       $ 3.78        702      $  7.44         599     $  8.40
</TABLE>


During fiscal year 1992, the Company issued stock warrants to purchasers of
Class B Non-Voting preferred stock, Series C. The warrants entitled the holders
to purchase 607,320 shares of common stock at $3.75 per share. In September
1992, the Company issued stock warrants to additional purchasers of Class B
Non-Voting preferred stock, Series C. The warrants entitled the holders to
purchase 363,644 shares of common stock at $4.13 per share. Warrants to
purchase 425,642, 202,996 and 331,326 shares of common stock were exercised
during the years ended June 30, 1996 and 1997, and June 28, 1998, respectively.
All remaining warrants expired effective February 8, 1998.

In connection with the Company's September 1995 private placement, the Company
issued an additional 300,000 warrants, which have an exercise price of $27.23
and expire September 2000. As of June 28, 1998, all of these warrants remain
outstanding and represent the only warrants outstanding.


7. COMMITMENTS

The Company currently leases three facilities under four separate lease
agreements. These facilities are comprised of both office and manufacturing
space. The first facility has a remaining lease period of approximately three
and one half years for a multi-suite block. Effective May 1, 1998, the Company
has notified the lessor of its intention to exercise a right to terminate for
all suites with the exception of the base suite. This right to terminate will
be effective May 1, 1999. Also associated with this facility is a sublease
agreement entered into in fiscal 1996 to lease an adjacent 1,900 square feet.
That sublease expires in October 1998 and will not be renewed. The lease term
for the second facility began in September 1995. This facility has a remaining
lease period of approximately two years with two options to renew for a total
of four additional years. All of these agreements provide for rental
adjustments for increases in property taxes, the consumer price index and
general property maintenance.

Rent expense associated with these leases totaled $338,000, $549,000 and
$522,000 for the years ended June 30, 1996 and 1997, and June 28, 1998,
respectively. Future minimum rentals as of June 28, 1998 under these leases are
as follows:


<TABLE>
<CAPTION>
                       MINIMAL RENTAL
YEARS ENDED                AMOUNT
- -------------------   ---------------
                       (IN THOUSANDS)
<S>                   <C>
   1999 ...........        $  389
   2000 ...........           334
   2001 ...........           284
   2002 ...........           138
                           ------
  Total ...........        $1,145
                           ======
</TABLE>


                                      F-25

<PAGE>

                              CREE RESEARCH, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. LONG-TERM DEBT

In November 1997, the Company entered into a term loan from a commercial bank
for up to $10,000,000 to finance the purchase and upfit of the new main
facility in Durham, North Carolina. Approximately $2,950,000 was disbursed
under the loan to finance the initial purchase of the facility with the
remaining proceeds expected to be disbursed on a monthly basis based on actual
expenditures incurred. Draws under the loan agreement may be made during the
eighteen month period ending in May 1999. The loan, which is collateralized by
the purchased property and subsequent upfits, accrues interest at a fixed rate
of 8% and carries customary covenants, including the maintenance of a minimum
tangible net worth and other requirements. Accrued interest is due monthly
through May 1999, at which time the outstanding principal balance will be
amortized over twenty years until 2011, when the loan balance becomes due. At
June 28, 1998, short term and long term borrowings associated with this loan
were $17,000 and $8,650,000, respectively, leaving $1,333,000 unused and
available.

The aggregate maturities for long-term debt for the five years after June 28,
1998 are:



<TABLE>
<CAPTION>
                               AMOUNT
YEARS ENDED                     DUE
- -----------------------   ---------------
                           (IN THOUSANDS)
<S>                       <C>
   1999 ...............        $   17
   2000 ...............           213
   2001 ...............           230
   2002 ...............           250
   2003 ...............           270
   Thereafter .........         7,687
                               ------
    Total .............        $8,667
                               ======
</TABLE>


9. INCOME TAXES

The Company accounts for its income taxes under the provisions of Statement of
Financial Accounting Standards No. 109 ("FAS 109"), "Accounting for Income
Taxes." Under the asset and liability method of FAS 109, deferred tax assets
and liabilities are recognized for the estimated future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates in effect for the
year in which those temporary differences are expected to be recovered or
settled. Under FAS 109, the effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.

The actual income tax expense attributable to earnings for the years ended June
30, 1996 and 1997, and June 28, 1998 differed from the amounts computed by
applying the U.S. federal tax rate of 34 percent to pretax earnings as a result
of the following:


                                      F-26

<PAGE>

                              CREE RESEARCH, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)



<TABLE>
<CAPTION>
                                                                                 YEARS ENDED
                                                                    --------------------------------------
                                                                     JUNE 30,       JUNE 30,      JUNE 28,
                                                                       1996           1997          1998
                                                                    ----------   -------------   ---------
                                                                                (IN THOUSANDS)
<S>                                                                 <C>          <C>             <C>
   Federal income tax provision at statutory rate (34%) .........     $   83       $ 1,265        $3,018
   State tax provision ..........................................         36           193           166
   Decrease in income tax expense resulting from:
    Foreign sales corporation ...................................         --            --          (214)
    Decrease in valuation allowance .............................       (106)       (1,279)         (358)
    Other .......................................................        (13)           (2)          (12)
                                                                      ------       ----------     ------
   Income tax expense ...........................................     $   --       $   177        $2,600
                                                                      ======       =========      ======
</TABLE>


The following are the components of the provision for income taxes:



<TABLE>
<CAPTION>
                                                                                           YEARS ENDED
                                                                                      ---------------------
                                                                                       JUNE 30,    JUNE 28,
                                                                                         1997        1998
                                                                                      ---------   ---------
                                                                                         (IN THOUSANDS)
<S>                                                                                   <C>         <C>
   Current:                                                                     
    Federal .......................................................................    $   54      $  699
    Foreign tax withholding .......................................................       220          50
    State .........................................................................        95         269
                                                                                       ------      ------
                                                                                          369       1,018
   Deferred:                                                                    
    Federal .......................................................................      (442)      1,582
    State .........................................................................       250          --
                                                                                       ------      ------
                                                                                         (192)      1,582
                                                                                       ------      ------
   Net provision ..................................................................    $  177      $2,600
                                                                                       ======      ======
</TABLE>
                                                    

There is no tax provision for fiscal 1996.

                                      F-27

<PAGE>

                              CREE RESEARCH, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are as follows:


<TABLE>
<CAPTION>
                                                             JUNE 30,     JUNE 28,
                                                               1997         1998
                                                           -----------   ---------
                                                               (IN THOUSANDS)
<S>                                                        <C>           <C>
   Deferred tax assets:
   Net operating loss carryforwards ....................    $  2,413      $1,304
   Research tax credits ................................         157         169
   Compensation ........................................         115          62
   Inventory ...........................................         199         120
   Bad debt ............................................          84          56
   Goodwill ............................................          31          --
   Alternative minimum tax .............................          64         261
   Foreign tax credit ..................................         220         270
   Other ...............................................          10          --
                                                            --------      ------
   Total gross deferred tax assets .....................       3,293       2,242
   Less valuation allowance ............................      (1,463)       (290)
                                                            --------      ------
   Net deferred tax asset ..............................       1,830       1,952
   Deferred tax liabilities:
   Property and equipment, due to depreciation .........       1,638       2,154
                                                            --------      ------
   Gross deferred tax liabilities ......................       1,638       2,154
                                                            --------      ------
   Net deferred tax asset (liability) ..................    $    192      $ (202)
                                                            ========      ======
</TABLE>


The net change in the total valuation allowance for the years ended June 30,
1997 and June 28, 1998 was $1,201,000 and $1,173,000, respectively. Included in
the valuation allowance is $815,000 and $0, respectively, for 1997 and 1998 to
offset net operating losses ("NOL") generated by the exercise of stock options.
The reduction in the valuation allowance does not impact the 1998 tax provision
as such taxes are reflected in additional paid in capital. The primary reason
for the reduction in the valuation allowance in 1997 and 1998 was the greater
likelihood of the utilization of future tax benefits from net operating loss
carryforwards. Realization of deferred tax assets associated with the NOL
carryforwards is dependent upon the Company generating sufficient taxable
income prior to their expiration. Management believes that there is a risk that
certain of the state NOL carryforwards may expire unused and, accordingly, has
established a valuation allowance against them. Although realization is not
assured for the remaining deferred tax assets, management believes it is more
likely than not that they will be realized through future taxable earnings.
However, the net deferred tax assets could be reduced in the future if
management's estimates of taxable income during the carryforward period are
significantly reduced.

