Filed Pursuant to Rule 424(b)(5)

Registration No. 333-109840

PROSPECTUS SUPPLEMENT

(TO PROSPECTUS DATED JANUARY 6, 2004)

8,800,000 Shares

Common Stock

RAE Systems Inc. is offering 7,000,000 shares of our common stock and the selling stockholders are offering 1,800,000 shares. Our common stock is traded on the American Stock Exchange under the symbol “RAE.” On January 22, 2004, the last reported sale price for our common stock was $4.76 per share.

INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE “RISK FACTORS” BEGINNING ON PAGE S-3.

	Per Share		Total
Public Offering Price	$	4.25	$	37,400,000
Underwriting Discount	$	.2550	$	2,244,000
Proceeds, before expenses, to RAE Systems Inc.	$	3.995	$	27,965,000
Proceeds, before expenses, to the Selling Stockholders	$	3.995	$	7,191,000

We and the selling stockholders have granted the underwriters the right for a period of 30 days to purchase up to an additional 1,320,000 shares of our common stock at the public offering price less underwriting discounts and commissions to cover over-allotments, if any.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares to purchasers on January 28, 2004.

Jefferies Quarterdeck Merriman Curhan Ford & Co.

THE DATE OF THIS PROSPECTUS SUPPLEMENT IS JANUARY 23, 2004.

ABOUT THIS PROSPECTUS SUPPLEMENT

This prospectus supplement and the accompanying prospectus are part of a “shelf” registration statement on Form S-3 that we filed with the Securities and Exchange Commission, or the SEC. This prospectus supplement describes the specific details regarding this offering, including the price, the amount of common stock being offered and the risks of investing in our common stock. The accompanying prospectus provides general information about us, some of which, such as the section entitled “Plan of Distribution,” may not apply to this offering. If information in this prospectus supplement is inconsistent with the accompanying prospectus, you should rely on this prospectus supplement. You should read both this prospectus supplement and the accompanying prospectus together with the additional information about us described in the accompanying prospectus in the section entitled “Where You Can Find More Information.”

You should rely only on the information contained in this prospectus supplement, the accompanying prospectus or the documents incorporated or deemed incorporated by reference herein or therein. We have not, and the underwriters have not, authorized anyone to provide you with information different from or in addition to that contained in this prospectus supplement, the prospectus or the documents incorporated or deemed incorporated by reference herein or therein. We are not, and the underwriters are not, making an offer to sell or seeking an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

The information contained in this prospectus supplement, the accompanying prospectus and the documents incorporated or deemed incorporated by reference herein or therein is complete and accurate as of the date of this prospectus supplement, but may have changed since that date.

FORWARD LOOKING INFORMATION

Some of the information in the prospectus, including the risk factors section set forth therein, this prospectus supplement and the documents we incorporate by reference in the prospectus and this prospectus supplement contain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including, without limitation, statements regarding the Registrant’s expectations, beliefs, intentions, and other events of future strategies that are signified by the words “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negative of such terms and other comparable terminology. Actual results could differ materially from those projected in the forward looking statements.

We believe it is important to communicate our expectations to our investors. However, there may be events in the future that we are not able to predict accurately or over which we have no control. The risk factors set forth in the prospectus, as well as any cautionary language in this prospectus supplement, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward looking statements. Before you invest in our common stock, you should be aware that the occurrence of the events described in these risk factors and elsewhere in the prospectus and this prospectus supplement could have a material adverse effect on our business, operating results, and financial condition.

TABLE OF CONTENTS

PROSPECTUS SUPPLEMENT
PROSPECTUS SUPPLEMENT SUMMARY	S-1
THE OFFERING	S-2
RISK FACTORS	S-3
USE OF PROCEEDS	S-8
CAPITALIZATION	S-8
PRICE RANGE OF COMMON STOCK	S-9
DIVIDEND POLICY	S-9
SELLING STOCKHOLDERS	S-10
MATERIAL U.S. FEDERAL TAX CONSEQUENCES TO NON-U.S. HOLDERS	S-11
UNDERWRITING	S-13
NOTICE TO CANADIAN RESIDENTS	S-16
LEGAL MATTERS	S-18
EXPERTS	S-18
PROSPECTUS
PROSPECTUS SUMMARY	1
SUMMARY CONSOLIDATED FINANCIAL DATA	4
RISK FACTORS	5
WHERE YOU CAN FIND MORE INFORMATION	9
FORWARD-LOOKING STATEMENTS	10
USE OF PROCEEDS	11
CAPITALIZATION	11
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	12
BUSINESS	20
MANAGEMENT	30
PRINCIPAL AND SELLING STOCKHOLDERS	32
DESCRIPTION OF CAPITAL STOCK	34
DESCRIPTION OF SECURITIES WARRANTS	37
PLAN OF DISTRIBUTION	41
LEGAL MATTERS	43
EXPERTS	43

PROSPECTUS SUPPLEMENT SUMMARY

The items in the following summary are described in more detail in this prospectus supplement, the prospectus or in the documents incorporated or deemed incorporated by reference herein or therein. This summary provides an overview of selected information and does not contain all of the information that you should consider. Therefore, you should also read the more detailed information in this prospectus supplement, the prospectus and the documents incorporated by reference herein or therein. All references to “we,” “us,” “our,” and similar terms refer to RAE Systems Inc. and its subsidiaries on a consolidated basis.

RAE Systems Inc.

We are a leading global developer and manufacturer of rapidly-deployable, multi-sensor chemical detection monitors and networks for homeland security and industrial applications. In addition, we offer a full line of portable single-sensor chemical and radiation detection products. Our technologically advanced products are based on proprietary technology, and include portable, wireless and fixed atmospheric monitors and photo-ionization detectors, and gamma and neutron detectors. Our products enable the military and first responders such as firefighters, law enforcement and other emergency management personnel to detect and provide early warning of weapons of mass destruction and other hazardous materials. Industrial applications include the detection of toxic industrial chemicals, volatile organic compounds and petrochemicals.

We were founded in 1991 to develop technologies for the detection and early warning of hazardous materials. We have a broad patent portfolio consisting of 18 issued and pending patents that are the basis for many of our products. For example, our patented photo-ionization detector technology allows our products to rapidly and reliably indicate many toxic chemicals and vapors in the part-per-billion range. In 1994, we expanded our operations into Shanghai, China, giving us access to high-quality, cost-efficient manufacturing and world-class research capabilities.

Our products are used by many U.S. government agencies, including the Department of Homeland Security, the Department of Justice, and the Department of State, as well as all branches of the U.S. military, and by numerous city and state agencies. Our end users also include many of the world’s leading corporations in the airline, automotive, computer and oil industries. Our products are used in civilian and government atmospheric monitoring programs in over 50 countries. Several government agencies and departments have standardized their programs based on our products for hazardous materials incident response.

S-1

THE OFFERING

Common stock offered:	8,800,000 shares
By the Company	7,000,000 shares
By the selling stockholders	1,800,000 shares
Common stock to be outstanding after the offering:	53,919,221 shares
Use of proceeds:	We currently intend to use the net proceeds from the sale of the common stock offered by this prospectus supplement for our general corporate purposes, the financing of capital expenditures, future acquisitions and additions to our working capital. Pending the application of the net proceeds, we will invest these proceeds in government securities and other short-term, investment-grade, interest bearing securities. See “Use of Proceeds.”
Risk Factors:	See “Risk Factors” and other information included in this prospectus supplement and the accompanying prospectus for a discussion of factors you should carefully consider before deciding to invest in shares of our common stock.
AMEX Market symbol:	RAE

The total number of shares of common stock outstanding after this offering is based on 46,919,221 shares outstanding as of January 22, 2004, and excludes:

• 5,213,551 shares of our common stock issuable upon exercise of warrants at a weighed average exercise price of $13.50 per share;

• 1,310,801 shares of our common stock subject to outstanding options under our 1993 stock option plan at a weighed average exercise price of $.76 per share;

• 2,935,579 shares of our common stock subject to outstanding options under our 2002 stock option plan at a weighed average exercise price of $1.69 per share, along with an additional 1,961,756 shares of common stock reserved for issuance under such plan;

• 400,000 shares of restricted stock subject to vesting provisions; and

• 807,438 shares of our common stock subject to outstanding options under the Nettaxi.com 1998 and 1999 stock option plans at a weighed average exercise price of $28.10 per share.

Unless otherwise specifically stated, information throughout this prospectus supplement assumes:

• no exercise of outstanding options or warrants to purchase shares of common stock;

• no shares of restricted stock have vested; and

• no exercise of the underwriters’ over-allotment option.

S-2

RISK FACTORS

Investing in our securities involves a high degree of risk. Before making any decision to invest in our securities, you should carefully consider the following risk factors in addition to the other information contained in this prospectus supplement and accompanying prospectus and incorporated by reference in this prospectus supplement and accompanying prospectus. If any of these risks occur, our business could suffer, the market price of our common stock could decline and you could lose all or part of your investment in our securities.

Risks Relating to our Business

Our future revenues are unpredictable, our operating results are likely to fluctuate from quarter to quarter, and if we fail to meet the expectations of securities analysts or investors, our stock price could decline significantly.

Our quarterly and annual operating results have fluctuated in the past and are likely to fluctuate significantly in the future due to a variety of factors, some of which are outside of our control. Accordingly, we believe that period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as indications of future performance. Some of the factors that could cause our quarterly or annual operating results to fluctuate include significant shortfalls in revenue relative to our planned expenditures, market acceptance of our products, the demand for our products as its relates to domestic terrorism, ongoing product development and production, competitive pressures and customer retention. In particular, there has been a surge in demand for our products and services associated with the response to domestic terrorism since September 11, 2001. This surge in demand has caused our net sales to increase, particularly in the fiscal year ended December 31, 2003. Given the increased budget for the U.S. Department of Homeland Security and the perceived need to outfit first responders with chemical and radiological detection capabilities, we believe that demand for our products and services will remain strong. However, we cannot assure you that this increased budget will result in increased sales of our products or that the U.S. government will maintain its current level of focus on responding to chemical and radiological attacks.

It is likely that in some future quarters demand for our products may decline and our operating results may fall below the expectations of investors. In this event, the trading price of our common stock could significantly decline.

The market for gas detection monitoring devices is highly competitive, and if we cannot compete effectively, our business may be harmed.

The market for gas detection monitoring devices is highly competitive and we expect the emerging wireless gas monitoring system market to be equally competitive. Competitors in the gas monitoring industry differentiate themselves on the basis of their technology, quality of product and service offerings, cost and time to market. Our primary competitors include Industrial Scientific Corporation, Mine Safety Appliances Company, BW Technologies, Ion Science, PerkinElmer, Inc., Draeger Safety Inc., Gastec Corporation and Bacou-Dalloz Group. Most of our competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial and marketing resources than us. In addition, some of our competitors may be able to:

• devote greater resources to marketing and promotional campaigns;

• adopt more aggressive pricing policies; or

• devote more resources to technology and systems development.

In light of these factors, we may be unable to compete successfully.

We might not be successful in the development or introduction of new products and services in a timely and effective manner, and, consequently, we may not be able to remain competitive and the results of operations may suffer.

Our revenue growth is dependent on the timely introduction of new products to market. We may be unsuccessful in identifying new product and service opportunities or in developing or marketing new products and services in a timely or cost-effective manner. In addition, while our current technology enables us to create products targeted to address the evolving market, we are unable to foresee whether we will continue to have the necessary technology in the future. In developing new products, we may be required to make significant investments before we can determine the commercial viability of the new product. If we fail to accurately foresee our customers’ needs and future activities, we may invest heavily in research and development of products that do not lead to significant sales.

S-3

We have recently expanded our current product line to include radiation detection and wireless systems for local and remote security monitoring. While we perceive a large market for such products, the radiation detection and wireless systems markets are still evolving, and we have little basis to assess the demand for these products and services or to evaluate whether our products and services will be accepted by the market. If our radiation detection products and wireless products and services do not gain broad market acceptance or if we do not continue to maintain the necessary technology, our business and results of operations will be harmed.

In addition, compliance with safety regulations, specifically the need to obtain regulatory approvals in certain jurisdictions, could delay the introduction of new products by us. As a result, we may experience delays in realizing revenues from our new products.

We may not be successful in promoting and developing our brand, which could prevent us from remaining competitive.

We believe that our future success will depend on our ability to maintain and strengthen the RAE Systems brand, which will depend, in turn, largely on the success of our marketing efforts and ability to provide our customers with high-quality products. If we fail to successfully promote and maintain our brand, or incur excessive expenses in attempting to promote and maintain our brand, our business will be harmed.

We depend on facilities located outside of the United States to manufacture a substantial portion of our products, which subjects us to additional risks.

A significant portion of our products and components are manufactured at our facility in Shanghai, China. Our business is subject to risks normally associated with conducting business outside the United States, such as foreign government regulations, changes in environmental laws, nation-specific or region-specific certifications, political unrest, disruptions or delays in shipments, fluctuations in foreign currency exchange rates and changes in the economic conditions in the countries in which our raw materials suppliers, service providers, and customers are located. Our business may also be adversely affected by the imposition of additional trade restrictions related to imported products, including quotas, duties, taxes and other charges or restrictions. If any of the foregoing factors were to render the conduct of business in a particular country undesirable or impractical, or if our current foreign manufacturing sources were to cease doing business with us for any reason, or if our ability to transfer products between China and other regions of the world were impeded, our business and results of operations could be adversely affected.

Any failure to adequately protect and enforce our intellectual property rights could harm our business.

We regard our intellectual property as critical to our success. We rely on a combination of patent, trademark, copyright, trade secret laws and non-disclosure agreements and confidentiality procedures to protect our proprietary rights. Notwithstanding these laws, we may be unsuccessful in protecting our intellectual property rights or in obtaining patents or registered trademarks for which we apply. Although processes are in place to protect our intellectual property rights, we cannot guarantee that these procedures are adequate to prevent misappropriation of our current technology or that our competitors will not develop technology that is similar to our own.

While there is no single patent or license to technology of material significance to the Company, our ability to compete is affected by our ability to protect our intellectual property rights in general. For example, we have a collection of patents related to our photo-ionization detector technology of which the first of such patents expires in 2012, and our ability to compete may be affected by any competing similar or new technology. In addition, if we lose the licensing rights to a patented or other proprietary technology, we may need to stop selling products incorporating that technology and possibly other products, redesign our products or lose a competitive advantage. We cannot ensure that our future patent applications will be approved or that our current patents will not be challenged by third parties. Furthermore, we cannot ensure that, if challenged, our patents will be found to be valid and enforceable.

Any litigation relating to our intellectual property rights could, regardless of the outcome, have a material adverse impact on our business and results of operations.

S-4

We might face intellectual property infringement claims that might be costly to resolve and affect our results of operations.

We may, from time to time, be subject to claims of infringement of other parties’ proprietary rights or claims that our own trademarks, patents or other intellectual property rights are invalid. Any claims of this type, regardless of merit, could be time-consuming to defend, result in costly litigation, divert management’s attention and resources or require us to enter into royalty or license agreements. The terms of any such license agreements may not be available on reasonable terms, if at all, and the assertion or prosecution of any infringement claims could significantly harm our business.

Some of our products may be subject to product liability claims which could be costly to resolve and affect our results of operations.

There can be no assurance that we will not be subject to third-party claims in connection with our products or that any indemnification or insurance available to us will be adequate to protect us from liability. A product liability claim, product recall or other claim, as well as any claims for uninsured liabilities or in excess of insured liabilities, could have a material adverse effect on our business and results of operations.

We may lose sales if our distributors stop selling our products.

We distribute our products primarily through distributors. We derive approximately 90% of our revenues via our sales distribution channels, and, as a result, we are dependent upon these distributors to sell our products and to assist us in promoting and creating a demand for our products. We believe that our future growth depends on the efforts of these distributors. As of the nine-month period ended September 30, 2003, 25 distributors cumulatively account for approximately 40% of our total product sales. In addition, the contractual obligations of our distributors to continue carrying our products must be renewed annually. If one or more of our distributors were to experience financial difficulties or become unwilling to promote and sell our products for any reason, including any refusal to renew their commitment as our distributor, we might not be able to replace such lost revenue, and our business and results of operations could be materially harmed.