As of June 28, 1998, the Company has net operating loss carryforwards for
Federal purposes of $3,493,000 and $2,346,000 for state purposes. The
carryforward expiration period is 2011 to 2013 for Federal tax purposes and
from 2000 to 2003 for state purposes.


10. ACQUISITION

In August 1994, the Company formed a North Carolina wholly-owned subsidiary,
RCD, to develop and market full color LED displays. Subsequently, RCD acquired
the net assets of Color Cells International, Ltd., a Hong-Kong based company in
this line of business, for cash consideration of $215,000 and assumption of
$152,000 of liabilities. The terms of the acquisition called for an "Earn-Out
Payment" based on calculated net profits, payable half in cash and half in Cree
common stock. Earn-Out Payments were subject to certain


                                      F-28

<PAGE>

                              CREE RESEARCH, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

limitations concerning the timing (calculation based on certain eligible
shipments through September 1997) and amount (maximum payments of $1.8 million)
of any such payments. As of the end of the earn-out period in September 1997,
no amounts had been earned or paid under this agreement.


11. RETIREMENT PLAN

The Company maintains an employee benefit plan (the "Plan") pursuant to Section
401(k) of the Internal Revenue Code. Under the Plan, there is no fixed dollar
amount of retirement benefits, and actual benefits received by employees will
depend on the amount of each employee's account balance at the time of
retirement. All employees are eligible to participate under the Plan on the
first day of a new fiscal quarter after date of hire. The Plan is not insured
by the Pension Benefit Guaranty Corporation.

The Company may, at its discretion, make contributions to the Plan. However,
the Company did not make any contributions to the Plan during the years ended
June 30, 1996, 1997 or June 28, 1998.


12. CONTINGENCIES

The consolidated securities class action lawsuits previously pending against
the Company and certain of its directors and officers in the U.S. District
Court for the Middle District of North Carolina were dismissed with prejudice
on November 28, 1997. The dismissal was pursuant to a stipulation of the named
parties entered after the court granted the defendant's motions to dismiss the
consolidated complaint for failure to state a claim. No payments were made to
the plaintiffs to obtain the dismissal. By stipulating to the dismissal with
prejudice, the plaintiffs waived any right to re-file the action or to appeal
the court's order of dismissal.


13. EARNINGS PER SHARE

The Company has adopted Statement of Financial Accounting Standards (SFAS) No.
128, "Earnings Per Share," as of December 28, 1997. SFAS No. 128 required the
Company to change its method of computing, presenting and disclosing earnings
per share information. All prior period data presented has been restated to
conform to the provisions of SFAS No. 128.

The following computation reconciles the differences between the basic and
diluted presentations:



<TABLE>
<CAPTION>
                                                                                 YEARS ENDED
                                                             ---------------------------------------------------
                                                                 JUNE 30,          JUNE 30,          JUNE 28,
                                                                   1996              1997              1998
                                                             ---------------   ---------------   ---------------
                                                                    (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                          <C>               <C>               <C>
   Basic:
   Net income ............................................    $        243      $      3,542      $      6,275
                                                              ============      ============      ============
   Weighted average common shares ........................          11,826            12,455            12,863
                                                              ============      ============      ============
   Basic income per common share .........................    $       0.02      $       0.28      $       0.49
                                                              ============      ============      ============
   Diluted:
   Net income ............................................    $        243      $      3,542      $      6,275
                                                              ============      ============      ============
   Weighted average shares:
   Common shares outstanding .............................          11,826            12,455            12,863
   Dilutive effect of stock options and warrants .........             789               670               631
                                                              ------------      ------------      ------------
   Total shares and common share equivalents .............          12,615            13,126            13,493
                                                              ============      ============      ============
   Diluted income per common share .......................    $       0.02      $       0.27      $       0.47
                                                              ============      ============      ============
</TABLE>


                                      F-29

<PAGE>

                              CREE RESEARCH, INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

14. NEW ACCOUNTING PRONOUNCEMENTS

The Company will adopt Statement of Financial Accounting Standards No. 130
"Reporting Comprehensive Income" ("SFAS No. 130") for the year ended June 27,
1999. SFAS No. 130 requires the Company to display an amount representing total
comprehensive income for the period in a financial statement which is displayed
with the same prominence as other financial statements. Upon adoption, all
prior period data presented will be restated to conform to the provisions of
SFAS No. 130. The application of the new pronouncement is not expected to have
a material impact on the Company's financial statements.

The Company will adopt Statement of Financial Accounting Standards No. 131
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
No. 131") for the year ended June 27, 1999. SFAS No. 131 requires the Company
to report selected information about operating segments in its financial
statements. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. The application of
the new pronouncement is not expected to have a material impact on the
Company's disclosures.


                                      F-30

<PAGE>


                                  (CREE LOGO)

                                 
 
                              CREE RESEARCH, INC.


                                1,300,000 SHARES


                                  COMMON STOCK





                               -----------------
                                   PROSPECTUS
                               -----------------
                                       , 1999




                               CIBC OPPENHEIMER




                       PRUDENTIAL SECURITIES INCORPORATED




                         MORGAN KEEGAN & COMPANY, INC.



- --------------------------------------------------------------------------------
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO
DEALER, SALESPERSON OR OTHER PERSON IS AUTHORIZED TO GIVE INFORMATION THAT IS
NOT CONTAINED IN THIS PROSPECTUS. THIS PROSPECTUS IS NOT AN OFFER TO SELL NOR
IS IT SEEKING AN OFFER TO BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE
OFFER OR SALE IS NOT PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS
CORRECT ONLY AS OF THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF THE
DELIVERY OF THIS PROSPECTUS OR ANY SALE OF THESE SECURITIES.


<PAGE>

 
                                   PART II

                    INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table sets forth the expenses of the Company payable in
connection with the issuance and distribution of the Common Stock being
registered hereby, excluding underwriting discounts and commission. All
expenses of the offering will be borne by the Company. All amounts shown are
estimates except the SEC registration fee, the NASD filing fee and the Nasdaq
fee:



<TABLE>
<S>                                                               <C>
       SEC Registration Fee ...................................    $ 17,431
       NASD Filing Fee ........................................       6,770
       Nasdaq Fee .............................................      17,500
       Printing and Engraving Expenses ........................     125,000
       Legal Fees and Expenses ................................     250,000
       Accounting Fees ........................................     175,000
       Blue Sky Expenses ......................................      10,000
       Transfer Agent and Registrar Fees and Expenses .........       5,000
       Miscellaneous Expenses .................................      43,299
                                                                   --------
          Total ...............................................    $650,000
                                                                   ========
</TABLE>


ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS

Sections 55-8-50 through 55-8-58 of the North Carolina Business Corporation Act
permit a corporation to indemnify its directors, officers, employees or agents
under either or both a statutory or nonstatutory scheme of indemnification.
Under the statutory scheme, a corporation may, with certain exceptions,
indemnify a director, officer, employee or agent of the corporation who was,
is, or is threatened to be made, a party to any threatened, pending or
completed legal action, suit or proceeding, whether civil, criminal,
administrative, or investigative, because of the fact that such person was a
director, officer, agent or employee of the corporation, or is or was serving
at the request of such corporation as a director, officer, employee or agent of
another corporation or enterprise. This indemnity may include the obligation to
pay any judgment, settlement, penalty, fine (including an excise tax assessed
with respect to an employee benefit plan) and reasonable expenses incurred in
connection with a proceeding (including counsel fees), but no such
indemnification may be granted unless such director, officer, agent or employee
(i) conducted himself in good faith, (ii) reasonably believed (1) that any
action taken in his official capacity with the corporation was in the best
interest of the corporation or (2) that in all other cases his conduct at least
was not opposed to the corporation's best interest and (iii) in the case of any
criminal proceeding, had no reasonable cause to believe his conduct was
unlawful. Whether a director has met the requisite standard of conduct for the
type of indemnification set forth above is determined by the board of
directors, a committee of directors, special legal counsel or the shareholders
in accordance with Section 55-8-55. A corporation may not indemnify a director
under the statutory scheme in connection with a proceeding by or in the right
of the corporation in which the director was adjudged liable to the corporation
or in connection with a proceeding in which a director was adjudged liable on
the basis of having received an improper personal benefit.

In addition to, and separate and apart from the indemnification described above
under the statutory scheme, Section 55-8-57 of the North Carolina Business
Corporation Act permits a corporation to indemnify or agree to indemnify any of
its directors, officers, employees or agents against liability and expenses
(including attorney's fees) in any proceeding (including proceedings brought by
or on behalf of the corporation) arising out of their status as such or their
activities in such capacities, except for any liabilities or expenses incurred
on account of activities that were, at the time taken, known or believed by the
person to be clearly in conflict with the best interests of the corporation.
The Company's bylaws provide for indemnification to the fullest extent
permitted under the North Carolina Business Corporation Act, provided, however,
that the Company will indemnify any person seeking indemnification in
connection with a proceeding initiated by such person only if such proceeding
was authorized by the Board of Directors of the Company. Accordingly,


                                      II-1

<PAGE>

the Company may indemnify its directors, officers and employees in accordance
with either the statutory or the non-statutory standard.

Sections 55-8-52 and 55-8-56 of the North Carolina Business Corporation Act
require a corporation, unless its articles of incorporation provide otherwise,
to indemnify a director or officer who has been wholly successful, on the
merits or otherwise, in the defense of any proceeding to which such director or
officer was a party. Unless prohibited by the articles of incorporation, a
director or officer also may make application and obtain court-ordered
indemnification if the court determines that such director or officer is fairly
and reasonably entitled to such indemnification as provided in Sections 55-8-54
and 55-8-56.

Finally, Section 55-8-57 of the North Carolina Business Corporation Act
provides that a corporation may purchase and maintain insurance on behalf of an
individual who is or was a director, officer, employee or agent of the
corporation against certain liabilities incurred by such persons, whether or
not the corporation is otherwise authorized by the North Carolina Business
Corporation Act to indemnify such party. The Company's directors and officers
are currently covered under directors' and officers' insurance policies
maintained by the Company.

As permitted by North Carolina law, Article VII of the Company's Articles of
Incorporation limits the personal liability of directors for monetary damages
for breaches of duty as a director provided that such limitation will not apply
to (i) acts or omissions not made in good faith that the director at the time
of the breach knew or believed were in conflict with the best interests of the
Company, (ii) any liability for unlawful distributions under N.C. Gen. Stat.
Section 55-8-33, (iii) any transaction from which the director derived an
improper personal benefit, or (iv) acts or omissions occurring prior to the
date the provision became effective.

Section 7 of the Underwriting Agreement to be filed as Exhibit 1.01 hereto also
contains certain provisions pursuant to which certain officers, directors and
controlling persons of the Company may be entitled to be indemnified by the
underwriters named therein.


ITEM 16. EXHIBITS

The following documents (unless indicated) are filed herewith and made a part
of this Registration Statement.



<TABLE>
<CAPTION>
     EXHIBIT
      NUMBER        DESCRIPTION OF EXHIBIT
- -----------------   ----------------------
<S>                 <C>
    1.01*           Form of Underwriting Agreement
    4.01 (1)        Specimen Common Stock Certificate
    4.02            Amended and Restated Articles of Incorporation
    4.03            Amended and Restated Bylaws
    5.01            Opinion of Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P.
   23.01            Consent of PricewaterhouseCoopers LLP
   23.02            Consent of Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P. (included in
                    Exhibit 5.01 hereto)
   24.01            Powers of Attorney (see page II-5)
   27.01            Financial Data Schedule
</TABLE>


- -------------------
(1)  Exhibit 4.2 to the Company's Registration Statement on Form SB-2, File No.
     33-55998, declared effective by the Securities and Exchange Commission on
     Febuary 8, 1993, and incorporated herein by reference.

*    To be filed by amendment.

ITEM 17. UNDERTAKINGS

1. The undersigned Registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
Registrant's annual report pursuant to section 13(a) or section 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's


                                      II-2

<PAGE>

annual report pursuant to section 15(d) of the Securities Exchange Act of 1934)
that is incorporated by reference in the registration statement 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. 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 provisions described in Item 15 above, 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 the 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 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.

3. 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 a 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; and (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 bone fide offering
thereof.


                                      II-3

<PAGE>


                                  SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Durham, State of North Carolina, on January 14,
1999.

                                        CREE RESEARCH, INC.

                                        BY: /s/  F. NEAL HUNTER
                                           ------------------------------------
                                                 F. NEAL HUNTER
                                           CHAIRMAN AND CHIEF EXECUTIVE OFFICER

                                      II-4

<PAGE>

                               POWER OF ATTORNEY

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints F. Neal Hunter and Cynthia B. Merrell and each of
them, each with full power to act without the other, his true and lawful
attorneys-in-fact and agents, with full powers of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any or all amendments to this registration statement, to
sign any related abbreviated registration statement filed pursuant to Rule
462(b) of the Securities Act of 1933, and to file the same, with all exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully for all intents and
purposes as he or she might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or their substitutes,
may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Act of 1933, this Registration
Statement has been signed by the following persons on January 14, 1999 in the
capacities indicated.



<TABLE>
<CAPTION>
                  SIGNATURE                                     TITLE
                  ---------                                     -----                   
<S>                                            <C>
    /s/  F. NEAL HUNTER                        Chairman and Chief Executive Officer
    --------------------------------------
    F. NEAL HUNTER

    /s/  CYNTHIA B. MERRELL                    Chief Financial Officer and Treasurer
    --------------------------------------     (Chief Accounting and Financial 
    CYNTHIA B. MERRELL                         Officer)                        

                                               
    /s/  CALVIN H. CARTER, JR., PH.D.          Director
    --------------------------------------
    CALVIN H. CARTER, JR., PH.D.

    /s/  JAMES E. DYKES                        Director
    --------------------------------------
    JAMES E. DYKES

    /s/  MICHAEL W. HALEY                      Director
    --------------------------------------
    MICHAEL W. HALEY

    /s/  WALTER L. ROBB, PH.D.                 Director
    --------------------------------------
    WALTER L. ROBB, PH.D.

    /s/  DOLPH W. VON ARX                      Director
    --------------------------------------
    DOLPH W. VON ARX

    /s/  JOHN W. PALMOUR, PH.D.                Director
    --------------------------------------
    JOHN W. PALMOUR, PH.D.
</TABLE>



                                      II-5

<PAGE>


                                 EXHIBIT INDEX



<TABLE>
<CAPTION>
     EXHIBIT
      NUMBER                                  DESCRIPTION OF EXHIBIT
- -----------------                             ----------------------
<S>                 <C>
    1.01*           Form of Underwriting Agreement
    4.01 (1)        Specimen Common Stock Certificate
    4.02            Amended and Restated Articles of Incorporation
    4.03            Amended and Restated Bylaws
    5.01            Opinion of Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P.
   23.01            Consent of PricewaterhouseCoopers LLP
   23.02            Consent of Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P.
                    (included in Exhibit 5.01 hereto)
   24.01            Powers of Attorney (see page II-5)
   27.01            Financial Data Schedule
</TABLE>


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

(1)  Exhibit 4.2 to the Company's Registration Statement on Form SB-2, File No.
     33-55998, as declared effective by the Securities and Exchange Commission
     on Febuary 8, 1993, and incorporated herein by reference. .

*    To be filed by amendment





                                                                    EXHIBIT 4.02

                             ARTICLES OF RESTATEMENT

                                       OF
                            ARTICLES OF INCORPORATION
                                       OF
                               CREE RESEARCH, INC.


Pursuant to Section 55-10-07 of the General Statutes of North Carolina, the
undersigned corporation hereby submits the following for the purpose of amending
and restating its Articles of Incorporation:

1.    The name of the corporation is Cree Research, Inc.

2.    The text of the Restated Articles of Incorporation is attached.

3.    These Restated Articles of Incorporation contain amendments requiring
      shareholder approval, and shareholder approval was obtained as required by
      Chapter 55 of the North Carolina General Statutes at a meeting duly called
      for said purpose on November 3, 1998.

4.    The Restated Articles of Incorporation do not contain an amendment
      providing for the exchange, reclassification or cancellation of issued
      shares.

This the 5th day of November, 1998.

                                    CREE RESEARCH, INC.