Because we purchase a significant portion of our component parts from a limited number of third party suppliers, we are subject to the risk that we may be unable to acquire quality components in a timely manner, which could result in delays of product shipments and damage our business and operating results.

We currently purchase component parts used in the manufacture of our products from a limited number of third party suppliers. We depend on these suppliers to meet our needs for various sensors, microprocessors and other material components. Moreover, we depend on the quality of the products supplied to us over which we have limited control. Should we encounter shortages and delays in obtaining components, we might not be able to supply products in a timely manner due to a lack of components, and our business could be adversely affected.

Any future acquisitions that we undertake could be difficult to integrate, disrupt our business, dilute stockholder value or harm our results of operations.

We may acquire or make investments in complementary businesses, technologies, services or products if appropriate opportunities arise. The process of integrating any acquired business, technology, service or product into our business and operations may result in unforeseen operating difficulties and expenditures. Integration of an acquired company also may consume much of our management’s time and attention that would otherwise be available for ongoing development of our business. Moreover, the anticipated benefits of any acquisition may not be realized. Future acquisitions could result in dilutive issuances of equity securities or the incurrence of debt, contingent liabilities or expenses related to goodwill recognition and other intangible assets, any of which could harm our business.

Our ownership interest in REnex will cause us to incur losses that we would not otherwise incur.

We own approximately 36 percent of REnex Technology Ltd., a wireless systems company still in the research and development stage, and which to date has not generated any revenues. We are required to incorporate our share of its expenses as losses in our Consolidated Statements of Operations. If REnex does not begin to generate revenues at the level we anticipate or otherwise incurs greater losses, we could incur greater losses than we anticipate and our results of operations will suffer.

S-5

The adoption of the fair value recognition provisions of SFAS No. 123 for stock-based employee compensation as provided for in SFAS No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure, an amendment of FASB Statement No. 123 will have a significant impact on our financial statements.

In connection with our merger with Nettaxi.com, certain options under our 1993 Stock Plan became subject to variable accounting in accordance with FASB Interpretation No. 44 (FIN 44). To eliminate the variable effects of such accounting treatment, we have adopted the fair value recognition provisions of SFAS No. 123 for stock-based employee compensation, effective January 1, 2003, under the modified prospective method as provided for in SFAS No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure, an amendment of FASB Statement No. 123. These fair value recognition provisions generally result in stock-based compensation charges for options granted under our 1993 and 2002 stock option plans. While our interim financial statements herein for the nine-month period ended September 30, 2003 reflect a non-cash compensation charge of only $496,900, these charges may increase significantly depending on the number of options granted in the future and, to a lesser extent, upon the volatility of our stock and the life of such options. Stock-based compensation charges have significantly impacted our financial statements, and will continue to impact our financial statements on a prospective basis.

Future sales of our common stock by existing stockholders could adversely affect our stock price.

Sales of substantial amounts of our common stock in the public market in the future could reduce the prevailing market prices for our common stock. Because approximately 46.8% of our common stock will be beneficially owned by our officers and directors after the consummation of this offering, future sales of large positions by the holders of such shares could adversely affect the trading price of our common stock. Specifically, this registration statement allows certain officers to sell up to 1,800,000 shares of our common stock. These sales, or the perception that these sales could occur, could adversely impact the trading price of our common stock.

Our business could suffer if we lose the services of any of our executive officers.

Our future success depends to a significant extent on the continued service of our executive officers, including Robert I. Chen, Joseph Ng, Peter Hsi and Hong Tao Sun. We have no employment agreements with any of these officers. The loss of the services of any of our executive officers could harm our business.

Our officers, directors and principal stockholders currently beneficially own approximately 50.8% of our common stock and after the consummation of this offering will beneficially own approximately 46.8% of our common stock and, accordingly, may exert substantial influence over the company.

Our executive officers and directors and principal stockholders, in the aggregate, beneficially own approximately 50.8% of our common stock. After consummation of this offering and assuming that the underwriters exercise their over-allotment option in full, such persons will beneficially own approximately 46.8% of our common stock. These stockholders acting together have the ability to control all matters requiring approval by our stockholders. These matters include the election and removal of the directors, amendment of our certificate of incorporation, and any merger, consolidation or sale of all or substantially all of our assets. In addition, they may dictate the management of our business and affairs. Furthermore, this concentration of ownership could have the effect of delaying, deferring or preventing a change in control, or impeding a merger or consolidation, takeover or other business combination, and may substantially reduce the marketability of our common stock.

Provisions in our charter documents and Delaware law could prevent or delay a change in control of the company, which could reduce the market price of our common stock or discourage potential acquirers from offering a premium over the prevailing trading price of our common stock.

Provisions in our certificate of incorporation and bylaws could have the effect of delaying or preventing a change of control of the company or changes in our management. For example, our certificate of incorporation contains provisions eliminating the right of stockholders to act by written consent, providing for the ability to issue up to 1,000,000 shares of preferred stock with rights, preferences, privileges and restrictions as designated by the board, establishing super-majority voting requirements for the amendment or repeal of certain provisions of the certificate of incorporation and providing for a classified board of directors. Our bylaws contains provisions requiring advance notice of stockholder proposals or board nominations, as well as the procedures for conduct at stockholder meetings. In addition, we are subject to the provision of Section 203 of the Delaware General Corporation Law, which restricts certain business combinations with interested stockholders.

These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. These provisions may also have the effect of discouraging or preventing a potential acquirer from offering our stockholders a premium over the prevailing trading price of our common stock.

S-6

Risks Relating to the Offering

We may need additional capital in the future to fund the growth of our business, and financing may not be available.

We currently anticipate that our available capital resources, combined with the net cash proceeds from this offering, cash flows from operations and expected interest income, will be sufficient to meet our expected working capital and capital expenditure requirements for the foreseeable future. However, we cannot assure you that such resources will be sufficient to fund the growth of our business. Our cash requirements will depend on numerous factors, including the rate of growth of our sales, the timing and levels of products purchased, research and development requirements, payment terms and credit limits from manufacturers, the timing and level of our accounts receivable collections and our ability to manage our business profitability.

We may also raise additional funds through public or private debt or equity financings if such financings become available on favorable terms, but such financings would likely dilute our stockholders. We cannot assure you that any additional financing we may need will be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to take advantage of unanticipated opportunities, develop new products or otherwise respond to competitive pressures. In any such case, our business, operating results or financial condition could be materially adversely affected.

Our stock price is volatile, and you may not be able to resell your shares at or above the offering price.

The market price of our common stock has been, and we expect will continue to be, subject to significant volatility. The value of our common stock may decline regardless of our operating performance or prospects. Factors affecting our market price include:

• our perceived prospects;

• variations in our operating results and whether we have achieved key business targets;

• changes in, or our failure to meet, earnings estimates;

• changes in securities analysts’ buy/sell recommendations;

• differences between our reported results and those expected by investors and securities analysts;

• announcements of new contracts by us or our competitors;

• market reaction to any acquisitions, joint ventures or strategic investments announced by us or our competitors; and

• general economic, political or stock market conditions.

Recent events have caused stock prices for many companies, including ours, to fluctuate in ways unrelated or disproportionate to their operating performance. The general economic, political and stock market conditions that may affect the market price of our common stock are beyond our control. The market price of our common stock at any particular time may not remain the market price in the future. In the past, securities class action litigation has been instituted against companies following periods of volatility in the market price of their securities. Any such litigation, if instituted against us, could result in substantial costs and a diversion of management’s attention and resources.

Our management team will have broad discretion over the use of the net proceeds from this offering.

Our management will use their discretion to direct the net proceeds from this offering. We currently intend to use the net proceeds from the sale of the common stock offered by this prospectus supplement for our general corporate purposes, the financing of capital expenditures, future acquisitions and additions to our working capital. Pending the application of the net proceeds, we will invest these proceeds in government securities and other short-term, investment-grade, interest bearing securities. Their judgments may not result in positive returns on your investment and you will not have an opportunity to evaluate the economic, financial or other information upon which our management bases its decisions.

S-7

We do not anticipate declaring any cash dividends on our common stock.

We have never declared or paid cash dividends on our common stock and do not plan to pay any cash dividends in the near future. Our current policy is to retain all funds and earnings for use in the operation and expansion of our business. In addition, our debt agreements prohibit the payment of cash dividends or other distributions on any of our capital stock except dividends payable in additional shares of capital stock.

USE OF PROCEEDS

We estimate that the net proceeds to us from the sale of our common stock in this offering will be approximately $27.62 million or $31.81 million assuming exercise of the underwriters’ over-allotment option, after deducting the estimated underwriting discounts, commissions and offering expenses payable by us in connection with this offering. We will not receive any of the proceeds of the sale of shares of common stock by the selling stockholders.

We currently intend to use the net proceeds from the sale of the common stock offered by this prospectus supplement for our general corporate purposes, the financing of capital expenditures, future acquisitions and additions to our working capital. Pending the application of the net proceeds, we will invest these proceeds in government securities and other short-term, investment-grade, interest bearing securities.

CAPITALIZATION

The following table sets forth our capitalization as of September 30, 2003, on a historical basis and as adjusted to give effect to the issuance and sale of 7,000,000 shares of our common stock in this offering and the application of net proceeds as described under “Use of Proceeds,” as if each had occurred on September 30, 2003. For purposes of the following table, we have assumed no exercise by the underwriters of the over-allotment option.

You should read this information together with our audited consolidated financial statements and related notes and the sections entitled “Use of Proceeds,” “Summary Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus supplement.

	September 30, 2003			As Adjusted
Cash and cash equivalents	$	6,678,300		$	34,293,300
Shareholders’ equity:
Common stock: $0.001 par value; 200,000,000 shares authorized; 46,591,721 shares issued and outstanding, actual and 53,591,721 shares issued and outstanding as adjusted		46,600			53,600
Additional paid-in-capital		18,437,500			46,045,500
Cumulative Other Comprehensive Income		3,300			3,300
Accumulated deficit		(4,330,400	)		(4,330,400	)
Total shareholders’ equity		14,157,000			41,772,000
Total capitalization	$	14,157,000		$	41,772,000

The 46,591,721 shares shown, actual and 53,591,721 shares adjusted as issued and outstanding respectively at September 30, 2003 in the table above exclude:

• 5,333,551 shares of our common stock issuable upon exercise of warrants at a weighted-average exercise price of $13.22 per share;

• 1,510,084 shares of our common stock subject to outstanding options under our 1993 Stock Plan at a weighted-average exercise price of $0.076 per share;

• 2,472,302 shares of our common stock subject to outstanding options under our 2002 Stock Option Plan at a weighted-average exercise price of $1.18;

• 400,000 shares of restricted stock given to our directors at a weighted-average exercise price of $0.985;

S-8

• 869,166 shares of our common stock subject to outstanding options under the Nettaxi.com 1998 and 1999 stock option plans at a weighted-average exercise price of $26.15 per share; and

• 139,983 options under our 1993 Stock Option Plan that were exercised between October 1, 2003 and December 23, 2003.

PRICE RANGE OF COMMON STOCK

Our common stock is listed on the American Stock Exchange and trades under the symbol “RAE.” The following table sets forth for the periods indicated the high and low bid prices for our common stock as reported by various Bulletin Board market makers when we were trading on the NASD OTC Market Bulletin Board through August 28, 2003 and the high and low composite per share closing sales prices as reported by the American Stock Exchange since our trading thereon on August 29, 2003.

	HIGH		LOW
FISCAL YEAR ENDED DECEMBER 31, 2003
Fourth quarter	$	3.57	$	2.36
Third quarter	$	3.99	$	1.75
Second quarter	$	2.12	$	0.50
First quarter	$	0.66	$	0.37
FISCAL YEAR ENDED DECEMBER 31, 2002
Fourth quarter	$	0.65	$	0.38
Third quarter	$	0.84	$	0.45
Second quarter	$	2.30	$	0.22
First quarter	$	0.28	$	0.11
FISCAL YEAR ENDED DECEMBER 31, 2001
Fourth quarter	$	0.19	$	0.09
Third quarter	$	0.36	$	0.08
Second quarter	$	0.50	$	0.09
First quarter	$	0.30	$	0.13

The last reported sale price of our common stock on the American Stock Exchange on January 22, 2004 was $4.76 per share.

DIVIDEND POLICY

To date, we have paid no cash dividends to our stockholders. We have no plans to pay cash dividends in the near future. Our debt agreements prohibit the payment of cash dividends or other distributions on any of our capital stock except dividends payable in additional shares of capital stock.

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SELLING STOCKHOLDERS

Certain Relationships with Selling Stockholders

Mr. Robert I. Chen and Mr. Peter Hsi are co-founders of RAE Systems Inc. Mr. Chen is the Company’s President, Chief Executive Officer, and Mr. Hsi is the Vice President, Chief Technology Officer.

Selling Stockholders Table

The following table sets forth information about the selling stockholders’ beneficial ownership of our common stock as of December 23, 2003 (such information has been provided by the selling stockholders) and after the sale of the common stock offered by each selling stockholder under this prospectus. The numbers presented assume that all of the shares offered by the selling stockholders are sold and that the selling stockholders acquire no additional shares of our common stock before the completion of this offering. We will pay all expenses incurred with respect to the registration and sale of the shares of common stock owned by the selling shareholders, other than underwriting fees, discounts or commissions, which will be borne by the selling stockholders.

Beneficial ownership of shares is determined under the rules of the Securities and Exchange Commission and generally includes any shares over which a person exercises sole or shared voting or investment power. Both Mr. Chen and Mr. Hsi possess sole voting and investment power with respect to all shares of common stock held by them, except as indicated by footnote or to the extent this power may be shared with a spouse. The percentage of outstanding shares beneficially owned is based on 46,731,704 shares of common stock outstanding as of December 23, 2003. Shares of common stock subject to options currently exercisable or exercisable within sixty (60) days of December 23, 2003 are deemed outstanding for calculating the percentage of outstanding shares of the person holding these options, but are not deemed outstanding for calculating the percentage of any other person. To the extent that any shares are issued upon exercise of options, warrants or other rights to acquire our capital stock that are presently outstanding or granted in the future or reserved for future issuance under our stock plans, there will be further dilution to new public investors.

	Common Stock Beneficially Owned Prior to the Offering			Shares of Common Stock Sold in the Offering	Common Stock Beneficially Owned Following Offering
Beneficial Owner	Shares	Percentage			Shares	Percentage (1)
Robert I. Chen	17,964,905	38.4	%	1,500,000	16,464,905	30.6	%
Peter H. Hsi	4,336,332	9.3	%	300,000	4,036,332	7.5	%
Total	22,301,237	47.7	%	1,800,000	20,501,237	38.1	%

⁽¹⁾ Gives effect to the sale of 7,000,000 shares of common stock offered by the Company.

Beneficial Owner	Common Stock Beneficially Owned Prior to the Offering			Shares of Common Stock Sold in the Offering	Common Stock Beneficially Owned Following Offering and Exercise of the Over- allotment Option
	Shares	Percentage			Shares	Percentage (2)
Robert I. Chen	17,964,905	38.4	%	1,725,000	16,239,905	29.6	%
Peter H. Hsi	4,336,332	9.3	%	345,000	3,991,332	7.3	%
Total	22,301,237	47.7	%	2,070,000	20,231,237	36.9	%

⁽²⁾ Gives effect to the sale of 7,000,000 shares of common stock offered by the Company and assumes an exercise of the over-allotment option of 1,050,000 additional shares of Company common stock to be issued.

Except as otherwise noted, the address for each person listed above is c/o RAE Systems, 1339 Moffett Park Drive, Sunnyvale, California 94089.