                                    By: /s/  ADAM H. BROOME        
                                        -----------------------------
                                          Adam H. Broome, Secretary




<PAGE>


                       RESTATED ARTICLES OF INCORPORATION
                                       OF
                               CREE RESEARCH, INC.


                                    ARTICLE I

      The name of the Corporation is Cree Research, Inc.

                                   ARTICLE II

      The period of duration of the Corporation shall be perpetual.

                                   ARTICLE III

      The purpose for which the Corporation is organized is to engage in any
lawful act or activity
 for which corporations may be organized under Chapter 55
of the General Statutes of North Carolina.

                                   ARTICLE IV

      The aggregate number of shares of capital stock which the Corporation
shall have authority to issue is 33,000,000 shares divided into two classes
consisting of (a) 30,000,000 shares of Common Stock with a par value of $0.005
per share; and (b) 3,000,000 shares of Preferred Stock with a par value of $0.01
per share. The Board of Directors is authorized from time to time to establish
one or more series of Preferred Stock and to determine the preferences,
limitations and relative rights of the Preferred Stock before issuance of any
shares of that class and of any series of Preferred Stock before issuance of
shares of that series.

                                    ARTICLE V

      The number of directors of the Corporation may be fixed by the bylaws.

                                   ARTICLE VI

      There shall be no preemptive rights with respect to the shares of the
capital stock of the Corporation.

                                   ARTICLE VII

      No director of the Corporation shall have personal liability arising out
of an action whether by or in the right of the Corporation or otherwise for
monetary damages for breach of his or her duty as a director; provided, however,
that the foregoing shall not limit or eliminate the personal liability of a
director with respect to (i) acts or omissions not made in good faith that such
director at the time of such breach knew or believed were in conflict with the
best interests of the Corporation, (ii) any liability under Section 55-8-33 of
the North Carolina General Statutes or any successor provision, (iii) any
transaction from which such director derived an improper personal benefit or
(iv) acts or omissions occurring prior to the date of the effectiveness of this
Article. As used in this Article, the term "improper personal benefit" does not
include a director's compensation or other incidental benefit for or on account
of his or 


<PAGE>

her service as a director, officer, employee, independent contractor, attorney 
or consultant of the Corporation.

      Furthermore, notwithstanding the foregoing provision, in the event that
Section 55-2-02 or any other provision of the North Carolina General Statutes is
amended or enacted to permit further limitation or elimination of the personal
liability of a director, the personal liability of the Corporation's directors
shall be limited or eliminated to the fullest extent permitted by the applicable
law.

      This Article shall not affect a charter or bylaw provision or contract or
resolution of the Corporation indemnifying or agreeing to indemnify a director
against personal liability. Any repeal or modification of this Article shall not
adversely affect any limitation hereunder on the personal liability of a
director with respect to acts or omissions occurring prior to such repeal or
modification.

                                  ARTICLE VIII

      The name and address of the incorporator is Fred D. Hutchison, Suite 450,
2626 Glenwood Avenue, Raleigh, North Carolina 27608.


                                                                    EXHIBIT 4.03

                                     BYLAWS

                                       OF

                               CREE RESEARCH, INC.
                      (as amended through January 14, 1999)


                                    ARTICLE I
                                     OFFICES

1. Principal Office. The principal office of the Corporation shall be located in
Durham County, North Carolina or such other place as is designated by the Board
of Directors.

2. Registered Office. The registered office of the Corporation required by law
to be maintained in the State of North Carolina may be, but need not be,
identical with the principal office.

3. 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 or as the affairs of the Corporation may require.

                                   ARTICLE II
                            MEETINGS OF SHAREHOLDERS

1. Place of Meetings. All 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 or agreed upon by a majority of the shareholders entitled to vote
thereat.

2. Annual Meeting. The annual meeting of the shareholders shall be held at the
principal office of the Corporation at ten o'clock (10:00) a.m., on the first
Tuesday in October of each year if not a legal
 holiday, and if such, the next
secular day following, for the purpose of electing Directors of the Corporation
and for the transaction of such other business as may be properly brought before
the meeting close.

<PAGE>

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

4. Special Meetings. Special meetings of the shareholders may be called at any
time by the President, the Secretary or the Board of Directors of the
Corporation, or by any shareholder pursuant to the written request of the
holders of not less than one-tenth of all the shares entitled to vote at the
meeting.

5. Notice of Meetings.

   (a) Written or printed notice stating the time and place of the meeting shall
be delivered not less than ten (10) nor more than fifty (50) days before the
date thereof, either personally or by mail, by or at the direction of the
President, the Secretary, or other person calling the meeting, to each
shareholder of record entitled to vote at such meeting. If mailed, such notice
shall be deemed to be delivered when deposited in the United States mail
addressed to the shareholder at his address as it appears on the record of
shareholders of the Corporation, with postage thereon prepaid.

   (b) In the case of an annual or substitute annual meeting, the notice of
meeting need not specifically state the business to be transacted thereat unless
it is a matter, other than election of Directors, on which the vote of the
shareholders is expressly required by the provisions of the North Carolina
Business Corporation Act. In the case of a special meeting, the notice of
meeting shall specifically state the purpose or purposes for which the meeting
is called.

                                       2

<PAGE>

   (c) When a meeting is adjourned for thirty (30) days or more, notice of the
adjourned meeting shall be given as in the case of an original meeting. When a
meeting is adjourned for less than thirty (30) days in any one adjournment, it
is not necessary to give any notice of the time and place of the adjourned
meeting or of the business to be transacted thereat other than by announcement
at the meeting at which the adjournment is taken.

6. Voting Lists. At least ten (10) days before each meeting of shareholders the
Secretary of the Corporation shall prepare an alphabetical list of the
shareholders entitled to vote at such meeting or any adjournment thereof, with
the address of and number of shares held by each, which list shall be kept on
file at the registered office of the Corporation for a period of ten (10) days
prior to such meeting, and shall be subject to inspection by any shareholder at
any time during the usual business hours. This list shall also be produced and
kept open at the time and place of the meeting and shall be subject to
inspection by any shareholder during the whole time of the meeting.

7. Quorum.

   (a) Unless otherwise provided by law, the holders of a majority of the shares
entitled to vote, represented in person or by proxy, shall constitute a quorum
at a meeting of shareholders. In the absence of a quorum at the opening of any
meeting of shareholders, such meeting may be adjourned from time to time by the
vote of a majority of the shares voting on the motion to adjourn, but no other
business may be transacted until and unless a quorum is present. At any
adjourned meeting at which a quorum is present, any business may be transacted
which might have been transacted at the original meeting.

                                       3

<PAGE>

   (b) The shareholders at a meeting at which a quorum is present may continue
to do business until adjournment, notwithstanding the withdrawal of sufficient
shareholders to leave less than a quorum.

8. Voting of Shares

   (a) Each outstanding share having voting rights shall be entitled to one vote
on each matter submitted to a vote at a meeting of shareholders.

   (b) Except in the election of Directors, the vote of a majority of the shares
voted on any matter at a meeting of shareholders, duly held and at which a
quorum is present, shall be the act of the shareholders on that matter, unless
the vote by a greater number is required by law or by the charter or Bylaws of
the Corporation.

   (c) Voting on all matters except the election of Directors 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, prior to the voting on any matter, demand a
ballot vote on that particular matter.

9. Proxies. Shares may be voted either in person or by one or more agents
authorized by a written proxy executed by the shareholder or by his duly
authorized attorney-in-fact. A proxy is not valid after the expiration of eleven
(11) months from the date of its execution, unless the person executing it
specifies therein the length of time for which it is to continue in force, or
limits its use to a particular meeting, but no proxy, whether or not designated
as irrevocable, shall be valid after ten (10) years from the date of its
execution, unless renewed or extended at any time before its expiration for not
more than ten (10) years from the date of such renewal or extension.

                                       4

<PAGE>

Section 10.  Notice of Shareholder Business and Nominations.

      (a)   Annual Meetings of Shareholders.

            (i) Nominations of persons for election to the Board of Directors of
the Corporation and the proposal of business to be considered by the
shareholders may be made at an annual meeting of shareholders: (a) pursuant to
the notice of meeting pursuant to Article II, Section 5 of these Bylaws; (b) by
or at the direction of the Board of Directors; or (c) by any shareholder of the
Corporation who was a shareholder of record at the time of giving of notice
provided for in this Bylaw (Article II, Section 10), who is entitled to vote at
the meeting and who complies with the notice procedures set forth in this Bylaw.

            (ii) For nominations or other business to be properly brought before
an annual meeting by a shareholder pursuant to clause (c) of paragraph (a)(i) of
this Bylaw, the shareholder must have given timely notice thereof in writing to
the Secretary of the Corporation and such other business must otherwise be a
proper matter for shareholder action. To be timely, a shareholder's notice shall
be delivered to the Secretary at the principal executive offices of the
Corporation not later than the close of business on the 60th calendar day nor
earlier than the close of business on the 90th calendar day prior to the first
anniversary of the preceding year's annual meeting; PROVIDED, HOWEVER, that in
the event that the date of the annual meeting is more than 30 calendar days
before or more than 60 calendar days after such anniversary date, notice by the
shareholder to be timely must be so delivered not earlier than the close of
business on the 90th calendar day prior to such annual meeting and not later
than the close of business on the later of the 60th calendar day prior to such
annual meeting or the 10th calendar day following the calendar day on which
public announcement of


                                       5

<PAGE>

the date of such meeting is first made by the Corporation. In no event shall the
public announcement of an adjournment of an annual meeting commence a new time
period for the giving of a shareholder's notice as described above. Such
shareholder's notice shall set forth: (a) as to each person whom the shareholder
proposes to nominate for election or reelection as a director all information
relating to such person that is required to be disclosed in solicitations of
proxies for election of directors in an election contest, or is otherwise
required, in each case pursuant to Regulation 14A under the Securities Exchange
Act of 1934, as amended (the "Exchange Act") and Rule 14a-11 thereunder
(including such person's written consent to being named in the proxy statement
as a nominee and to serving as a director if elected); (b) as to any other
business that the shareholder proposes to bring before the meeting, a brief
description of the business desired to be brought before the meeting, the
reasons for conducting such business at the meeting and any material interest in
such business of such shareholder and the beneficial owner, if any, on whose
behalf the proposal is made; and (c) as to the shareholder giving the notice and
the beneficial owner, if any, on whose behalf the nomination or proposal is made
the name and address of such shareholder, as they appear on the Corporation's
books, and of such beneficial owner and the class and number of shares of the
Corporation which are owned beneficially and of record by such shareholder and
such beneficial owner.

      (b)   Special Meetings of Shareholders.

            (i) Only such business shall be conducted at a special meeting of
shareholders as shall have been brought before the meeting pursuant to the
notice of meeting under Article II, Section 5 of these Bylaws. If directors are
to be elected at a special meeting of shareholders pursuant to the notice of
meeting, nominations of persons for election to the Board of 


                                       6

<PAGE>

Directors at such meeting may be made (a) by or at the direction of the Board of
Directors, or (b) by any shareholder of the Corporation who is a shareholder of
record at the time of giving of notice provided for in this Bylaw, who shall be
entitled to vote at the meeting and who complies with the notice procedures set
forth in this Bylaw.

            (ii) In the event a special meeting of shareholders is called for
the purpose of electing one or more directors to the Board of Directors, any
shareholder may, pursuant to clause (b) above, nominate a person or persons (as
the case may be) for election to such position(s) as specified in the notice of
meeting, if the shareholder shall have delivered notice containing the
information specified in paragraph (a)(ii) of this Bylaw to the Secretary at the
principal executive offices of the Corporation not earlier than the close of
business on the 90th calendar day prior to such special meeting and not later
than the close of business on the later of the 60th calendar day prior to such
special meeting or the 10th calendar day following the day on which public
announcement is first made of the date of the special meeting and of the
nominees proposed by the Board of Directors to be elected at such meeting. In no
event shall the public announcement of an adjournment of a special meeting
commence a new time period for the giving of a shareholder's notice as described
above.

      (c)   General.

            (i) Only such persons who are nominated in accordance with the
procedures set forth in this Bylaw shall be eligible to serve as directors and
only such business shall be conducted at a meeting of shareholders as shall have
been brought before the meeting in accordance with the procedures set forth in
this Bylaw. Except as otherwise provided by law, the Articles of Incorporation
or these Bylaws, the Chairman of the meeting shall 


                                       7

<PAGE>

have the power and duty to determine whether a nomination or any business
proposed to be brought before the meeting was made or proposed, as the case may
be, in accordance with the procedures set forth in this Bylaw and, if any
proposed nomination or business is not in compliance with this Bylaw, to declare
that such defective proposal or nomination shall be disregarded.

            (ii) For purposes of this Bylaw, "public announcement" shall mean
disclosure in a press release reported a national news service or in a document
publicly filed by the Corporation with the Securities and Exchange Commission
pursuant to Section 13, 14 or 15(d) of the Exchange Act.

            (iii) Notwithstanding the foregoing provisions of this Bylaw, a
shareholder shall also comply with all applicable requirements of the Exchange
Act and the rules and regulations thereunder with respect to the matters set
forth in this Bylaw. Nothing in this Bylaw shall be deemed to affect any rights
of shareholders to request inclusion of proposals in the Corporation's proxy
statement pursuant to Rule 14a-8 under the Exchange Act.

11. Informal Action by Shareholders. Any action which is required or permitted
to be taken at a meeting of the shareholders may be taken without a meeting if a
consent in writing, setting forth the action so taken, shall be signed by all of
the persons who would be entitled to vote upon such action at a meeting, and
filed with the Secretary of the Corporation to be kept in the Corporate Minute
Book, whether done before or after the action so taken. Such consent shall have
the same force and effect as a unanimous vote of shareholders.


                                       8

<PAGE>

                                   ARTICLE III
                                    DIRECTORS

1. General Powers. The business and affairs of the Corporation shall be managed
by the Board of Directors or by such committees as the Board may establish
pursuant to these Bylaws.

2. Number, Term and Qualification. The number of Directors of the Corporation
shall be not less than three (3), the exact number of which shall be determined
from time to time by resolution of the shareholders. Each Director shall hold
office until his death, resignation, retirement, removal, disqualification, or
his successor is elected and qualifies. Directors need not be residents of the
State of North Carolina or shareholders of the Corporation.

3. Election of Directors. Except as provided in paragraph 6 of this Article III,
the Directors shall be elected at the annual meeting of shareholders; and those
persons who receive the highest number of votes shall be deemed to have been
elected. If any shareholder so demands, election of Directors shall be by
ballot.

4. Cumulative Voting. At each election for Directors, every shareholder entitled
to vote at such election shall have the right to vote, in person or by proxy,
the number of shares standing of record in his name for as many persons as there
are Directors to be elected and for whose election he has a right to vote, or to
cumulate his vote by giving one candidate as many votes as the number of such
Directors multiplied by the number of his shares shall equal, or by distributing
such votes on the same principle among any number of such candidates. This right
of cumulative voting shall not be exercised unless some shareholder or proxy
holder announces in open meeting, before the voting for Directors starts, his
intention so to vote cumulatively; and if such announcement is made, the chair
shall declare that all 


                                       9

<PAGE>

shares entitled to vote have the right to vote cumulatively and shall announce
the number of shares present in person and by proxy and shall thereupon grant a
recess of not less than one hour nor more than four hours, as he shall
determine, or of such other period of time as is unanimously then agreed upon.

5. Removal. Directors may be removed from office with or without cause by a vote
of shareholders holding a majority of the outstanding shares entitled to vote at
an election of Directors; provided, however, unless the entire Board is removed,
an individual Director may not be removed if the number of shares voting against
the removal would be sufficient to elect a Director if such shares were voted
cumulatively at an annual election. If any Directors are so removed, new
Directors may be elected at the same meeting.

6. Vacancies. A vacancy occurring in the Board of Directors, including a vacancy
created by an increase in the authorized number of Directors approved by the
shareholders in accordance with these Bylaws, may be filled by a majority of the
remaining Directors, though less than a quorum, or by the sole remaining
Director. The shareholders may elect a Director at any time to fill any vacancy
not filled by the Directors.

7. Chairman. There may be a Chairman of the Board of Directors elected by the
Directors from their number at any meeting of the Board. The Chairman shall
serve as an officer of the Corporation as provided in Article V and shall
preside at all meetings of the shareholders and of the Board of Directors and
perform such other duties as may be directed by the Board of Directors.