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MATERIAL U.S. FEDERAL TAX CONSEQUENCES TO NON-U.S. HOLDERS

The following is a summary of material U.S. federal income tax considerations relating to the purchase, ownership and disposition of our common stock if you are “Non-U.S. Holder”, including a beneficial owner of common stock other than: (1) a citizen or resident of the U.S.; (2) an entity formed under the laws of the U.S. or a state of the U.S.; (3) an estate the income of which is subject to U.S. federal income tax regardless of its source; or (4) a trust subject to the primary supervision of a court within the U.S. which has one or more U.S. persons with authority to control all substantive decisions, or which has a valid election in effect under applicable Treasury Regulations to be treated as a U.S. person.

The rules governing U.S. federal income taxation of a Non-U.S. Holder of common stock are complex, and we have provided only a summary of such rules. Special rules may apply to certain Non-U.S. Holders such as “controlled foreign corporations,” “passive foreign investment companies” and “foreign personal holding companies.” Non-U.S. Holders should consult with their own tax advisors to determine the effect of federal, state, local and foreign income tax laws, as well as treaties, with regard to an investment in the common stock, including any reporting requirements.

The following discussion is limited to the U.S. federal income tax consequences relevant to a Non-U.S. Holder. For purposes of withholding tax on dividends discussed below, a Non-U.S. Holder (as defined above) includes a non-resident fiduciary of an estate or trust. For purposes of the following discussion, dividends and gain on the sale, exchange or other disposition of common stock will be considered to be “U.S. trade or business income” if such income or gain is (1) effectively connected with the conduct of a U.S. trade or business or (2) in the case of a Non-U.S. Holder eligible for the benefits of an applicable bilateral income tax treaty, attributable to a permanent establishment (or, in the case of an individual, a fixed base) in the United States.

This summary is based on laws, regulations, rulings and decisions now in effect, all of which are subject to change. This summary deals only with holders that will hold the common stock as “capital assets” within the meaning of Section 1221 of the Internal Revenue Code of 1986, as amended, which we sometimes refer to as the Code and does not address tax considerations applicable to investors that may be subject to special tax rules, such as financial institutions, mutual funds, tax-exempt organizations, insurance companies, dealers in securities or currencies, traders in securities who elect to apply mark-to-market method of accounting, persons that will hold stock as a position in a hedging transaction, “straddle” or “conversion transaction” for tax purposes or persons deemed to sell stock under the constructive sale provisions of the Code.

We have not sought any ruling from the Internal Revenue Service (or IRS) with respect to the statements made and the conclusions reached in the following summary, and there can be no assurance that the IRS will agree with such statements and conclusions. In addition, the IRS is not precluded from successfully adopting a contrary position. This summary does not consider the effect of any applicable foreign, state, local or other tax laws.

All prospective purchasers of common stock should consult their own tax advisors with respect to the application of the United States federal income and estate tax laws to their particular situation as well as any tax consequences arising under the laws of any state, local or foreign taxing jurisdiction or under any applicable tax treaty.

Sale or Other Disposition of Our Common Stock

Except as described below and subject to the discussion below concerning backup withholding, any gain realized by a Non-U.S. Holder on the sale, exchange or other disposition of common stock generally will not be subject to U.S. federal income tax unless (1) such gain is U.S. trade or business income, (2) subject to certain exceptions, the Non-U.S. Holder is an individual who is present in the United States for 183 days or more in the taxable year of the disposition, (3) the Non-U.S. Holder is subject to tax pursuant to the provisions of U.S. tax law applicable to certain U.S. expatriates (including certain former citizens or residents of the United States), or (4) we are a U.S. real property holding corporation at any time within the shorter of the five-year period preceding such sale or other disposition or the period such holder held the common stock. We believe that we are not currently a “United States real property holding corporation” and that we will not become one in the future.

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Taxation of Dividends

In general, dividends paid to a Non-U.S. Holder of common stock will be subject to withholding of U.S. federal income tax at a 30% rate unless such rate is reduced by an applicable income tax treaty. Dividends that are U.S. trade or business income generally are subject to U.S. federal income tax at regular income tax rates, and generally are not subject to the 30% withholding tax or treaty-reduced rate if the Non-U.S. Holder files the appropriate form with the payor. Any U.S. trade or business income received by a Non-U.S. Holder that is a corporation also may, under certain circumstances, be subject to an additional “branch profits tax” at a 30% (or, if applicable, treaty-reduced) rate. A Non-U.S. Holder of common stock who wishes to claim the benefit of an applicable treaty rate would be required to satisfy applicable certification and other requirements. A Non-U.S. Holder of common stock that is eligible for a reduced rate of withholding tax pursuant to an applicable income treaty may obtain a refund of amounts withheld at a higher rate by filing an appropriate claim for refund with the IRS.

Information Reporting and Backup Withholding Tax

We must report annually to the IRS and to each Non-U.S. Holder any dividend that is subject to withholding or is exempt from U.S. withholding tax pursuant to a tax treaty. Copies of these information returns may also be made available under the provisions of a specific treaty or agreement to the tax authorities of the country in which the Non-U.S. Holder resides.

Information reporting and backup withholding of U.S. federal income tax at a current rate of 28% generally may apply to payments made by us or our agent to Non-U.S. Holders if the payee fails to make the appropriate certification that the holder is not a U.S. person or if we or our paying agent has actual knowledge that the payee is a U.S. person.

The payment of the proceeds from the disposition of common stock to or through the U.S. office of any broker, foreign or domestic, will be subject to information reporting and possible backup withholding unless the owner certifies as to its Non-U.S. Holder status under penalties of perjury or otherwise establishes an exemption, provided that the broker does not have actual knowledge that the holder is a U.S. person or that the conditions of any other exemption are not, in fact, satisfied. The payment of the proceeds from the disposition of common stock to or through a non-U.S. office of a non-U.S. broker that is not a U.S. related person generally will not be subject to backup withholding. The payment of proceeds from the disposition of common stock through the foreign office of a broker that is either a U.S. person or a U.S. related person (as defined below) will be subject to information reporting, but not backup withholding, unless such broker has documentary evidence in its files of the Non-U.S. Holder’s foreign status and certain other conditions are met or you otherwise establish an exemption.

Both backup withholding and information reporting will apply to the proceeds of such dispositions if the broker has actual knowledge that the payee is a U.S. Holder. A U.S. related person is (1) a “controlled foreign corporation” for United States tax purposes, (2) a foreign person 50% or more of whose gross income from all sources for certain periods is effectively connected with a U.S. trade or business or (3) a foreign partnership, if at any time during its tax year, one or more of its partners are U.S. persons (as defined in Treasury Regulations under the Code) who in the aggregate hold more than 50% of the income or capital interest in the partnership or if, at any time during its tax year, such foreign partnership is engaged in a U.S. trade or business.

Any amounts withheld under the backup withholding rules from a payment to a Non-U.S. Holder will be allowed as a refund or a credit against such Non-U.S. Holder’s U.S. federal income tax liability, provided that the requisite procedures are followed.

U.S. Federal Estate Tax

Common stock held by a decedent at the time of his or her death will be included in such Non-U.S. Holder’s gross estate for U.S. federal estate tax purposes unless an applicable estate tax treaty provides otherwise. Investors are individuals should be aware that there have been recent amendments to the U.S. federal estate tax rules, and such holders should consult with their own tax advisors with regard to an investment in the common stock.

THE PRECEDING DISCUSSION OF CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES IS FOR GENERAL INFORMATION ONLY AND MAY NOT BE APPLICABLE DEPENDING UPON A HOLDER’S PARTICULAR SITUATION. ACCORDINGLY, EACH INVESTOR SHOULD CONSULT ITS OWN TAX ADVISOR AS TO PARTICULAR TAX CONSEQUENCES TO IT OF PURCHASING, HOLDING AND DISPOSING OF THE COMMON STOCK, INCLUDING THE APPLICABILITY AND EFFECT OF ANY STATE, LOCAL OR FOREIGN TAX LAWS, AND OF ANY PROPOSED CHANGES IN APPLICABLE LAWS.

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UNDERWRITING

Subject to the terms and conditions stated in the underwriting agreement between us, the selling stockholders and Jefferies Quarterdeck, a division of Jefferies & Company, Inc., as representative of the several underwriters, each of the underwriters named below has severally agreed to purchase, and we and the selling stockholders have agreed to sell to each named underwriter, the number of shares set forth opposite the name of each underwriter.

Underwriters	Number of Shares
Jefferies Quarterdeck, a division of Jefferies & Company, Inc.	7,040,000
Merriman Curhan Ford & Co.	1,760,000
Total	8,800,000

The underwriting agreement provides that the obligations of the several underwriters to purchase the shares offered by us and the selling stockholders are subject to some conditions. The underwriters are obligated to purchase all of the shares offered by us and the selling stockholders, other than those covered by the over-allotment option described below, if any of the shares are purchased. The underwriting agreement also provides that, in the event of a default by an underwriter, in some circumstances the purchase commitments of non-defaulting underwriters may be increased or the underwriting agreement may be terminated.

The underwriters propose to offer the shares to the public initially at the public offering price set forth on the cover of this prospectus, and to some dealers at that price less a concession not in excess of $0.15 per share. The underwriters may allow, and those dealers may reallow, a discount not in excess of $0.10 per share to other dealers. After the offering, the public offering price, the concession to selected dealers and the reallowance to other dealers may be changed by the underwriters. There can be no assurance that the prices at which the common stock will sell in the public market after this offering will not be lower than the price at which they are sold by the underwriters or that an active trading market in the shares will develop and continue after this offering.

We and each of the selling stockholders have granted to the underwriters an over-allotment option, exercisable not later than 30 days after the date of this prospectus, to purchase, from time to time, in whole or in part, up to an aggregate of 1,320,000 additional shares at the public offering price less the underwriting discount set forth on the cover of this prospectus.

The underwriters may exercise the over-allotment option only to cover over-allotments, if any, made in connection with the sale of the common stock offered by us and the selling stockholders. To the extent that option is exercised, each underwriter will be obligated, subject to some conditions, to purchase a number of additional shares approximately proportionate to that underwriter’s initial purchase commitment as indicated in the table above.

The following table shows the per share and total underwriting discounts and commissions to be paid to the underwriters by us and the selling stockholders. Such amounts are shown assuming both no exercise and full exercise of the underwriters’ over-allotment option to purchase 1,320,000 additional shares.

	Paid By Us			Paid By The Selling Stockholders
	Without Exercise of Over-allotment Option		With Full Exercise of Over-allotment Option	Without Exercise of Over-allotment Option	With Full Exercise of Over-allotment Option
Per share	$	.2550	.2550	.2550	.2550
Total	$	1,785,000	2,052,750	459,000	527,850

We estimate that the total expenses of this offering, excluding the underwriting discounts and commissions, will be approximately $0.35 million. The underwriters have agreed to pay certain expenses in connection with the offering.

This offering of the shares is made for delivery when, as and if accepted by the underwriters and subject to prior sale and to withdrawal, cancellation or modification of this offering without notice. The underwriters reserve the right to reject an order for the purchase of shares in whole or in part.

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We have agreed to indemnify the underwriters against certain liabilities, including liabilities under the Securities Act, and to contribute to payments the underwriters may be required to make in respect of these liabilities.

Our common stock is listed on the American Stock Exchange under the symbol “RAE.”

We and our executive officers and directors, the selling stockholders and certain other stockholders have agreed not to offer, sell, contract to sell, grant any option to purchase, announce or disclose any intention to sell, transfer the economic risk of ownership in, make any short sale, pledge or otherwise dispose of, directly or indirectly, or file a registration statement under the Securities Act relating to, any shares of our common stock or securities either owned as of the date of this prospectus or thereafter acquired without the prior written consent of the underwriters for a period of 90 days (or 180 days, in the case of the selling stockholders) after the date of this prospectus supplement, other than:

• the sale by the selling stockholders of their shares of common stock in this offering including, if exercised, pursuant to the over-allotment option; and

• certain permitted transfers such as transfers to family members, trusts established for the benefit of a transferring stockholder and its family members or transfers by stockholders that are partnerships or corporations to the partners or stockholders of such stockholder, but in each case subject to the prior execution by the transferee(s) of a lock-up agreement satisfactory to Jefferies Quarterdeck.

• Upon the expiration of this 90-day (or 180-day, in the case of the selling stockholders) lock-up period, substantially all of these shares will become eligible for sale, subject to the restrictions of Rule 144. These restrictions will not affect our ability to:

• Issue, sell or award shares of our common stock or securities convertible into, exercisable or exchangeable for, shares of our common stock pursuant to a management incentive plan in effect as of the date hereof as long as such shares and securities do not vest and are not exercisable prior to the expiration of the applicable lock-up period (other than upon the death or disability of a holder thereof);

• Issue shares of our common stock or other securities pursuant to the exercise of stock options currently outstanding; or

• Issue shares of our common stock or securities convertible into, or exercisable or exchangeable for, shares of our common stock in connection with an acquisition of or merger with another corporation as long as such securities are not registered under the Securities Act during the applicable lock-up period.

We have been advised by the representatives of the underwriters that, in accordance with Regulation M under the Securities Act, some persons participating in this offering may engage in transactions, including syndicate covering transactions, stabilizing bids or the imposition of penalty bids, that may have the effect of stabilizing or maintaining the market price of the shares at a level above that which might otherwise prevail in the open market.

A “syndicate covering transaction” is a bid for or the purchase of shares on behalf of the underwriters to reduce a syndicate short position incurred by the underwriters in connection with this offering. The underwriters may create a syndicate short position by making short sales of our shares and may purchase our shares in the open market to cover syndicate short positions created by short sales. Short sales involve the sale by the underwriters of a greater number of shares than they are required to purchase in this offering. Short sales can be either “covered” or “naked.” “Covered” short sales are sales made in an amount not greater than the underwriters’ over-allotment option to purchase additional shares from us and one of the selling stockholders in this offering. “Naked” short sales are sales in excess of the over-allotment option. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the shares in the open market after pricing that could adversely affect investors who purchase in this offering. If the underwriters create a syndicate short position, they may choose to reduce or “cover” this position by either exercising all or part of the over-allotment option to purchase additional shares from us and the selling stockholders or by engaging in “syndicate covering transactions.” The underwriters may close out any covered short position by either exercising their over-allotment option or purchasing shares in the open market. The underwriters must close out any naked short position by purchasing shares in the open market. In determining the source of shares to close out the covered short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares through the over-allotment option. A “stabilizing bid” is a bid for or the purchase of shares on behalf of the underwriters for the purpose of fixing or maintaining the price

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of our common stock. A “penalty bid” is an arrangement that permits the representatives of the underwriters to reclaim the selling concession from an underwriter or a syndicate member when shares sold by such underwriter or syndicate members are purchased by the representatives in a syndicate covering transaction and, therefore, have not been effectively placed by the underwriter or syndicate member.

We have been advised by the representatives of the underwriters that these transactions may be effected on the American Stock Exchange or otherwise and, if commenced, may be discontinued at any time. Similar to other purchase activities, these activities may have the effect of raising or maintaining the market price of our common stock or preventing or retarding a decline in the market price of our common stock. As a result, the price of our common stock may be higher than the price that might otherwise exist in the open market.

Jefferies/Quarterdeck, LLC is a wholly-owned subsidiary of Jefferies Group, Inc., the parent company of Jefferies & Company, Inc. Other than as set forth in this prospectus and with respect to its contractual relationship with us pursuant to the letter agreement described below, Jefferies/Quarterdeck, LLC does not have any material relationships with us or any of our officers, directors or other controlling persons.

Both Jefferies & Company, Inc. and Jefferies/Quarterdeck, LLC have provided and in the future may provide investment banking and other financial advisory services to us, including strategic planning with respect to acquisitions, for which we have paid and expect to pay customary fees and expenses. In connection with such financial advisory services. Jefferies/Quarterdeck, LLC received 450,000 warrants to purchase our common stock pursuant to a letter agreement dated June 4, 2003. As a result, the warrants may be deemed underwriting compensation and, with certain exceptions, shall not be sold, transferred, assigned or hypothecated for a period of two years following the effective date of the offering or such shorter period as may be applicable pursuant to any amendment to NASD Rule 2710.