8. Compensation. The Board of Directors may compensate Directors for their
services as such and may provide for the payment of all expenses incurred by
Directors in attending regular and special meetings of the Board.

                                       10

<PAGE>

9.    Executive and Other Committees.

      (a) The Board of Directors, by resolution adopted by a majority of the
number of Directors then in office, may designate from among its members an
Executive Committee and one or more other committees, each consisting of two or
more directors, and each of which, to the extent provided in the resolution,
shall have and may exercise all of the authority of the Board of Directors,
except no such committee shall have authority as to the following matters:

            (i) The dissolution, merger or consolidation of the Corporation; or
the sale, lease or exchange of all or substantially all of the property of the
Corporation.

            (ii) The designation of any such committee or the filling of
vacancies in the Board of Directors or on any such committee.

            (iii) The fixing of compensation of the Directors for serving on the
Board or on any such committee.

            (iv) The amendment or repeal of the Bylaws or adoption of new
Bylaws.

            (v) The amendment or repeal of any resolution of the Board which by
its terms shall not be so amendable or repealable.

      (b) Any such committee, or any member thereof, may be discharged or
removed by action of the majority of the Board of Directors. Any resolutions
adopted or other action taken by any such committee within the scope of the
authority delegated to it by the Board of Directors shall be deemed for all
purposes to be adopted or taken by the Board of Directors.

                                       11

<PAGE>

                                   ARTICLE IV
                              MEETINGS OF DIRECTORS

1. Regular Meetings. A regular meeting of the Board of Directors shall be held
immediately after, and at the same place as, the annual meeting of shareholders.
In addition, the Board of Directors may provide, by resolution, the time and
place, either within or without the State of North Carolina, for the holding of
additional regular meetings.

2. Special Meetings. Special meetings of the Board of Directors may be called by
or at the request of the Chairman of the Board, if one has been duly elected,
the President or any two Directors. Such meetings may be held either within or
without the State of North Carolina.

3. Notice of Meetings.

   (a) The Secretary shall give notice, at least two days before the meeting, by
any usual means of communication of any regular meeting of the Board of
Directors.

   (b) The person or persons calling a special meeting of the Board of Directors
shall, at least two days before the meeting, give notice thereof by any usual
means of communication. Such notice or waiver of notice shall specify the
business to be transacted at, or the purpose of, the meeting that is called.
Notice of an adjourned meeting need not be given if the time and place are fixed
at the meeting adjourning and if the period of adjournment does not exceed ten
(10) days in any one adjournment.

   (c) Attendance by a Director at a meeting shall constitute a waiver of notice
of such meeting, except where a Director attends a meeting for the express
purpose of objecting to the transaction of any business because the meeting is
not lawfully called or convened.

                                       12

<PAGE>

4. Quorum. A majority of the Directors in office shall constitute a quorum for
the transaction of business at any meeting of the Board of Directors.

5. Manner of Acting.

   (a) Except as otherwise provided in Paragraph 5, the act of a majority of the
Directors then in office shall be the act of the Board of Directors, unless a
greater number is required by law, the charter of the Corporation, or a Bylaw
adopted by the shareholders.

   (b) The vote of a majority of the number of Directors then in office shall be
required to adopt a resolution constituting an Executive Committee or other
committee of the Board. The vote of a majority of the Directors then holding
office shall be required to adopt, amend or repeal a Bylaw, or to adopt a
resolution dissolving the Corporation without action by the shareholders, in
circumstances authorized by law. Vacancies in the Board of Directors may be
filled as provided in paragraph 6 of Article III of these Bylaws.

6. Informal Action by Directors. Action taken by the Directors or members of a
committee of the Board of Directors without a meeting is nevertheless Board or
committee action if written consent to the action in question is signed by all
of the Directors or members of the committee, as the case may be, and filed with
the minutes of the proceedings of the Board or committee, whether done before or
after the action so taken.

7. Attendance by Telephone. Any one or more Directors or members of a committee
may participate in a meeting of the Board or committee by means of a conference
telephone or similar communications device which allows all persons
participating in


                                       13

<PAGE>

the meeting to hear each other, and such participation in the meeting shall be
deemed presence in person at such meeting.

                                    ARTICLE V
                                    OFFICERS

1. Officers. The officers of the Corporation shall consist of a Chairman, a
President, a Secretary, a Treasurer and such other officers (including, without
limitation, one or more Executive Vice Presidents, Vice Presidents, Assistant
Secretaries and Assistant Treasurers) as may from time to time be appointed in
accordance with these Bylaws. The Chairman shall be chosen from among the
directors.

2. Appointment and Term. The Chairman, the President and any Executive Vice
Presidents shall be appointed by the Board of Directors. Other officers may be
appointed either by the Board of Directors or by the Chairman. The Board of
Directors may appoint officers at any regular meeting or at any special meeting
called for such purpose. Each officer shall hold office until his death,
resignation, retirement, removal or disqualification, or until his successor is
appointed and qualifies.

3. Removal. Any officer or other agent appointed by the Board of Directors may
be removed by the Board, with or without cause, and any officer or other agent
appointed by the Chairman may be removed either by the Board or by the Chairman,
with or without cause. Such removal shall be without prejudice to the contract
rights, if any, of the person so removed.

4. Chairman. The Chairman shall be the chief executive officer of the
Corporation. Subject to the direction of the Board of Directors, he shall have
general executive charge, management and control of the properties, business and
operations of the 


                                       14

<PAGE>

Corporation with all such powers as may be reasonably incident to such
responsibilities. He may sign certificates for shares of capital stock of the
Corporation and may agree upon and execute leases, contracts, evidences of
indebtedness and other obligations in the name of the Corporation, and any
deeds, mortgages, bonds or other instruments which may be lawfully executed on
behalf of the Corporation, except where required by law to be otherwise signed
or executed and except where the signing and execution thereof shall be
delegated by the Board of Directors to some other officer or agent. He shall
have such other powers and duties as from time to time may be assigned to him by
the Board of Directors.

5. President. The President shall be the chief operating officer of the
Corporation. Subject to the direction of the Chairman, he shall supervise the
day-to-day operation of the Corporation, shall act in a general executive
capacity and shall assist the Chairman in the administration and operation of
the Corporation's business and general supervision of its policies and affairs.
Unless the Board of Directors otherwise determines, the President shall have the
authority to sign certificates for shares of capital stock of the Corporation
and may agree upon and execute leases, contracts, evidences of indebtedness and
other obligations in the name of the Corporation, and any deeds, mortgages,
bonds or other instruments which may be lawfully executed on behalf of the
Corporation, except where required by law to be otherwise signed or executed and
except where the signing and execution thereof shall be delegated by the Board
of Directors to some other officer or agent. Unless the Board of Directors
otherwise determines, the President shall, in the absence of or because of the
inability to act of the Chairman, perform all duties of the Chairman and preside
at all meetings of shareholders and (should he be a director) of the Board of

                                       15

<PAGE>

Directors. He shall have such other powers and duties as from time to time may
be assigned to him by the Board of Directors or the Chairman.

6. Executive Vice Presidents. The Executive Vice Presidents, in the order of
their appointment unless otherwise determined by the Board of Directors, shall,
in the absence or disability of the President, perform the duties and exercise
the powers of that office. In addition, they shall perform such other duties and
have such other powers as the Board of Directors or the Chairman shall
prescribe.

7. Vice Presidents. The Vice Presidents shall perform such duties and have such
powers as the Board of Directors or the Chairman or President shall prescribe.

8. Secretary. The Secretary shall keep accurate records of the acts and
proceedings of all meetings of shareholders, directors and committees. He shall
give all notices required by law and by these Bylaws. He shall have general
charge of the corporate books and records and of the corporate seal, and he
shall affix the corporate seal to any lawfully executed instrument requiring it.
He shall have general charge of the stock transfer books of the Corporation and
shall keep, at the registered or principal office of the Corporation or at the
offices of any transfer agent designated by 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. He shall sign such instruments as may require
his signature, and, in general, attest the signature or certify the incumbency
or signature of any other officer of the Corporation and shall perform all
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 Chairman.