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NOTICE TO CANADIAN RESIDENTS

Offers and Sales in Canada

This prospectus is not, and under no circumstances is to be construed as, an advertisement or a public offering of shares in Canada or any province or territory thereof. Any offer or sale of shares in Canada will be made only under an exemption from the requirements to file a prospectus with the relevant Canadian securities regulators and only by a dealer properly registered under applicable provincial securities laws or, alternatively, pursuant to an exemption from the dealer registration requirement in the relevant province or territory of Canada in which such offer or sale is made.

This prospectus is for the confidential use of only those persons to whom it is delivered by the underwriters in connection with the offering of the shares into Canada. The underwriters reserve the right to reject all or part of any offer to purchase shares for any reason or allocate to any purchaser less than all of the shares for which it has subscribed.

Responsibility

Except as otherwise expressly required by applicable law or as agreed to in contract, no representation, warranty, or undertaking (express or implied) is made and no responsibilities or liabilities of any kind or nature whatsoever are accepted by any underwriter or dealer as to the accuracy or completeness of the information contained in this prospectus or any other information provided by the Company or the selling stockholders in connection with the offering of the shares into Canada.

Resale Restrictions

The distribution of the shares in Canada is being made on a private placement basis only and is exempt from the requirement that the Company and the selling stockholders prepare and file a prospectus with the relevant Canadian regulatory authorities. Accordingly, any resale of the shares must be made in accordance with applicable securities laws, which will vary depending on the relevant jurisdiction, and which may require resales to be made in accordance with exemptions from registration and prospectus requirements. Canadian purchasers are advised to seek legal advice prior to any resale of the shares.

Representations of Purchasers

Each Canadian investor who purchases shares will be deemed to have represented to the Company, the selling stockholders, the underwriters and any dealer who sells shares to such purchaser that: (i) the offering of the shares was not made through an advertisement of the shares in any printed media of general and regular paid circulation, radio,

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television or telecommunications, including electronic display, or any other form of advertising in Canada; (ii) such purchaser has reviewed the terms referred to above under “Resale Restrictions” above; (iii) where required by law, such purchaser is purchasing as principal for its own account and not as agent; and (iv) such purchaser or any ultimate purchaser for which such purchaser is acting as agent is entitled under applicable Canadian securities laws to purchase such shares without the benefit of a prospectus qualified under such securities laws, and without limiting the generality of the foregoing: (a) in the case of a purchaser located in a province other than Ontario and Newfoundland and Labrador, without the dealer having to be registered, (b) in the case of a purchaser located in a province other than Ontario or Quebec, such purchaser is an “accredited investor” as defined in section 1.1 of Multilateral Instrument 45-103 – Capital Raising Exemptions, (c) in the case of a purchaser located in Ontario, such purchaser, or any ultimate purchaser for which such purchaser is acting as agent, is an “accredited investor”, other than an individual, as that term is defined in Ontario Securities Commission Rule 45-501 – Exempt Distributions and is a person to which a dealer registered as an international dealer in Ontario may sell shares, and (d) in the case of a purchaser located in Québec, such purchaser is a “sophisticated purchaser” within the meaning of section 44 or 45 of the Securities Act (Québec).

Taxation and Eligibility for Investment

Any discussion of taxation and related matters contained in this prospectus does not purport to be a comprehensive description of all the tax considerations that may be relevant to a decision to purchase the shares. Canadian purchasers of shares should consult their own legal and tax advisers with respect to the tax consequences of an investment in the shares in their particular circumstances and with respect to the eligibility of the shares for investment by the purchaser under relevant Canadian federal and provincial legislation and regulations.

Rights of Action for Damages or Rescission

(Ontario)

Securities legislation in Ontario provides that every purchaser of shares pursuant to this prospectus shall have a statutory right of action for damages or rescission against the Company and any selling stockholder in the event this prospectus contains a misrepresentation as defined in the Securities Act (Ontario). Ontario purchasers who purchase shares offered by this prospectus during the period of distribution are deemed to have relied on the misrepresentation if it was a misrepresentation at the time of purchase. Ontario purchasers who elect to exercise a right of rescission against the Company and any selling stockholder on whose behalf the distribution is made shall have no right of action for damages against the Company or the selling stockholders. The right of action for rescission or damages conferred by the statute is in addition to, and without derogation from, any other right the purchaser may have at law. Prospective Ontario purchasers should refer to the applicable provisions of Ontario securities legislation and are advised to consult their own legal advisers as to which, or whether any, of such rights or other rights may be available to them.

The foregoing summary is subject to the express provisions of the Securities Act (Ontario) and the rules, regulations and other instruments thereunder, and reference is made to the complete text of such provisions contained therein. Such provisions may contain limitations and statutory defences on which the Company and the selling stockholders may rely. The enforceability of these rights may be limited as described herein under “Enforcement of Legal Rights.”

The rights of action discussed above will be granted to the purchasers to whom such rights are conferred upon acceptance by the relevant dealer of the purchase price for the shares. The rights discussed above are in addition to and without derogation from any other right or remedy which purchasers may have at law. Similar rights may be available to investors in other Canadian provinces.

Enforcement of Legal Rights

The Company is organized under the laws of the State of Delaware in the United States of America. All, or substantially all, of the directors and officers of the Company, as well as the selling stockholders and the experts named herein, may be located outside of Canada and, as a result, it may not be possible for Canadian purchasers to effect service of process within Canada upon the Company or such persons. All or a substantial portion of the assets of the Company and such other persons may be located outside of Canada and, as a result, it may not be possible to satisfy a judgement against the Company or such persons in Canada or to enforce a judgement obtained in Canadian courts against the Company or such persons outside of Canada.

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Language of Documents

Upon receipt of this document, you hereby confirm that you have expressly requested that all documents evidencing or relating in any way to the sale of the securities described herein (including for greater certainty any purchase confirmation or any notice) be drawn up in the English language only. Par la réception de ce document, vous confirmez par les présentes que vous avez expressément exigé que tous les documents faisant foi ou se rapportant de quelque manière que ce soit à la vente des valeurs mobilières décrites aux présentes (incluant, pour plus de certitude, toute confirmation d’achat ou tout avis) soient rédigés en anglais seulement.

LEGAL MATTERS

The validity of the common stock offered hereby will be passed upon for us by our counsel, Gray Cary Ware & Freidenrich LLP, East Palo Alto, California. Certain legal matters relating to the offering will be passed upon for the underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, Los Angeles, California.

EXPERTS

BDO Seidman LLP, independent auditors, have audited our consolidated financial statements and schedule included in our Annual Report on Form 10-K for the year ended December 31, 2002, as set forth in their report, which is incorporated by reference in this prospectus and elsewhere in the registration statement. Our consolidated financial statements and schedule are incorporated by reference in reliance on BDO Seidman LLP’s report, given on their authority as experts in accounting and auditing.

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PROSPECTUS

$30,000,000

plus

1,800,000 shares of common stock to be offered by the selling stockholders.

RAE SYSTEMS INC.

CONVERTIBLE PREFERRED STOCK

PREFERRED STOCK

COMMON STOCK

SECURITIES WARRANTS

We may offer and sell, from time to time, up to $30,000,000 of any of the following securities under this prospectus:

• shares of convertible preferred stock;

• shares of preferred stock;

• shares of common stock, $0.001 par value; and

• securities warrants.

In addition, we may offer and sell, from time to time, up to 1,800,000 shares of common stock, $0.001 par value, of the selling stockholders named in this prospectus. The securities under this prospectus may be sold in one or more transactions, at fixed prices, at prevailing market prices at the time of sale, at varying prices determined at the time of sale, at negotiated prices or by any other lawful method. See the “Plan of Distribution” section below. This prospectus describes the general terms of these securities and the general manner in which we will offer the securities. The specific terms of any securities we offer will be included in a supplement to this prospectus. The prospectus supplement will also describe the specific manner in which we will offer the securities, which may include sales to or through underwriters, agents, dealers or other purchasers. The prospectus supplement may also add, update or change information contained in this prospectus. You should read this prospectus and any prospectus supplements carefully before making an investment in our securities. This prospectus may not be used to offer or sell securities unless accompanied by a prospectus supplement.

This prospectus also relates to the public offering of shares of our common stock by the selling stockholders named in this prospectus. We will receive no part of the proceeds of the sale of any shares offered in this prospectus by the selling stockholders. All expenses of registration incurred in connection with this offering are being borne by us, but all selling and other expenses incurred by the selling stockholders will be borne by such selling stockholders.

Our common stock is quoted on the American Stock Exchange under the symbol “RAE.” On January 5, 2004, the last reported sale price of our common stock on the American Stock Exchange was $3.32. We have no current intention to list the other classes of securities being offered under this prospectus on any securities exchange or to designate such securities for quotation on the NASDAQ Stock Market.

INVESTING IN ANY OF OUR SECURITIES INVOLVES RISK. YOU SHOULD CAREFULLY CONSIDER THE RISK FACTORS BEGINNING ON PAGE 5 OF THIS PROSPECTUS BEFORE YOU MAKE AN INVESTMENT IN THE SECURITIES.

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.

The date of this prospectus is January 6, 2004.

TABLE OF CONTENTS

	Page
PROSPECTUS SUMMARY	1
SUMMARY CONSOLIDATED FINANCIAL DATA	4
RISK FACTORS	5
WHERE YOU CAN FIND MORE INFORMATION	9
FORWARD-LOOKING STATEMENTS	10
USE OF PROCEEDS	11
CAPITALIZATION	11
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	12
BUSINESS	20
MANAGEMENT	30
PRINCIPAL AND SELLING STOCKHOLDERS	32
DESCRIPTION OF CAPITAL STOCK	34
DESCRIPTION OF SECURITIES WARRANTS	37
PLAN OF DISTRIBUTION	41
LEGAL MATTERS	43
EXPERTS	43

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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus. We urge you to read this entire prospectus carefully, including the “Risk Factors” section and our consolidated financial statements and the notes to those statements before making an investment decision.

RAE Systems Inc.

We are a leading global developer and manufacturer of rapidly-deployable, multi-sensor chemical detection monitors and networks for homeland security and industrial applications. In addition, we offer a full line of portable single-sensor chemical and radiation detection products. Our technologically advanced products are based on proprietary technology, and include portable, wireless and fixed atmospheric monitors and photo-ionization detectors, and gamma and neutron detectors. Our products enable the military and first responders such as firefighters, law enforcement and other emergency management personnel to detect and provide early warning of weapons of mass destruction and other hazardous materials. Industrial applications include the detection of toxic industrial chemicals, volatile organic compounds and petrochemicals.

We were founded in 1991 to develop technologies for the detection and early warning of hazardous materials. We have a broad patent portfolio consisting of 18 issued and pending patents that are the basis for many of our products. For example, our patented photo-ionization detector technology allows our products to rapidly and reliably indicate many toxic chemicals and vapors in the part-per-billion range readings. In 1994, we expanded our operations into Shanghai, China, giving us access to high-quality, cost-efficient manufacturing and world-class research capabilities.

Our products are used by many U.S. government agencies, including the Department of Homeland Security, the Department of Justice, and the Department of State, as well as all branches of the U.S. military, and by numerous city and state agencies. Our end users also include many of the world’s leading corporations in the airline, automotive, computer and oil industries. Our products are used in civilian and government atmospheric monitoring programs in over 50 countries. Several government agencies and departments have standardized their programs based on our products for hazardous materials incident response.

Industry Background

The market for our products has evolved from being strictly focused on environmental and industrial monitoring to now encompassing public safety and the threat of terrorism. The increasing concerns about domestic terrorist attacks in the United States as well as the increasing risks of unconventional methods of attack using chemical or radiological agents has created the need for technologically advanced, hazardous material detection devices to address the vulnerability of public venues to such attacks. In response to such risks, the U.S. Congress has authorized a fiscal year 2003 federal budget of $33.6 billion for the Department of Homeland Security. Although only a small perentage of the budget request will be allocated toward products and services we offer, we believe that there are specific areas of funding where chemical and radiological monitors will help address end-users’ needs and requirements.

The need for sophisticated monitoring has been most apparent for emergency response personnel, who are typically the first to arrive on the scene. To date, most first responders have not been trained for and have not carried chemical and radiological detection equipment to detect harmful agents, preventing them from recognizing a potentially lethal situation. We believe first responders need a suite of products that provide a practical, comprehensive solution to protect them from this danger. The following features are important to this solution:

• portability for easy transport;

• rapid deployment for emergency response;

• fast and reliable detection of a broad array of chemicals;

• an open system architecture that allows networking among multiple detectors; and

• wireless networking for monitoring from remote locations.

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To address these and other shortcomings, the President’s budget authorizes in excess of $2.0 billion to better train, equip and support the over 1.7 million firefighters, police officers and emergency medical technicians in the United States. We believe that the nature of the incidents to which first responders respond often involve chemical and/or radiological threats, and consequently, we believe that a significant portion of this amount will be spent for chemical and/or radiological detection products and services.

The same equipment capabilities that are necessary to support first responders are also necessary to address other areas where there are increasing demands for chemical and radiation detection. For example, the United States is focused on maintaining the security of its ports, and this security is dependent upon effective cargo container security and monitoring measures being efficiently applied in order to thwart the introduction of hazardous chemical and radiological devices into the country. The United States alone receives approximately six million loaded containers per year in its 361 seaports. Similarly, indoor air quality and security is a key issue for both the industrial and environmental industries. With harmful toxic industrial chemicals creating a potentially dangerous work environment for employees as well as risks of terrorist attacks against public and private buildings through airborne chemical and radiological agents, a need exists for the constant monitoring of air quality.

While attention has shifted primarily to public safety and the threat of terrorism, the market for our products remains active in the more traditional fields of environmental and industrial monitoring. The continued application of our products in these established markets stems from the dependence of numerous key industries on sensors since they provide vital information that can affect worker safety, products, processes, and systems. According to The Freedonia Group, the overall demand for gas and chemical sensors in the U.S. is expected to reach 61 million units by 2006, up from 43 million in 2001, a compounded annual growth rate of 7.2%. A few examples of the prevalent need for monitoring in the environmental and industrial industries include:

• chemicals and manufacturing (process control);

• municipal and volunteer fire departments (arson investigations);

• petroleum (leaks and explosive vapors);

• transportation (airplane wing tank entry); and

• hazardous materials clean-up (environmental remediation).

Our Strengths

We believe that we are well positioned to compete in today’s market through our various strengths. These strengths include:

• our comprehensive product portfolio;

• our position as a technological leader in the industry;

• our established customer base;

• our state-of-the-art, cost-efficient manufacturing; and

• our strong research, development and engineering capabilities.

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Our Strategy

Since our inception, we have focused on becoming a leader in the development of hazardous materials detection monitoring devices. We intend to maintain this focus by pursuing the following strategies:

• aggressively pursue the homeland security market;

• aggressively pursue the rapidly expanding network detection market;

• continue to develop new products and solutions;

• expand the applications for which our products can be used;

• leverage our cost-efficient infrastructure; and

• selectively pursue acquisitions, joint ventures and licensing agreements.

Our Challenges and Certain Risks We Face

Our ability to capitalize on our strengths and implement our strategy faces a number of challenges and risks, including:

• the highly-competitive gas detection monitoring device market;

• the rapidly-evolving product needs of the first responder community and our other customers;

• the dependence of our many of our customers on federal, state and local government funding;

• the ability of our competitors to develop alternative technology or develop a broader array of products; and

• our dependence on members of our management team to develop new products, maintain good customer relations and identify new business opportunities.

For further information about these challenges and other risks, see “Risk Factors” beginning on page 5. You should carefully consider all of the risk factors together with all of the other information included in this prospectus and in any accompanying prospectus supplement.

Corporate Information

Our principal executive offices are located at 1339 Moffett Park Drive, Sunnyvale, California 94089, our telephone number is (408) 752-0723, and our website is located at www.raesystems.com. Information on our website is not a part of this prospectus.