                                       16

<PAGE>

9. 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 Chairman. The Treasurer shall keep full and accurate
accounts of the finances of the Corporation in books especially provided for
that purpose, 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 finan- cial statements. If financial statements are prepared
for the Corporation on the basis of generally accepted accounting prin- ciples,
the annual financial statements must also be prepared on that basis. The
Treasurer shall, in general, perform all duties incident to such office and such
other duties as may be assigned from time to time by the Board of Directors or
the Chairman.

10. Assistant Secretaries and Treasurers. The Assistant Secretaries and
Assistant Treasurers shall, in the absence or disability of the Secretary or the
Treasurer, perform the respective duties and exercise the respective powers of
those offices, and they shall, in general, perform such other duties as shall be
assigned to them by the Board of Directors or Chairman, or by the Secretary or
the Treasurer, respectively.

11. Bonds. The Board of Directors, by resolution, may require any or all
officers, agents and employees of the Corporation to give bond to the
Corporation, with sufficient sureties, conditioned on the faithful performance
of the duties of their respective offices or positions, and to comply with such
other conditions as may from time to time be required by the Board of Directors.


                                       17

<PAGE>

12. Action With Respect to Securities of Other Corporations. Unless otherwise
directed by the Board of Directors, the Chairman shall have power to vote and
otherwise act on behalf of the Corporation, in person or by proxy, at any
meeting of security holders of or with respect to any action of security holders
of any other corporation in which this Corporation may hold securities and
otherwise to exercise any and all rights and powers which this Corporation may
possess by reason of its ownership of securities in such other corporation.

                                   ARTICLE VI
                          CONTRACTS, LOANS AND DEPOSITS

1. Contracts. The Board of Directors may authorize any officer or officers, or
agent or agents, to enter into any contract or execute and deliver any
instrument on behalf of the Corporation, and such authority may be general or
confined to specific instances.

2. Loans. No loans shall be contracted on behalf of the Corporation and no
evidence of indebtedness shall be issued in its name unless authorized by a
resolution of the Board of Directors. Such authority may be general or confined
to specific instances.

3. Checks and Drafts. All checks, drafts or other orders for the payment of
money issued in the name of the Corporation shall be signed by such officer or
officers, or agent or agents, of the Corporation and in such manner as shall
from time to time be determined by resolution of the Board of Directors.

4. Deposits. All funds of the Corporation not otherwise employed shall be
deposited from time to time to the credit of the Corporation in such depository
or depositories as the Board of Directors shall direct.

                                       18

<PAGE>

                                   ARTICLE VII
                    CERTIFICATES FOR SHARES AND OTHER TRANSFER

1. Certificates for Shares. Certificates representing shares of the Corporation
shall be issued, in such form as the Board of Directors shall determine, to
every shareholder for the fully paid shares owned by him. These certificates
shall be signed by the President or any Vice President or a person who has been
designated as the chief executive officer of the Corporation and by the
Secretary, Assistant Secretary, Treasurer or Assistant Treasurer and sealed with
the seal of the Corporation or a facsimile thereof. The signatures of any such
officers upon a certificate may be facsimiles or may be engraved or printed or
omitted if the certificate is countersigned by a transfer agent, or registered
by a registrar, other than the Corporation itself or an employee of the
Corporation. In case any officer who has signed or whose facsimile or other
signature has been placed upon such certificate shall have ceased to be such
officer before such certificate is issued, it may be issued by the Corporation
with the same effect as if he were such officer at the date of its issue. They
shall be consecutively numbered or otherwise identified; and the name and
address of the persons to whom they are issued, with the number of shares and
date of issue, shall be entered on the stock transfer books of the Corporation.

2. Transfer of Shares. Transfer of shares shall be made on the stock transfer
books of the Corporation only upon surrender of the certificates for the shares
sought to be transferred by the record holder thereof or by his duly authorized
agent, transferee or legal representative. All certificates surrendered for
transfer shall be canceled before new certificates for the transferred shares
shall be issued.


                                       19

<PAGE>

3. Closing Transfer Books and Fixing Record Date.

      (a) For the purpose of determining shareholders entitled to notice of or
to vote at any meeting of shareholders or any adjournment thereof, or entitled
to receive payment of any dividend, or in order to make a determination of
shareholders for any other proper purpose, the Board of Directors may provide
that the stock transfer books shall be closed for a stated period but not to
exceed, in any case, fifty (50) days. If the stock transfer books shall be
closed for he purpose of determining shareholders entitled to notice of or to
vote at a meeting of shareholders, such books shall be closed for at least ten
(10) full days immediately preceding the date of such meeting.

      (b) In lieu of closing the stock transfer books, the Board of Directors
may fix in advance a date as the record date for any such determination of
shareholders, such date in any case to be not more than sixty (60) days and, in
case of a meeting of shareholders, not less than ten (10) full days immediately
preceding the date on which the particular action, requiring such determination
of shareholders, is to be taken.

      (c) If the stock transfer books are not closed and no record date is fixed
for the determination of shareholders entitled to notice of or to vote at a
meeting of shareholders, or of shareholders entitled to receive payment of a
dividend, the date on which notice of the meeting is mailed or the date on which
the resolution of the Board of Directors declaring such dividend is adopted, as
the case may be, shall be the record date for such determination of
shareholders.

      (d) When a determination of shareholders entitled to vote at any meeting
of shareholders has been made as provided in this Section 3, such determination
shall apply to any adjournment thereof regardless of its length except where the
determination


                                       20

<PAGE>

has been made through the closing of the stock transfer books and the stated 
period of closing has expired.

4. Lost Certificates. The Board of Directors may authorize the issuance of a new
share certificate in place of a certificate claimed to have been lost or
destroyed, upon receipt of an affidavit of such fact from the person claiming
the loss or destruction. When authorizing such issuance of a new certificate,
the Board may require the claimant to give the Corporation a bond in such sum as
it may direct to indemnify the Corporation against loss from any claim with
respect to the certificate claimed to have been lost or destroyed; or the Board
may, by resolution reciting that the circumstances justify such action,
authorize the issuance of the new certificate without requiring such a bond.

                                  ARTICLE VIII
                        INDEMNIFICATION AND REIMBURSEMENT
                            OF DIRECTORS AND OFFICERS

1. Expenses and Liabilities: The Corporation shall have the power to indemnify
any present or former director, officer, employee or agent of the Corporation,
or any person who has served or is serving in such capacity at the request of
the Corporation in any other corporation, partnership, joint venture, trust or
other enterprise or as a trustee or administrator under an employee benefit
plan, with respect to any liability or litigation expenses, including reasonable
attorneys' fees, incurred by any such person to the extent and upon the terms
and conditions provided by law. Therefore, to the extent and upon the terms and
conditions provided by law, the Corporation shall so indemnify any and all of
its officers and directors against liability and litigation expenses, including
reasonable attorneys' fees, arising out of their status as such or their
activities in any of the foregoing capacities (excluding, however, liability or
litigation expenses which any of the foregoing may incur on account of his or
her activities which 


                                       21

<PAGE>

were, at the time taken, known or believed by him or her to be clearly in
conflict with the best interest of the Corporation). Such officers and directors
shall be entitled to recover from the Corporation, and the Corporation shall
pay, all reasonable costs, expenses, and attorneys' fees in connection with the
enforcement of rights to indemnification granted herein. Any person who at any
time after the adoption of this bylaw serves or has served in either of the
aforesaid capacities for or on behalf of the Corporation shall be deemed to be
doing or to have done so in reliance upon and as consideration for the right of
indemnification provided herein. Such right shall inure to the benefit of the
legal representatives of any such person and shall not be exclusive of any other
rights to which such person may be entitled apart from the provisions of this
bylaw.

The right of indemnification hereinabove provided for shall not be exclusive of
any rights to which any such director, officer, employee or agent may otherwise
be entitled under any bylaw, agreement, vote of the Board of Directors or
shareholders or otherwise with respect to any liability or litigation expenses
arising out of his activities in such capacity.

2. Advance Payment of Expenses. Expenses incurred by a director, officer,
employee or agent in defending a civil or criminal action, suit or proceeding
may be paid by the Corporation in advance of the final disposition of such
action, suit or proceeding, as authorized by the Board of Directors in the
specific case, upon receipt of an undertaking by or on behalf of the director,
officer, employee or agent to repay such amount unless it shall ultimately be
determined that he or she is entitled to be indemnified by the Corporation
against such expenses. Notwithstanding the above, the Corporation shall, upon
receipt of an undertaking by or on behalf of the director or officer involved to
repay the expenses described in the first paragraph of this Article VIII unless
it shall ultimately be 


                                       22

<PAGE>

determined that he or she is entitled to be indemnified by the Corporation
against such expenses, pay such expenses incurred by such director or officer in
defending a civil or criminal action, suit or proceeding in advance of the final
disposition of such action, suit or proceeding.

3. Insurance. The Corporation shall have the power to purchase and maintain
insurance on behalf of any person who is or was a director, officer, employee or
agent of the Corporation, or is or was serving at the request of the Corporation
as a director, officer, employee or agent of another corporation, partnership,
joint venture, trust or other enterprise or as a trustee or administrator under
an employee benefit plan against any liability asserted against him and incurred
by him in such capacity, or arising out of his status as such, whether or not
the Corporation or other such enterprise would have the power to indemnify him
against such liability.

                                   ARTICLE IX
                               GENERAL PROVISIONS

1. Dividends. The Board of Directors may from time to time declare, and the
Corporation may pay, dividends on its outstanding shares in the manner and upon
the terms and conditions provided by law and by its charter.

2. Seal. The corporate seal of the Corporation shall consist of two concentric
circles between which is the name of the Corporation and in the center of which
is inscribed "1987", and such seal, as impressed on the margin hereof, is hereby
adopted as the corporate seal of the Corporation.

3. Waiver of Notice. Whenever any notice is required to be given to any
shareholder or Director under the provisions of the North Carolina Business
Corporation Act or under the provisions of the charter or Bylaws of the
Corporation, a waiver thereof in 


                                       23

<PAGE>

writing signed by the person or persons entitled to such notice, whether before
or after the time stated therein, shall be equivalent to the giving of such
notice.

4. Fiscal Year. The fiscal year of the Corporation shall be determined by the
Board of Directors.

5. Form of Records. Any records maintained by the Corporation in the regular
course of its business, including its stock ledger, books of account, and minute
books, may be kept on, or be in the form of, punch cards, magnetic tape,
photographs, microphotographs, or any other information storage device; provided
that the records so kept can be converted into clearly legible form within a
reasonable time. The Corporation shall so convert any records so kept upon the
request of any person entitled to inspect the same.

6. Amendments. Except as otherwise provided herein, these Bylaws may be amended
or repealed and new Bylaws may be adopted by the affirmative vote of a majority
of the Directors then holding office at any regular or special meeting of the
Board of Directors or by affirmative vote of shareholders entitled to exercise a
majority of voting power of the Corporation.

The Board of Directors shall have no power to adopt a Bylaw:

      (1) Changing the statutory requirement for a quorum of Directors or action
by Directors or changing the statutory requirement for a quorum of shareholders
or action by shareholders;

      (2) Providing for the management of the Corporation otherwise than by the
Board of Directors or the committees thereof;

                                       24

<PAGE>

      (3)   Increasing or decreasing the number of Directors; or

      (4) Classifying and staggering the election of Directors.

No Bylaw adopted or amended by the shareholders may be altered or repealed by
the Board of Directors.

                                       25


          Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P.
                         2500 First Union Capitol Center
                          Raleigh, North Carolina 27601
                           (919) 821-1220 (telephone)
                           (919) 821-6800 (facsimile)


                                                January 14, 1999


Cree Research, Inc.
4600 Silicon Drive
Durham, North Carolina  27703

        Re:    Registration Statement on Form S-3

Ladies and Gentlemen:

        We are counsel for Cree Research, Inc. (the "Company") in connection
with the issuance and sale by the Company of up to 1,495,000 shares of the
Company's Common Stock (including up to 195,000 shares subject to the
underwriters' over-allotment option), $0.005 par value per share. These shares
are described in the Company's Registration Statement on Form S-3 filed with the
Securities and Exchange Commission (the "Commission") under the Securities Act
of 1933, as amended (the "Act"), on January 14, 1999, with which this opinion is
filed as an exhibit (the "Registration Statement").

        We have examined the Amended and Restated Articles of Incorporation and
Amended and Restated Bylaws of the Company, the minutes of the meetings of the
Board of Directors of the Company relating to the authorization and the issuance
of securities and such other documents, records, and matters of law as we have
deemed necessary for purposes of this opinion.
 In our examination, we have
assumed the genuineness of all signatures, the authenticity of all documents as
originals, the conformity to originals of all documents submitted to us as
certified copies or photocopies, and the authenticity of the originals of such
latter documents. In 


<PAGE>

Cree Research, Inc.
January 14, 1999
Page 2

rendering the opinion set forth below, we also have relied upon a certificate of
an officer of the Company whom we believe is responsible.

        Based upon the foregoing and the additional qualifications set forth
below, it is our opinion that the 1,495,000 shares of Common Stock of the
Company which are being registered pursuant to the Registration Statement will,
when issued and delivered against payment therefor as contemplated by the
Registration Statement, be validly issued, fully paid and nonassessable.

        The opinion expressed herein does not extend to compliance with state
and federal securities laws relating to the sale of these securities.

        We hereby consent to the reference to our firm in the Registration
Statement under the heading "Legal Matters" and to the filing of this opinion as
an exhibit to the Registration Statement. Such consent shall not be deemed to be
an admission that this firm is within the category of persons whose consent is
required under Section 7 of the Act or the regulations promulgated pursuant to
the Act.

        This opinion is limited to the laws of the State of North Carolina, and
no opinion is expressed as to the laws of any other jurisdiction.

        Our opinion is as of the date hereof, and we do not undertake to advise
you of matters that might come to our attention subsequent to the date hereof
which may affect our legal opinion expressed herein.

        This opinion is rendered solely for your benefit in connection with the
transactions described above. This opinion may not be used or relied upon by any
other person without our prior written consent.

                                            Sincerely yours,

                                            SMITH, ANDERSON, BLOUNT, DORSETT,
                                                  MITCHELL & JERNIGAN, L.L.P.

                                        /s/ SMITH, ANDERSON, BLOUNT, DORSETT, 
                                                  MITCHELL & JERNIGAN, L.L.P.
                                             


                       CONSENT OF INDEPENDENT ACCOUNTANTS

We consent to the inclusion in the Prospectus constituting part of this
registration statement on Form S-3 of our report dated July 22, 1998, on our
audits of the financial statements of Cree Research, Inc. and subsidiaries. We
also consent to the references to our firm under the captions "Selected
Financial Data" and "Experts."


/s/ PricewaterhouseCoopers LLP

Raleigh, North Carolina
January 14, 1999





<TABLE> <S> <C>

<ARTICLE>                     5
<CIK>                         0000895419
<NAME>                        CREE RESEARCH, INC.
<MULTIPLIER>                                   1,000
       
<S>                             <C>
<PERIOD-TYPE>                   6-MOS
<FISCAL-YEAR-END>                        JUN-27-1999
<PERIOD-START>                           JUN-29-1998
<PERIOD-END>                             DEC-27-1998
<CASH>                                         12,769 
<SECURITIES>                                      905 
<RECEIVABLES>                                  12,261 
<ALLOWANCES>                                      151 
<INVENTORY>                                     3,402 
<CURRENT-ASSETS>                               30,141 
<PP&E>                                         56,989 
<DEPRECIATION>                                 12,017 
<TOTAL-ASSETS>                                 78,103 
<CURRENT-LIABILITIES>                           5,758 
<BONDS>                                             0
<PREFERRED-MANDATORY>                               0 
<PREFERRED>                                         0 
<COMMON>                                       49,648
<OTHER-SE>                                     10,341 
<TOTAL-LIABILITY-AND-EQUITY>                   59,989 
<SALES>                                        26,317 
<TOTAL-REVENUES>                               26,317 
<CGS>                                          14,044 
<TOTAL-COSTS>                                  19,071 
<OTHER-EXPENSES>                                    0 
<LOSS-PROVISION>                                    0 
<INTEREST-EXPENSE>                               (115)
<INCOME-PRETAX>                                 7,246 
<INCOME-TAX>                                    2,029 
<INCOME-CONTINUING>                             5,217 
<DISCONTINUED>                                      0 
<EXTRAORDINARY>                                     0 
<CHANGES>                                           0 
<NET-INCOME>                                    5,217 
<EPS-PRIMARY>                                    0.41 
<EPS-DILUTED>                                    0.39 
                                               

</TABLE>