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SUMMARY CONSOLIDATED FINANCIAL DATA

Set forth below are summary statements of operations data for the nine months ended September 30, 2003 and 2002, and for the years ended December 31, 2002, 2001, 2000, 1999 and 1998, and summary balance sheet data as of September 30, 2003 and as of December 31, 2002, 2001, 2000, 1999 and 1998. The summary financial data as of December 31, 2002 and 2001, and for the years ended December 31, 2002, 2001 and 2000, are derived from RAE’s audited consolidated financial statements included elsewhere in this prospectus. The summary financial data as of December 31, 2000 and 1999, and for the year ended December 31, 1999, are derived from RAE’s audited consolidated financial statements not included in this prospectus. The summary financial data as of September 30, 2003 and December 31, 1998, and for the nine months ended September 30, 2003 and 2002, and for the year ended December 31, 1998, has been derived from the unaudited consolidated financial statements of RAE and has been prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, contains all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the financial data as of these dates and for these periods. The financial data for the nine months ended September, 2003 are not necessarily indicative of the results that may be expected for any future period or for a full year. This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” appearing elsewhere in this prospectus.

	Nine Months Ended September 30,					Year Ended December 31,
	2003		2002			2002			2001			2000		1999		1998
	(Unaudited)		(Unaudited)													(Unaudited)
Statement of Operations Data:
Net sales	$	22,767,800	$	15,581,700		$	21,844,800		$	19,013,600		$	18,194,100	$	10,832,900	$	9,436,300
Gross margin	$	13,955,700	$	9,003,800		$	13,070,700		$	11,971,700		$	11,615,100	$	7,702,600	$	6,629,100
Operating income (loss)	$	2,952,600	$	(9,535,700	)	$	(8,970,400	)	$	(97,200	)	$	1,281,700	$	822,300	$	2,116,000
Net income (loss)	$	2,294,600	$	(9,835,900	)	$	(9,454,800	)	$	136,800		$	829,200	$	505,900	$	1,397,200
Basic income (loss) per share	$	0.05	$	(0.26	)	$	(0.24	)	$	0.01		$	0.04	$	0.02	$	0.06
Diluted income (loss) per share	$	0.05	$	(0.26	)	$	(0.24	)	$	0.00		$	0.02	$	0.01	$	0.04
Weighted-Average Common Shares:
Basic outstanding shares		45,914,155		37,976,136			39,902,169			24,154,797			22,864,656		22,573,482		22,392,586
Diluted outstanding shares		49,909,777		37,976,136			39,902,169			37,067,871			35,436,168		35,002,580		32,923,678

	At September 30,		At December 31,
	2003		2002		2001		2000		1999		1998
	(Unaudited)										(Unaudited)
Balance Sheet Data:
Working capital	$	11,991,500	$	8,350,900	$	5,105,900	$	4,528,900	$	1,280,000	$	1,465,400
Total assets	$	19,204,500	$	16,669,700	$	15,043,200	$	12,706,400	$	8,804,600	$	5,546,100
Long-term liabilities	$	376,800	$	384,500	$	644,300	$	819,100	$	450,600	$	39,800
Total shareholders’ equity	$	14,157,000	$	10,859,700	$	3,438,500	$	2,954,800	$	2,034,000	$	1,502,900

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RISK FACTORS

Investing in our securities involves a high degree of risk. You should consider the following risk factors, as well as other information contained or incorporated by reference in this prospectus and any accompanying prospectus supplement, before deciding to purchase any of the securities offered by this prospectus and any accompanying prospectus supplement. If any of these risks occur, our business could suffer, the market price of our common stock could decline and you could lose all or part of your investment in our securities.

Our future revenues are unpredictable, our operating results are likely to fluctuate from quarter to quarter, and if we fail to meet the expectations of securities analysts or investors, our stock price could decline significantly.

Our quarterly and annual operating results have fluctuated in the past and are likely to fluctuate significantly in the future due to a variety of factors, some of which are outside of our control. Accordingly, we believe that period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as indications of future performance. Some of the factors that could cause our quarterly or annual operating results to fluctuate include significant shortfalls in revenue relative to our planned expenditures, market acceptance of our products, ongoing product development and production, competitive pressures and customer retention.

It is likely that in some future quarters our operating results may fall below the expectations of investors. In this event, the trading price of our common stock could significantly decline.

The market for gas detection monitoring devices is highly competitive, and if we cannot compete effectively, our business may be harmed.

The market for gas detection monitoring devices is highly competitive and we expect the emerging wireless gas monitoring system market to be equally competitive. Competitors in the gas monitoring industry differentiate themselves on the basis of their technology, quality of product and service offerings, cost and time to market. Our primary competitors include Industrial Scientific Corporation, Mine Safety Appliances Company, BW Technologies, Ion Science, PerkinElmer, Inc., Draeger Safety Inc., Gastec Corporation and Bacou-Dalloz Group. Most of our competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial and marketing resources than us. In addition, some of our competitors may be able to:

• devote greater resources to marketing and promotional campaigns;

• adopt more aggressive pricing policies; or

• devote more resources to technology and systems development.

In light of these factors, we may be unable to compete successfully.

We might not be successful in the development or introduction of new products and services in a timely and effective manner, and, consequently, we may not be able to remain competitive and the results of operations may suffer.

Our revenue growth is dependent on the timely introduction of new products to market. We may be unsuccessful in identifying new product and service opportunities or in developing or marketing new products and services in a timely or cost-effective manner. In addition, while our current technology enables us to create products targeted to address the evolving market, we are unable to foresee whether we will continue to have the necessary technology in the future. In developing new products, we may be required to make significant investments before we can determine the commercial viability of the new product. If we fail to accurately foresee our customers’ needs and future activities, we may invest heavily in research and development of products that do not lead to significant sales.

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We have recently expanded our current business of providing gas detection instruments to include radiation detection and wireless systems for local and remote security monitoring. While we perceive a large market for such products, the radiation detection and wireless systems markets are still evolving, and we have little basis to assess the demand for these products and services or to evaluate whether our products and services will be accepted by the market. If our radiation detection products and wireless products and services do not gain broad market acceptance or if we do not continue to maintain the necessary technology, our business and results of operations will be harmed.

In addition, compliance with safety regulations, specifically the need to obtain regulatory approvals in certain jurisdictions, could delay the introduction of new products by us. As a result, we may experience delays in realizing revenues from our new products.

We may not be successful in promoting and developing our brand, which could prevent us from remaining competitive.

We believe that our future success will depend on our ability to maintain and strengthen the RAE Systems brand, which will depend, in turn, largely on the success of our marketing efforts and ability to provide our customers with high-quality products. If we fail to successfully promote and maintain our brand, or incur excessive expenses in attempting to promote and maintain our brand, our business will be harmed.

We depend on facilities located outside of the United States to manufacture a substantial portion of our products, which subjects us to additional risks.

A significant portion of our products and components are manufactured at our facility in Shanghai, China. Our business is subject to risks normally associated with conducting business outside the United States, such as foreign government regulations, changes in environmental laws, nation-specific or region-specific certifications, political unrest, disruptions or delays in shipments, fluctuations in foreign currency exchange rates and changes in the economic conditions in the countries in which our raw materials suppliers, service providers, and customers are located. Our business may also be adversely affected by the imposition of additional trade restrictions related to imported products, including quotas, duties, taxes and other charges or restrictions. If any of the foregoing factors were to render the conduct of business in a particular country undesirable or impractical, or if our current foreign manufacturing sources were to cease doing business with us for any reason, or if our ability to transfer products between China and other regions of the world were impeded, our business and results of operations could be adversely affected.

Any failure to adequately protect and enforce our intellectual property rights could harm our business.

We regard our intellectual property as critical to our success. We rely on a combination of patent, trademark, copyright, trade secret laws and non-disclosure agreements and confidentiality procedures to protect our proprietary rights. Notwithstanding these laws, we may be unsuccessful in protecting our intellectual property rights or in obtaining patents or registered trademarks for which we apply. Although processes are in place to protect our intellectual property rights, we cannot guarantee that these procedures are adequate to prevent misappropriation of our current technology or that our competitors will not develop technology that is similar to our own. While there is no single patent or license to technology of material significance to the Company, our ability to compete is affected by our ability to protect our intellectual property rights in general. For example, we have a collection of patents related to our photo-ionization detector technology of which the first of such patents expires in 2012, and our ability to compete may be affected by any competing similar or new technology. In addition, if we lose the licensing rights to a patented or other proprietary technology, we may need to stop selling products incorporating that technology and possibly other products, redesign our products or lose a competitive advantage. We cannot ensure that our future patent applications will be approved or that our current patents will not be challenged by third parties. Furthermore, we cannot ensure that, if challenged, our patents will be found to be valid and enforceable.

Any litigation relating to our intellectual property rights could, regardless of the outcome, have a material adverse impact on our business and results of operations.

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We might face intellectual property infringement claims that might be costly to resolve and affect our results of operations.

We may, from time to time, be subject to claims of infringement of other parties’ proprietary rights or claims that our own trademarks, patents or other intellectual property rights are invalid. Any claims of this type, regardless of merit, could be time-consuming to defend, result in costly litigation, divert management’s attention and resources or require us to enter into royalty or license agreements. The terms of any such license agreements may not be available on reasonable terms, if at all, and the assertion or prosecution of any infringement claims could significantly harm our business.

Some of our products may be subject to product liability claims which could be costly to resolve and affect our results of operations.

There can be no assurance that we will not be subject to third-party claims in connection with our products or that any indemnification or insurance available to us will be adequate to protect us from liability. A product liability claim, product recall or other claim, as well as any claims for uninsured liabilities or in excess of insured liabilities, could have a material adverse effect on our business and results of operations.

We may lose sales if our distributors stop selling our products.

We distribute our products primarily through distributors. We derive approximately 90% of our revenues via our sales distribution channels, and, as a result, we are dependent upon these distributors to sell our products and to assist us in promoting and creating a demand for our products. We believe that our future growth depends on the efforts of these distributors. As of the nine-month period ended September 30, 2003, 25 distributors cumulatively account for approximately 40% of our total product sales. In addition, the contractual obligations of our distributors to continue carrying our products must be renewed annually. If one or more of our distributors were to experience financial difficulties or become unwilling to promote and sell our products for any reason, including any refusal to renew their commitment as our distributor, we might not be able to replace such lost revenue, and our business and results of operations could be materially harmed.

Because we purchase a significant portion of our component parts from a limited number of third party suppliers, we are subject to the risk that we may be unable to acquire quality components in a timely manner, which could result in delays of product shipments and damage our business and operating results.

We currently purchase component parts used in the manufacture of our products from a limited number of third party suppliers. We depend on these suppliers to meet our needs for various sensors, microprocessors and other material components. While other third party suppliers exist, we are dependent on the quality of the components supplied to us by our existing vendors which we may not be able to obtain from other third party suppliers. Should we encounter shortages and delays in obtaining components, we might not be able to supply products in a timely manner, and our business could be adversely affected.

Any future acquisitions that we undertake could be difficult to integrate, disrupt our business, dilute stockholder value or harm our results of operations.

We may acquire or make investments in complementary businesses, technologies, services or products if appropriate opportunities arise. The process of integrating any acquired business, technology, service or product into our business and operations may result in unforeseen operating difficulties and expenditures. Integration of an acquired company also may consume much of our management’s time and attention that would otherwise be available for ongoing development of our business. Moreover, the anticipated benefits of any acquisition may not be realized. Future acquisitions could result in dilutive issuances of equity securities or the incurrence of debt, contingent liabilities or expenses related to goodwill recognition and other intangible assets, any of which could harm our business.

Our ownership interest in REnex will cause us to incur losses that we would not otherwise incur.

We own approximately 36 percent of REnex Technology Ltd., a wireless systems company still in the research and development stage, and which to date has not generated any revenues. We are required to incorporate our share of its expenses as losses in our Consolidated Statements of Operations. If REnex does not begin to generate revenues at the level we anticipate or otherwise incurs greater losses, we could incur greater losses than we anticipate and our results of operations will suffer.

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The adoption of the fair value recognition provisions of SFAS No. 123 for stock-based employee compensation as provided for in SFAS No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure, an amendment of FASB Statement No. 123 will have a significant impact on our financial statements.

In connection with our merger with Nettaxi.com, certain options under our 1993 Stock Plan became subject to variable accounting in accordance with FASB Interpretation No. 44 (FIN 44). To eliminate the variable effects of such accounting treatment, we have adopted the fair value recognition provisions of SFAS No. 123 for stock-based employee compensation, effective January 1, 2003, under the modified prospective method as provided for in SFAS No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure, an amendment of FASB Statement No. 123. These fair value recognition provisions generally result in stock-based compensation charges for options granted under our 1993 and 2002 stock option plans. While our interim financial statements herein for the nine-month period ended September 30, 2003 reflect a non-cash compensation charge of only $496,900, these charges may increase significantly depending on the number of options granted in the future and, to a lesser extent, upon the volatility of our stock and the life of such options. Stock-based compensation charges have significantly impacted our financial statements, and will continue to impact our financial statements on a prospective basis.

Future sales of our common stock by existing stockholders could adversely affect our stock price.

Sales of substantial amounts of our common stock in the public market in the future could reduce the prevailing market prices for our common stock. Because approximately 50.8% of our common stock is beneficially owned by our officers and directors, future sales of large positions by the holders of such shares could adversely affect the trading price of our common stock. Specifically, this registration statement allows certain officers to sell up to 1,800,000 shares of our common stock. These sales, or the perception that these sales could occur, could adversely impact trading price of our common stock.

Our business could suffer if we lose the services of any of our executive officers.

Our future success depends to a significant extent on the continued service of our executive officers, including Robert I. Chen, Joseph Ng, Peter Hsi and Hong Tao Sun. We have no employment agreements with any of these officers. The loss of the services of any of our executive officers could harm our business.

Our officers, directors and principal stockholders beneficially own approximately 50.8% of our common stock and, accordingly, may exert substantial influence over the company.

Our executive officers and directors and principal stockholders, in the aggregate, beneficially own approximately 50.8% of our common stock. These stockholders acting together have the ability to control all matters requiring approval by our stockholders. These matters include the election and removal of the directors, amendment of our certificate of incorporation, and any merger, consolidation or sale of all or substantially all of our assets. In addition, they may dictate the management of our business and affairs. Furthermore, this concentration of ownership could have the effect of delaying, deferring or preventing a change in control, or impeding a merger or consolidation, takeover or other business combination, and may substantially reduce the marketability of our common stock.

Provisions in our charter documents and Delaware law could prevent or delay a change in control of the company, which could reduce the market price of our common stock or discourage potential acquirers from offering a premium over the prevailing trading price of our common stock.

Provisions in our certificate of incorporation and bylaws could have the effect of delaying or preventing a change of control of the company or changes in our management. For example, our certificate of incorporation contains provisions eliminating the right of stockholders to act by written consent, providing for the ability to issue up to 1,000,000 shares of preferred stock with rights, privileges and restrictions as designated by the board, establishing supermajority voting requirements for the amendment or repeal of certain provisions of the certificate of incorporation and providing for a classified board of directors. Our bylaws contain provisions requiring advance notice of stockholder proposals or board nominations, as well as the procedures for conduct at stockholder meetings. In addition, we are subject to the the provision of Section 203 of the Delaware General Corporation Law, which restricts certain business combinations with interested stockholders. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. These provisions may also have the effect of discouraging or preventing a potential acquirer from offering our stockholders a premium over the prevailing trading price of our common stock.

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ABOUT THIS PROSPECTUS

This prospectus is part of a registration statement that we have filed with the Securities and Exchange Commission utilizing a “shelf” registration process. Under a shelf registration process, we may, over time, sell any combination of the securities described in this prospectus in one or more offerings up to a total dollar amount of $30,000,000. In addition, the selling stockholders named herein may, over time, sell up to an aggregate of 1,800,000 shares of our common stock. This prospectus provides you with a general description of the securities we or the selling stockholders may offer. Each time we or the selling stockholders sell securities, we will provide a prospectus and a prospectus supplement that will contain specific information about the terms of that particular offering and the securities. The prospectus supplement may also add, update or change information contained in this prospectus. Any statement that we make in this prospectus will be modified or superseded by any inconsistent statement made by us in a prospectus supplement. The information in this prospectus is accurate as of December 8, 2003. You should read both this prospectus and the applicable prospectus supplement, if any, together with additional information described under the heading “Where You Can Find More Information.”

You should rely only on the information contained or incorporated by reference in this prospectus and any prospectus supplement. We have not authorized any dealer, salesman or any other person to provide you with additional or different information. This prospectus and any prospectus supplement are not an offer to sell or the solicitation of an offer to buy any securities other than the securities to which they relate and are not an offer to sell or the solicitation of an offer to buy securities in any jurisdiction to any person to whom it is unlawful to make an offer or solicitation in that jurisdiction. You should not assume that the information in this prospectus or any prospectus supplement or in any document incorporated by reference in this prospectus or any prospectus supplement is accurate as of any date other than the date of the document containing the information. We will disclose any material changes in our affairs in a post-effective amendment to the registration statement of which this prospectus is a part, a prospectus supplement or a future filing with the SEC incorporated by reference in this prospectus.

Unless the context requires otherwise or unless otherwise noted, all references in this prospectus or any prospectus supplement to “we,” “us,” “our,” “RAE” or “RAE Systems” are to RAE Systems Inc. and its subsidiaries on a consolidated basis. We maintain a website at www.raesystems.com. Information contained in our website does not constitute part of this prospectus unless otherwise specifically incorporated by reference herein.

WHERE YOU CAN FIND MORE INFORMATION

We file annual, quarterly and other reports, proxy statements and other information with the SEC. Our SEC filings are available to the public over the Internet at the SEC’s web site at http://www.sec.gov. You may also read and copy at prescribed rates any document we file with the SEC at the SEC’s public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the SEC’s public reference room in Washington, D.C. by calling the SEC at 1-800-SEC-0330.

The SEC allows us to “incorporate by reference” the information we file, which means that we can disclose important information to you without actually including the specific information in this prospectus by referring you to other documents. The information incorporated by reference is an important part of this prospectus, and information that we file later with the SEC will automatically update and supersede this information. We incorporate by reference the documents listed below and any future filings made with the SEC under Sections 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934, as amended until we sell all of the securities described in this prospectus or we earlier terminate the offering:

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• The description of our common stock contained in our Registration Statement on Form 8-A dated August 28, 2003, filed pursuant to Section 12 of the Exchange Act, including any amendment or report filed for the purpose of updating such description.

• Our Annual Report on Form 10-K for the fiscal year ended December 31, 2002.

• Our Quarterly Reports on Form 10-Q for the periods ended March 31, 2003, June 30, 2003 and September 30, 2003.

• Our Current Report on Form 8-K, filed August 28, 2003.

• Our definitive Proxy Statement on Schedule 14A filed March 31, 2003.

We make available free of charge on or through our Internet website, www.raesystems.com, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Information contained in our website does not constitute part of this prospectus unless otherwise specifically incorporated by reference herein.

You may request a copy of these filings at no cost, by writing or telephoning us at the following address or telephone number:

Investor Relations Department

RAE Systems Inc.

1339 Moffett Park Drive

Sunnyvale, California 94089

(408) 752-0723

You should rely only on the information incorporated by reference or provided in this prospectus or any prospectus supplement. We have not authorized anyone else to provide you with different information. We are not making an offer of the securities in any state where the offer is not permitted. You should not assume that the information in this prospectus, any prospectus supplement or any document incorporated by reference is accurate as of any date other than the date of those documents.

FORWARD-LOOKING STATEMENTS

Some of the information in this prospectus (including information incorporated or deemed incorporated by reference herein) contains “forward-looking statements” within the meaning of the Private Litigation Reform Act of 1995. Forward-looking statements are those involving future events and future results that are based on our current expectations, estimates, forecasts, and projects as well as the current beliefs and assumptions of our management. Words such as “outlook,” “believes,” “expects,” “appears,” “may,” “will,” “should,” “anticipates,” or the negative thereof or comparable terminology, are intended to identify such forward looking statements. Any statement that is not a historical fact, including estimates, projections, future trends and the outcome of events that have not yet occurred, is a forward-looking statement. Forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore actual results may differ materially and adversely from those expressed in any forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed under the section entitled “Risk Factors” below and elsewhere in this prospectus, in any prospectus supplement, and in our other reports filed with the SEC. Many of such factors relate to events and circumstances that are beyond our control. You should not place undue reliance on forward-looking statements.

This prospectus contains product names, trade names and trademarks of RAE and other organizations.

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USE OF PROCEEDS

Unless otherwise provided in a prospectus supplement, we intend to use the net proceeds from the sale of the securities offered by this prospectus and any prospectus supplement for our general corporate purposes, capital expenditures, future acquisitions and additions to our working capital. We will not receive any proceeds from any sales by the selling stockholders of their shares of common stock.

CAPITALIZATION

The following table sets forth our cash and capitalization as of September 30, 2003. This table should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the historical consolidated financial statements and the related notes appearing elsewhere in this prospectus.

	September 30, 2003
Cash and cash equivalents	$	6,678,300
Shareholders’ equity:
Common stock: $0.001 par value; 200,000,000 shares authorized;
46,591,721 shares issued and outstanding		46,600
Additional paid-in-capital		18,437,500
Cumulative other comprehensive income		3,300
Accumulated deficit		(4,330,400	)
Total shareholders’ equity		14,157,000
Total capitalization	$	14,157,000

The 46,591,721 shares shown as issued and outstanding at September 30, 2003 in the table above exclude:

• 5,333,551 shares of our common stock issuable upon exercise of warrants at a weighted-average exercise price of $13.22 per share;

• 1,510,084 shares of our common stock subject to outstanding options under our 1993 Stock Plan at a weighted-average exercise price of $0.076 per share;

• 2,472,302 shares of our common stock subject to outstanding options under our 2002 Stock Option Plan at a weighted-average exercise price of $1.18;

• 400,000 shares of restricted stock given to our directors at a weighted-average exercise price of $0.985;

• 869,166 shares of our common stock subject to outstanding options under the Nettaxi.com 1998 and 1999 stock option plans at a weighted-average exercise price of $26.15 per share; and

• 139,983 options under our 1993 Stock Option Plan that were exercised between October 1, 2003 and December 23, 2003.

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

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. In some cases, readers can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue.” These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those stated herein. Although management believes that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, performance, or achievements. For further information, refer to the section entitled “Risk Factors” in this prospectus. The following discussion should be read in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere in this prospectus.

OVERVIEW

We are a leading global developer and manufacturer of rapidly-deployable, multi-sensor chemical detection monitors and networks for homeland security and industrial applications. In addition, we offer a full line of portable single-sensor chemical and radiation detection products. We were founded in 1991 to develop technologies for the detection and early warning of hazardous materials. The market for our products has evolved from being strictly focused on environmental and industrial monitoring to now encompassing public safety and the threat of terrorism.

Our technologically advanced products are based on proprietary technology, and include portable, wireless and fixed atmospheric monitors and photo-ionization detectors and gamma and neutron detectors. Our products enable the military and first responders such as firefighters, law enforcement and other emergency management personnel to detect and provide early warning of weapons of mass destruction and other hazardous materials. Industrial applications include the detection of toxic industrial chemicals, volatile organic compounds and petrochemicals.

We generate revenue from the sale of our gas and radiation monitoring devices, smart sensing platform and solutions, and through the service and repair of our equipment. We sell our products through a network of approximately 180 distributors, which account for approximately 90% of our sales. Our customer base is varied and includes many of the world’s leading corporations in the airline, automotive, oil and computer industries. We also have a significant number of instruments currently in service with many U.S. government agencies and the armed forces, and by numerous city, state and federal agencies and departments.

In connection with becoming a public company through a reverse merger transaction with Nettaxi.com on April 9, 2002, certain options under our 1993 Stock Plan became subject to variable accounting in accordance with FASB Interpretation No. 44 (FIN 44). As of December 31, 2002, there were 2,014,941 options outstanding under the 1993 Stock Plan that were subject to variable accounting. For the year ended December 31, 2002, the financial statements herein reflect a $374,700 variable accounting charge. Based on the life of these options, the variable accounting treatment would have resulted in unpredictable stock-based compensation dependent on fluctuations in quoted prices of our common stock for the next nine years. To eliminate the variable effects of such accounting treatment, we have adopted the fair value recognition provisions of SFAS 123 for stock-based employee compensation, effective January 1, 2003, under the modified prospective method as provided for in SFAS 148, Accounting for Stock-Based Compensation, Transition and Disclosure, an amendment of FASB Statement No. 123. These fair value recognition provisions generally result in stock-based compensation charges for options granted under our 1993 and 2002 stock option plans. While our interim financial statements herein for the nine-month period ended September 30, 2003 reflect non-cash compensation charges of only $496,900, these charges may increase significantly depending on the number of options granted in the future and, to a lesser extent, upon the volatility of our stock and the life of such options. Stock-based compensation charges have significantly impacted our financial statements, and will continue to impact our financial statements on a prospective basis.

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In December 2001, we issued 700,000 non-plan stock purchase rights, which vested and were exercised immediately, to an officer, a director and a consultant at an exercise price of $0.125 per share. The fair value of the underlying shares of common stock on the date of issuance was approximately $700,000. Under the terms of the stock purchase agreement with these individuals, the shares were placed in escrow and were earned contingent upon the consummation of the merger with Nettaxi.com. In accordance with the terms of the merger agreement, the 700,000 shares were converted into 1,084,083 shares using an exchange ratio of 1 to 1.54869. Based on the intrinsic or fair value of the respective equity instruments as of April 9, 2002, the effective date of the merger, we recorded a non-cash compensation charge of $2.3 million. Additionally, in connection with the merger, we recorded a $2.1 million non-cash compensation charge for the 960,000 shares of stock that were issued to Baytree Capital, and a $4.3 million non-cash compensation charge for the warrants issued to Michael Gardner, Robert Rositano and Dean Rositano.

REnex Technology Ltd. (REnex) completed a $3 million private placement in July of 2002. As a result, RAE Asia’s equity and voting interest in REnex decreased from 47% to approximately 36%. Prior to July 2002, RAE Asia exercised managerial control over the day-to-day operations of REnex and held approximately 90% of the voting shares of REnex. Accordingly, prior to 2002, REnex was consolidated in our financial statements. As RAE Asia no longer owns a majority interest in the voting shares, our financial statements herein reflect a change in the accounting for REnex from the consolidated method to the equity method. This change has been applied with effect from January 1, 2002 and, accordingly, has significantly impacted the comparability of the 2002 amounts versus the 2001 amounts regarding Research and Development expenses, Equity in Loss of Unconsolidated Affiliate, and Minority Interest in Loss of Consolidated Subsidiary in the Consolidated Statements of Operations, and the Investments in Unconsolidated Affiliate in the Consolidated Balance Sheet.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates are used for, but not limited to, allowance for doubtful accounts, inventory allowances, warranty costs, contingencies and taxes. Actual results could differ materially from those estimates. The following critical accounting policies are impacted significantly by judgments, assumptions, and estimates used in the preparation of the condensed consolidated financial statements.

The allowance for doubtful accounts is provided for estimated credit losses at a level deemed appropriate to adequately provide for known and inherent risks related to such amounts. The allowance is based on reviews of loss, adjustments history, current economic conditions and other factors that deserve recognition in estimating potential losses. While management uses the best information available in making its determination, the ultimate recovery of recorded accounts receivable is also dependent upon future economic and other conditions that may be beyond management’s control. If there were a deterioration of a major customer’s credit worthiness, or if actual defaults were higher than what has been experienced historically, our estimates of the recoverability of amounts due could be overstated. Our operating results could be adversely affected.

Inventories are stated at the lower of cost (moving weighted average method) or market. Inventory purchases are typically based on estimated future demand. In the event of a sudden and significant decrease in demand for our products, or if there were a higher occurrence of inventory obsolescence due to changing technology and customer requirements, we could be required to increase our inventory allowances. Our gross margins could be adversely affected.

We generally provide a one to three year limited liability on our products and establish the estimated costs of fulfilling these warranty obligations at the time the related revenue is recorded. Historically, warranty costs have been insignificant. If we were to experience an increase in warranty claims compared to our historical experience, or costs of servicing warranty claims were greater than expectations on which the warranty reserve has been based, our operating results could be adversely affected.

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We are subject to various loss contingencies arising in the ordinary course of business. We consider the likelihood of loss or impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss in determining loss contingencies. An estimated loss contingency is accrued when management concludes that it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. We regularly evaluate current information available to determine whether such accruals should be adjusted.

We recognize deferred tax assets (future tax benefits) and liabilities for the expected future tax consequences of temporary differences between the book carrying amounts and the tax basis of assets and liabilities. The deferred tax assets and liabilities represent the expected future tax return consequences of those differences, which are expected to be either deductible or taxable when the assets and liabilities are recovered or settled. Future tax benefits pertaining to unrealized foreign losses have been fully offset by a 100% valuation allowance as management is unable to determine that it is more likely than not that this deferred tax asset will be realized.

RESULTS OF OPERATIONS

Comparison of the Nine Months ended September 30, 2002 and 2003

Net Sales. Net sales increased from $15.6 million for the nine-month period ended September 30, 2002 to $22.8 million for the nine-month period ended September 30, 2003, an increase of 46.1%. This increase was due to a significant increase in government sales, particularly for homeland security applications where we recognized a significant increase in sales of our MultiRAE and MiniRAE 2000 products, which increased by $2.7 million, and AreaRAE mobile sensor networks, which increased by $1.7 million. We also experienced a substantial increase in Asia for indoor air quality applications in the amount of $111,900. Additionally, we recognized growth in our confined space entry products and our consumable and radiation products in the amount of $804,000.

Cost of Sales. Cost of sales increased from $6.6 million for the nine-month period ended September 30, 2002 to $8.8 million for the nine-month period ended September 30, 2003, an increase of 34.0%. This increase was primarily due to an increase in the sales volume. Gross margins increased from $9.0 million, or 57.8% of revenue, for the nine-month period ended September 30, 2002 to $14.0 million, or 61.3% of revenue, for the nine-month period ended September 30, 2003. The gross margin increased due to production efficiencies resulting from the increase in sales volume as well as our product mix, specifically the growth in our systems sales, which have higher sales margins. Our cost of materials decreased slightly during this period as a result of favorable price variances.

Sales and Marketing. Sales and marketing expenses increased from $4.0 million for the nine-month period ended September 30, 2002 to $5.1 million for the nine-month period ended September 30, 2003, an increase of 27.5%. We realized an increase in the sales and marketing cost resulting from an increase in our tradeshow and advertising presence to support our homeland defense position, our mobile sensor network solution, and our suite of radiation detectors. This increase in tradeshow and advertising expenses amounted to $569,400. Our expenses increased overseas by $190,900 to build the infrastructure to support anticipated growth in Europe and Asia.

Research and Development. Research and development expenses increased from $1.9 million for the nine-month period ended September 30, 2002 to $2.2 million for the nine-month period ended September 30, 2003, an increase of 12.0%. The increase in research and development expenses of $233,000 was primarily the result of an increase in headcount in the amount of $153,500 to support the development of a monitor that combines radiological and chemical sensors in a single unit, the development of a solution for cargo container security and inventory tracking, and the further development of our line of consumable products.

General and Administrative. General and administrative expenses increased from $3.3 million for the nine-month period ended September 30, 2002 to $3.6 million for the nine-month period ended September 30, 2003, an increase of 9.6%. This increase was due to accrued management incentives of $412,500 and the payment of an AMEX listing fee of $65,000. These were partially offset by adoption of the fair value recognition provisions of SFAS 123 for stock-based employee compensation, effective January 1, 2003, under the modified prospective method as provided for in SFAS 148. We incurred a non-cash fair value accounting charge of $496,900 in connection with our outstanding options under our 1993 and 2002 stock option plans in the nine-month period ended September 2003 as compared to a non-cash compensation charge of $592,400 in the same period of 2002.

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Legal Fees and Settlement Costs. Legal fees and settlement costs decreased from $575,100 for the nine-month period ended September 30, 2002 to $130,000 for the nine-month period ended September 30, 2003. This was primarily due to the settlement of certain lawsuits including Lahey vs. Nettaxi, Envision Media vs. Nettaxi, Straugnan vs. RAE Systems vs. Ion Science.

Merger Costs. We incurred non-cash merger costs of $8.7 million for the nine-month period ended September 30, 2002 in connection with our merger transaction with Nettaxi.com. These costs were not a factor for the nine-month period ended September 30, 2003.

Other Income (Expense), net. Other Expense, net for the nine-month period ended September 30, 2002 was $263,800. For the same period in 2003, we had Other Expenses, net of $208,000, a difference of $55,800. We recognized a decrease in interest expense due to the payment of outstanding loans in the amount of $90,400, partially offset by a decrease in interest income in the amount of $22,500. Other expenses, net for the nine-month periods ended September 30, 2003 and 2002 consisted primarily of equity in loss of unconsolidated affiliate in the amount of $198,100 and $198,400, respectively.

Income Taxes. For the nine-month periods ended September 30, 2002 and 2003, we recognized tax expenses of $36,400 and $450,000, respectively. The tax expenses relating to the nine months ended September 30, 2003, consisted of a provision of $898,500 relating to the pre-tax income, reduced by $448,500 relating to the settlement with the Internal Revenue Service of certain outstanding tax assessments originating in prior years.

Net Income (Loss). Net loss for the nine-month period ended September 30, 2002 was $9.8 million, of which $9.3 million was attributable to non-cash accounting charges resulting from our merger with Nettaxi.com. For the same period in 2003, we had net income of $2.3 million. The increase primarily resulted from an increase in sales to our government customers ($2 million), an increase in the sales of our flagship products with higher margins ($1.1 million), and a decrease in our legal expenses due to the settlement of certain lawsuits ($445,100). The increase was partially offset by an increase in sales and marketing expenses, particularly advertising and direct mail ($569,447), and an increase in general and administrative expenses resulting from the accrual of management incentives ($412,500).

Comparison of Years Ended December 31, 2001 and 2002

Net Sales. Net sales increased from $19.0 million for the year ended December 31, 2001 to $21.8 million for the year ended December 31, 2002, an increase of 14.9%. This increase was primarily the result of a worldwide increase in the sales of our confined space gas monitors and the sales of our flexible multi-gas monitors with our patented photo-ionization detector in the amount of $2.2 million. We also saw an increase in the sales of our smart sensing solutions in the amount of $487,000.

Cost of Sales. Cost of sales increased from $7.0 million for the year ended December 31, 2001 to $8.8 million for the year ended December 31, 2002, an increase of 24.6%. This increase was primarily due to additional material required to support higher volume production as well as additional personnel and related expenses to support our expanding business opportunities and to bring the manufacturing of our key components in-house. Gross margins increased from $12.0 million, or 63.0% of revenue, for the year ended December 31, 2001 to $13.1 million, or 59.8% of revenue, for the year ended December 31, 2002 due to sales volume increases. The decrease in the margin as a percent of revenue, however, was attributable to increases in our manufacturing cost to support our expanding business. It was also attributable to a shift in the product mix and a decrease in the price of selected products to remain competitive in the marketplace.

Sales and Marketing. Sales and marketing expenses increased from $4.5 million for the year ended December 31, 2001 to $5.4 million for the year ended December 31, 2002, an increase of 19.4%. Sales and marketing costs increased in the amount of $510,100 to build the infrastructure to support future growth. Our advertising and sales collateral increased in the amount of $398,100 to support our wireless systems business, our new line of consumable products, and our expanding international and homeland security businesses. These increases were partially offset by a decrease in commissions resulting from the elimination of our outside sales representatives. This decrease in commissions amounted to $252,900.

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Research and Development. Research and development expenses decreased from $3.3 million for the year ended December 31, 2001 to $2.5 million for the year ended December 31, 2002, a decrease of 23.1%. The decrease in research and development expenses of $758,200 was primarily the result of a change in the accounting of REnex from the consolidated method to the equity method. This was partially offset by an increase in our research and development activities in the amount of $105,700, specifically in the area of wireless communications and sensor development.

General and Administrative. General and administrative expenses increased from $3.1 million for the year ended December 31, 2001 to $4.4 million for the year ended December 31, 2002, an increase of 45.6%. As a result of being a public entity, we incurred fees, including those for public relations, SEC filings, and D&O insurance of $202,400 that we would not have otherwise incurred. We also increased our professional fees for management consulting, tax planning and preparation, and for the quarterly review and yearly audit by $688,900. Also included in the $4.4 million is an accounting charge of $374,700 relating to options granted under our 1993 Stock Plan that were subject to variable accounting.

Legal Fees and Settlement Costs. Legal fees decreased from $1.2 million for the year ended December 31, 2001 to $968,700 for the year ended December 31, 2002, a decrease of 21.7%. Our legal costs were high as a result of attorney fees and settlement costs associated with our lawsuits. Three of the five lawsuits, including Lahey vs. Nettaxi, Envision Media vs. Nettaxi, and RAE Systems vs. Ion Science, were settled or dismissed as of December 31, 2002.

Merger Costs. Merger costs were $8.7 million for the year ended December 31, 2002. Specifically, we recorded a non-cash compensation charge of $2.3 million based on the 1,084,083 shares of our common stock issued to Messrs. Ng, Flanzraich and Frost, a non-cash charge of $2.1 million based on the shares issued to Baytree Capital and a $4.3 million non-cash charge based on the warrants issued to Messrs. Gardner, Robert Rositano and Dean Rositano. These equity instruments were issued in connection with the closing of our merger with Nettaxi.

Other Income (Expense), net. Other expenses, net, for the year ended December 31, 2001 were $167,100. For the same period in 2002, we had other expenses, net of $348,800, a change of $181,700. The change was primarily due to a change in the accounting of REnex from the consolidated method to the equity method of $283,700 as well as a decrease in interest income resulting from a decline in interest rates ($82,400). These changes were partially offset by a decrease in interest expense resulting from having paid off the existing loans ($175,300).

Net Income (Loss). Net income for the year ended December 31, 2001 was $136,800. For the same period in 2002, we had a net loss of $9.5 million. The decrease of net income was primarily the result of a $9.3 million non-cash accounting charge relating to merger costs and compensation, an increase in sales and marketing expenses to support the new line of consumable products and the smart sensing solutions business in the amount of $996,900, variable accounting charges of $374,700, and an increase in public company activities and professional services in the amount of $905,700. These increases were partially offset by a decrease in commissions resulting from the elimination of our outside sales representatives in the amount of $252,900 and the deconsolidation of REnex in the amount of $758,200.

Comparison of Years Ended December 31, 2000 and 2001

Net Sales. Net sales increased from $18.2 million for the year ended December 31, 2000 to $19.0 million for the year ended December 31, 2001. Sales for the year ended December 31, 2000 included the recognition of $3.8 million from a single contract, the proceeds of which were recognized entirely in 2000. Excluding revenue derived from the contract, our net sales increased by $4.6 million, or 31.9%, primarily for environmental remediation applications for the year ended December 31, 2001 as compared to the year ended December 31, 2000.

Cost of Sales. Cost of sales increased from $6.6 million for the year ended December 31, 2000 to $7.0 million for the year ended December 31, 2001. The increase was due primarily to an increase in sales. Gross margins decreased from 63.8% for the year ended December 31, 2000 to 63.0% for the year ended December 31, 2001. The decrease in gross margins was primarily the result of decreases in the prices of certain confined space products in order to remain competitive in the market place. This decrease was offset by the introduction of new products with higher gross margins.

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Sales and Marketing. Sales and marketing expenses decreased from $4.6 million for the year ended December 31, 2000 to $4.5 million for the year ended December 31, 2001. The decrease was due primarily to a decrease in trade show expenses in the amount of $49,600.

Research and Development. Research and development expenses increased from $3.2 million for the year ended December 31, 2000 to $3.3 million for the year ended December 31, 2001. The completion of the development of various products resulted in a reduction of approximately $500,000 in research and development expenses in 2001 as personnel costs, consulting fees and raw materials costs associated with such development were eliminated. The reclassification of five employees from research and development to manufacturing resulted in a decrease of $176,000 of research and development expenses in 2001. The consolidation of REnex, our 47% owned subsidiary resulted in an increase of research and development expenses of $792,000 for the year ended December 31, 2001.

General and Administrative. General and administrative expenses increased from $2.2 million for the year ended December 31, 2000 to $3.1 million for the year ended December 31, 2001. The increase was primarily due to additional personnel and personnel related expenses in the amount of $73,600 as well as an increase in bad debt and miscellaneous reserves in the amount of $150,000. Also, in connection with various stock option grants to employees and consultants, RAE incurred non-cash compensation charges of $200,100 for the year ended December 31, 2001 as compared to $62,100 for the year ended December 31, 2000.

Legal Fees and Settlement Costs. Legal fees and settlement costs increased from $291,100 for the year ended December 31, 2000 to $1.2 million for the year ended December 31, 2001. The increase was primarily due to costs associated with the settlement and litigation of various lawsuits, including Dragerwerk vs. RAE Systems and Gastec vs. RAE Systems.

Other Income (Expense), net. Other expenses, net, were $61,800 for the year ended December 31, 2000 and $167,100 for the year ended December 31, 2001. The increase was primarily attributable to a decrease in interest income resulting from a decline in interest rates in the amount of $61,500.

Net Income (Loss). Net income decreased from $829,200 for the year ended December 31, 2000 to $136,800 for the year ended December 31, 2001. The decrease in net income was primarily the result of an increase in legal fees and settlement costs ($945,800), an increase in general and administrative expenses ($819,800), and the increased research and development activity at REnex ($427,300), which was partially offset by an increase in sales ($819,500).

Liquidity and Capital Resources

To date, we have financed our operations primarily through bank borrowings, revenues from operations and proceeds of issuances of equity securities. As of September 30, 2003, we had $6.7 million in cash and cash equivalents. At September 30, 2003, we had $12.0 million of working capital (the excess of current assets over current liabilities) and had a current ratio of 3.6 to 1.0. We also have a $3 million line of credit for future growth expansion.

Net cash used by operating activities for the nine months ended September 30, 2003 was $86,200, as compared with net cash provided by operating activities of $451,000 for the nine months ended September 30, 2002. The unfavorable effects on operating cash flows is due primarily to changes in operating assets and liabilities, specifically accounts receivable of $2.3 million, income taxes payable of $1.1 million and inventories of $947,400. These were partially offset by net income of $2.3 million, depreciation and amortization of $637,500, inventory reserve of $248,500, equity in loss of unconsolidated affiliate of $133,100 and compensation expense under fair value accounting of $496,900.

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Net cash provided by investing activities for the nine months ended September 30, 2002 was $673,700, as compared with net cash used in investing activities of $484,600 for the nine months ended September 30, 2002. Net cash provided by investing activities in the nine months ended September 30, 2002 was primarily the result of the release of the restricted cash of $3.3 million resulting from having paid off our lines of credit. Cash used in investing activities in the nine months ended September 30, 2003 consisted primarily of acquisition of property and equipment in the amount of $416,300.

Net cash provided by financing activities for the nine months ended September 30, 2003 was $52,300 as compared with $1.6 million for the nine months ended September 30, 2003. Cash provided by financing activities for the nine months ended September 30, 2003 was primarily the result of the issuance of common stock of $171,900 which was offset by payments of capital lease obligations of $119,600. Cash provided by financing activities for the nine month period ended September 30, 2002 consisted primarily of net proceeds from our merger with Nettaxi.com of $6.2 million, partially offset by payments on notes payable and lines of credit of $4.4 million.

We believe that our existing balances of cash and cash equivalents, together with cash generated from product sales, will be sufficient to meet our cash needs for working capital and capital expenditures for at least the next twelve months. Our future capital requirements will depend on many factors that are difficult to predict, including the size, timing and structure of any future acquisitions, future capital investments, and future results of operations. Any future financing we may require may be unavailable on favorable terms, if at all. Any difficulty in obtaining additional financial resources could force us to curtail our operations or could prevent us from pursuing our growth strategy. Any future funding may dilute the ownership of our shareholders.

Contractual Cash Obligations

The following table quantifies our future contractual obligations as of December 31, 2002:

	Total		2003		2004		2005		2006		2007		Thereafter
Contractual Obligations:
Operating Leases	$	3,238,200	$	493,700	$	508,800	$	488,700	$	420,200	$	396,300	$	930,500
Capital Leases		285,600		178,400		107,200		—		—		—		—
TOTAL	$	3,523,800	$	672,100	$	616,000	$	488,700	$	420,200	$	396,300	$	930,500

Market Risk

The following discussion analyzes our disclosure to market risk related to concentration of credit risk, changes in interest rates and foreign currency exchange rates.

Concentration of Credit Risk

Currently, we have cash and cash equivalents deposited with two large United States financial institutions, one large Hong Kong financial institution, two large Shanghai financial institutions and one large Danish financial institution. Our deposits may exceed the amount of insurance available to cover such deposits. To date, we have not experienced any losses of deposits of cash and cash equivalents. Management regularly reviews our deposit amounts and the credit worthiness of the financial institution which holds our deposits.

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Interest Rate Risk

As of September 30, 2003, we had cash and cash equivalents of $6.7 million consisting of cash and highly liquid short-term investments. The impact of interest rate fluctuations was immaterial. Declines of interest rates over time will, however, reduce our interest income from our short-term investments.

Foreign Currency Exchange Rate Risk

To date, a substantial portion of our recognized revenue has been denominated in United States dollars and generated primarily from customers in the United States, and our exposure to foreign currency exchange rates has been immaterial. As sales to our international customers increase, our operating results may become subject to significant fluctuations based upon changes in exchange rates of specific currencies in relation to the United States dollar. Furthermore, to the extent that we engage in international sales denominated in United States dollars, any fluctuation in the value of the United States dollar relative to foreign currencies could affect our competitive position in the international markets. Although we would continue to monitor our exposure to currency fluctuations, and, when appropriate, may use financial hedging techniques in the future to minimize the effect of these fluctuations, we cannot assure you that exchange rate fluctuations will not adversely affect our financial results in the future.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses financial accounting and reporting for costs associated with exit or disposal activities (SFAS 146). This Statement requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. SFAS 146 also establishes that fair value is the objective for initial measurement of the liability. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of this Statement did not have a material impact on our financial position or results of operations.

In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure, an amendment of FASB Statement No. 123 (SFAS 148). This statement provides alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock based compensation. It also amends the disclosure provisions of SFAS 123 to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation. Further, SFAS 148 amends Accounting Principles Board Opinion No. 28, Interim Financial Reporting, to require disclosure about those effects in interim financial information. We have elected to adopt the fair value recognition provisions of SFAS 123 for stock-based employee compensation, effective January 1, 2003 under the modified prospective method as provided for in SFAS 148. The effects of the adoption of SFAS 123 in accordance with SFAS 148 are reflected in our financial statements.

In November 2002, the FASB issued FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45). FIN 45 requires a guarantor to recognize, at the inception of a qualified guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. FIN 45 is effective on a prospective basis for qualified guarantees issued or modified after December 31, 2002. The adoption of this Interpretation did not have a material impact on our financial position or results of operations.

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BUSINESS

We are a leading global developer and manufacturer of rapidly-deployable, multi-sensor chemical detection monitors and networks for homeland security and industrial applications. In addition, we offer a full line of portable single-sensor chemical and radiation detection products. Our technologically advanced products are based on proprietary technology, and include wireless monitoring technology, photo-ionization detectors, and gamma and neutron detectors. Our products enable the detection and early warning of weapons of mass destruction, toxic industrial chemicals and other hazardous materials.

We were founded in 1991 to develop technologies for the detection and early warning of hazardous materials. Since our inception we have a history of innovating and introducing revolutionary new products. For example, we:

1994 1995	- -	Introduced MiniRAE professional PID Received PID patent approval
1996	-	Introduced MultiRAE (multiple gas) PID monitors
1998	-	Received ISO 9001 certification Introduced MiniRAE 2000 handheld PID
1999	-	Introduced ppbRAE
2000	-	Introduced AreaRAE family of mobile sensor network-based gas detection systems
2002	-	Introduced RAEGuard PID and IAQRAE, the first portable IAQ monitor to include CO2, PID, relative humidity and temperature
2003	-	Planned introduction of AreaRAE Gamma

Industry Background

The market for chemical and radiological monitors is broadly divided into two categories: (i) homeland security and (ii) industrial and environmental. Within these categories, the market is further identified into several major areas of focus such as first responders, cargo container security, military and indoor air quality and security.

Homeland Security

Increasing concerns about the risk to the public of terrorist attacks using unconventional methods such as chemical or radiological agents has created the need for technologically advanced, hazardous material detection devices. In response to such risks, the U.S. government created the Department of Homeland Security and requested a fiscal year 2003 federal budget of $33.6 billion. Although only a small percentage of the budget request will be allocated toward products and services we offer, we believe that there are several specific areas of funding where chemical and radiological monitors will help address end-users’ needs and requirements. Collectively, organizations within the Department of Homeland Security that utilize our products have been allocated $7.9 billion. In addition to the Department of Homeland Security, the Department of Defense has requested $1.1 billion for its fiscal year 2004 chemical and biological defense program, of which $441.5 million will be allocated towards contamination avoidance (consisting of detection and identification of chemical and biological agents). The following outlines the particular applications in the requested budgets:

First Responders. Within homeland security, the need for sophisticated monitoring has been most apparent for emergency response personnel, who are typically the first to arrive on the scene. To date, most first responders have not been trained for and have not carried chemical and radiological detection equipment to detect harmful agents, preventing them from recognizing a potentially lethal situation. We believe first responders need a suite of products that provide a practical, comprehensive solution to protect them from this potential danger. The following features are important to this solution:

• portability for easy transport;

• rapid deployment for emergency response;

• fast and reliable detection of a broad array of chemicals;

• an open system architecture that allows networking among multiple detectors; and

• wireless networking for monitoring from remote locations.

To address these and other shortcomings, the President’s budget authorizes $2.8 billion to better train, equip and support the over 1.7 million firefighters, police officers and emergency medical technicians in the United States. We believe that the nature of the incidents to which first responders respond often involve chemical and/or radiological threats, and consequently, we believe that a significant portion of this amount will be spent for chemical or radiological detection products and services.

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Border and Port Security. The same equipment capabilities necessary to support first responders are also vital to areas of concern such as maintaining the security of U.S. ports and borders. Port security is dependent upon effective cargo container security and monitoring measures being efficiently applied in order to thwart the introduction of hazardous chemical and radiological devices into the country. For example, the United States alone receives approximately six million loaded containers per year in its 361 seaports, of which less than 4% are inspected. There is also a similar requirement for chemical and radiological detection equipment to assist the U.S. Coast Guard, Border Patrol and Bureau of Customs in securing coastlines and borders. To assist these organizations in this task, an amount of $5.1 billion has been requested.

Indoor Air Quality. Both governmental authorities and civilian organizations have recognized the need for pervasive indoor air quality monitoring. With the potential for harmful chemical and radiological terrorist attacks on public and private buildings as well as toxic industrial chemicals creating a potentially dangerous environment, responsible authorities have asked for a comprehensive solution that can: (i) be deployed quickly for emergency response; (ii) provide fast and reliable detection of a broad array of chemicals; (iii) work through an open system architecture that allows networking among multiple sites; and (iv) allow wireless networking for monitoring from off-site locations. The potential for such monitoring exists in a vast number of areas including school campuses, shopping malls, private office buildings, federal buildings and hospitals.

Industrial and Environmental

While attention has shifted primarily to public safety and the threat of terrorism, the market for chemical and radiological sensors remains active in the more traditional areas of environmental and industrial monitoring. The continued application of sensing products in these established markets stems from the dependence by numerous key industries on sensors since they provide vital information that can affect worker safety, products, processes, and systems. According to The Freedonia Group, the overall demand for gas and chemical sensors in the U.S. is expected to reach 61 million units by 2006, up from 43 million in 2001, a compounded annual growth rate of 7.2%.

A few examples of the prevalent need for monitoring in the environmental and industrial industries include:

• chemicals and manufacturing (process control);

• municipal and volunteer fire departments (arson investigations);

• petroleum (leaks and explosive vapors);

• transportation (airplane wing tank entry); and

• hazardous materials clean-up (environmental remediation).

Our Strengths

We have a comprehensive product portfolio. Our broad portfolio of portable, rapidly-deployable and rugged products consists of atmospheric monitors, photo-ionization detectors, radiation detectors, gas detection tubes, sampling pumps and security monitoring devices. Our products incorporate a broad array of sensors available in the industry today, with the ability to detect over 300 chemicals. Based upon our familiarity with the market and our competition, we believe that we offer the only products with multiple sensors that can be joined in a wireless network and monitored from a base location.

We are a technological leader in the industry. We have a history of being the first to market in the industry. For example, in 1994, we introduced the world’s smallest portable photo-ionization detection monitor; in 1996, we were the first to introduce a multi-sensor chemical detection product; and in 2001, we were the first to introduce a wireless network of chemical sensors. In addition, we expect to be the first to introduce a monitor with a combination of radiological and chemical sensors in a single unit. We believe our expertise and knowledge of current and future standards for monitoring sensors through wired and wireless delivery platforms will allow us to continue to be an industry leader in developing the most appropriate design architecture for modular systems that can be quickly and efficiently reconfigured as the mission requirements dictate.

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We have an established customer base. We have an impressive list of customers and end users across many governmental entities and industries that we support with our array of products and solutions. They have been used extensively in high-profile events such as the Salt Lake City Olympics, the Super Bowl, the U.S. Open golf tournament and the Major League Baseball All-Star game. In addition, our equipment has been utilized to monitor the indoor air quality and security of such high value installations as Soldier Field in Chicago and the HSBC Arena in Buffalo. We believe that use of our products by early adopters in high-profile events has led to incremental sales and customer penetration.

We have state-of-the-art, cost-efficient manufacturing. We have a state-of-the-art, cost-efficient manufacturing facility in Shanghai, China that is currently producing the majority of our shipped products. We believe that our facility will allow a significant scaling of production to both meet the needs for and allow us to leverage future growth.

We have strong research, development and engineering capabilities. We have assembled a leading team of research, development and engineering scientists consisting of 47 people, of which approximately 20% hold doctorate degrees. In addition, we are engaged in a collaborative effort with Shanghai University, which is known for its research depth in the electronics engineering, telecommunications and material science fields. This collaboration has enabled rapid, cost-efficient and high return research, development and engineering activities, including new instrument development and state-of-the-art sensor technologies.

Our Strategy

Since our inception, we have focused on becoming a leader in the development of hazardous materials detection monitoring devices. We intend to maintain this focus by pursuing the following strategies:

Aggressively Pursue the Homeland Security Market. The heightened concerns about domestic terrorist attacks in the United States triggered by recent events led to the creation of the Department of Homeland Security as well as the allocation of billions of dollars of the federal budget to counter these threats. In addition, many state and local government agencies also have committed resources to combat the threat of such attacks. As our products already address many of the needs of these governmental agencies, we intend to capitalize and become a leading provider in this growing market.

Aggressively Pursue the Rapidly Expanding Network Detection Market. We believe the market for network detection devices is growing rapidly as a result of reduced costs, increased safety and greater advanced warning that remote detection over a wide coverage area offers. Our unique combination of wireless and sensor technology is ideally positioned to satisfy this growing demand from our customer base. Our current network products enable data to be transmitted from remote locations in the field to a base station located up to two miles from the site of the detector, and can also be hosted via the Internet. For example, in May 2003, the Department of Homeland Security sponsored a simulated chemical/radiological attack in Seattle where our AreaRAE solution was used to transmit data over the emergency response network to a command and control center in Virginia.

Continue to Develop New Products and Solutions. We intend to continue to develop products and solutions based on our patented technology and ongoing research and development that are a compelling value proposition. A number of our hazardous material detection devices have been first to the market, and we expect to continue to demonstrate our ability to innovate by being the first to combine radiation and chemical detection in a wireless network device which we introduced in October 2003. The project is expected to be ready for customer delivery in March 2004.

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Expand the Applications for Which Our Products Can Be Used. We intend to leverage our core technologies across a number of new applications and industries as the benefits of atmospheric hazard detection become more widely recognized. Through our marketing efforts, we are continually increasing our presence within and across markets and educating potential customers about the benefits of our products. For example, we plan to introduce our wireless sensors in cargo container security and monitoring products to improve safety and operational efficiencies.

Leverage Our Cost-Efficient Infrastructure. We have significant additional capacity in our state-of-the-art manufacturing facility in Shanghai, China. As we continue to grow our business, we expect to realize manufacturing efficiencies, thereby reducing per unit costs. In addition, we expect to benefit from significant savings by complementing our research and development cost capabilities at our headquarters in Sunnyvale, California with more cost-efficient intellectual capital available in China.

Selectively Pursue Acquisitions, Joint Ventures and Licensing Agreements. We will continue to pursue acquisitions, joint ventures and licensing agreements in order to more rapidly and effectively develop new technology. We are confident in our ability to continue to develop state-of-the-art technology; however, we also believe that the industry is very fragmented and there exists a considerable opportunity to acquire new technologies and processes to further broaden and complement our product offerings.

TECHNOLOGY

Our main strengths are in the development of sensor and measurement technology and integrated wireless technology. As an instrument manufacturer, we have differentiated ourselves from our competition by developing a broad array of specific chemical sensors, including an array of gas detectors and photo-ionization detectors.

Sensor and Measurement Technology

Our products are based on a broad array of proprietary and patented gas and chemical sensors. We design and manufacture the following sensors:

• Photo-ionization detectors for the measurement of volatile organic compounds, highly toxic chemical warfare agents, and toxic industrial chemicals;

• Catalytic bead pellistors for the measurement of combustible gas;

• Non-dispersive infrared sensors for the measurement of carbon dioxide and hydrocarbons; and

• Electro-mechanical sensors for the measurement of toxic gases such as carbon monoxide.

Our main competitive discriminator is our proprietary photo-ionization technology. Photo-ionization detectors use ultraviolet light to break up the molecules of the substances being detected into charged fragments or “ions.” This produces a flow of electrical current proportional to the concentration of contaminant. Our patented photo-ionization detector technology enables dependable, linear, part-per-billion range readings for many toxic gases and vapors. Photo-ionization detection is particularly suited to the detection of the highly toxic, long-chain, low vapor pressure volatile organic compounds associated with many toxic industrial chemicals and chemical warfare agents.

Integrated Wireless Technology

In 1999, anticipating the emergence of robust wireless networks, we began to develop wireless capabilities for our gas monitoring instruments that enable them to detect gas from remote locations. In 2000, we introduced the AreaRAE, a wireless-enabled gas detector, which allows for the real-time transmission of monitoring information from a base station located up to two miles away from the detectors. The AreaRAE enables HazMat teams, firefighters, law enforcement officials and other emergency management personnel users to remain a safe distance away from toxins, flames and explosives. The AreaRAE incorporates technologies such as global positioning system and geographic information system capabilities to create situational awareness for decision makers located in a central command and control location. In addition, the AreaRAE can be made to interface with the Internet, making our measurements available from virtually any location with Internet access. We intend to further enhance our products to include video or imaging capabilities that will enable security monitoring.

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In addition, we own approximately 36% of REnex, a wireless systems company still in the research and development stage. REnex is targeting to develop wireless high-powered modem technology, which we believe we will be able to use in our wireless products.

Radiation Technology

Depending on application needs and market price point requirements, we develop and/or license the appropriate radiation technologies. Through licensing arrangements and internal development, we have acquired alpha, gamma and neutron particle detection technologies and products. These are highly sensitive instruments capable of detecting low levels of radiation on a real time basis which makes them ideal for border control applications. This is in contrast to dosimeters, which are used in nuclear plants to protect personnel from long-term radiation exposure.

Our scintillating crystal-based sensors detect low levels of radiation and are ideal for detecting illicit trafficking of radiological material. Our cost-efficient, low-power consumption devices enable us to address low-maintenance, long-term stability requirements in both the cargo container security and indoor air quality/security markets.

PRODUCTS

We manufacture technologically advanced portable single and multiple sensor atmospheric monitors, integrated systems, photo-ionization detectors, indoor air quality and security monitors, gas detection tubes and sampling pumps. Our products are described in detail below:

Product	Description		Application
Integrated Systems
AreaRAE	Wireless, multi-channel, integrated gas detection systems	• • • • •	HazMat and emergency response Confined space entry Plant turnarounds Venue protection Oil platform protection
Photo-ionization Detection
MiniRAE 2000	Most versatile handheld volatile organic compound monitor on the market with sensitivity range of 0 – 10,000 part-per-million	• • • •	Confined space entry Emergency response to hazardous spills Environmental remediation Soil remediation
UltraRAE	Combines vapor separation tubes and photo-ionization detection into compound-specific monitor	• • • • •	Military Crude oil production, pipelines Transportation of HazMats Refineries Plant turnarounds
ppbRAE	Most sensitive hand-held photo-ionization detection monitor in the world capable of detecting volatile organic compounds down to 1 part-per-billion	• • • •	Emergency response to hazardous spills Indoor air quality in new, sick and mixed usage buildings Personal monitoring Drug detection
ModuRAE	Permanently installed photo-ionization detection monitor with ppb resolution	• •	Hazardous waste sites Chemical factories
Radiation Detection
GammaRAE Pager	Rapid detector of gamma sources, includes cesium iodide (CsI) scintillator that provides low level detection in a compact unit	• • • •	Emergency response Customs and border patrols Law enforcement Military
NeutronRAE Pager	Rapid detector of gamma and neutron sources, includes both cesium iodide (CsI) and lithium iodide (LiI) scintillators that provide low level detection in a compact unit		Emergency response Customs and border patrols Law enforcement Military
Multi-Sensor
MultiRAE IR	One-to-five gas surveyor with CO2 and photo-ionization detection	• • •	Indoor air quality Beverage and brewery Food industry
MultiRAE PLUS	Hand-held, 1-to-5 gas monitor with lower explosive limit measurement capability, O2, two toxic sensors, and photo-ionization detector for toxic volatile organic compound detection	• • •	Confined space entry Wing tank entry HazMat
Sentry RAE	One-to-five gas area monitor with photo-ionization detection for continuous operation	• •	Confined space entry Plant turnarounds
VRAE	Hand-held 5-gas confined space monitor and sniffer	• • •	Refineries and petrochemical plants – Confined space entry, hot work permits Utilities – Cable vaults, transformer stations Waste water treatment plants
QRAE / QRAE PLUS	Economical, robust 4-gas confined space monitor	• • •	Confined space entry Refineries and petrochemicals plants Power plants
IAQRAE	Indoor air quality monitor with CO2, photo-ionization detection, relative humidity, temperature and toxic gas sensors	• • •	Indoor air quality Beverage and brewery Food industry
Single-Sensor
ToxiRAE Plus PID, Toxic, O2, LEL	Pocket-sized, single-gas monitors with plug-in smart sensors	• • •	Oil fields and refineries Mining and metals Pulp and paper mills
Tubes
Gas Detection Tubes	Single-use, single-sensor for the detection of specific chemicals	• • •	Refineries Petrochemical plants Compressed gas distribution facilities

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STRATEGIC RELATIONSHIPS

To respond to the perceived need for security in maritime transport, we have collaborative arrangements with several companies in the container manufacturing industry. In addition, from time to time we enter into licensing, marketing and joint development agreements with certain parties by which we license technology or collaborate on product development and implementation or joint sales or marketing efforts.

SALES, MARKETING AND DISTRIBUTION

Most of our products are sold through a worldwide organization that includes direct sales personnel and distributors managed through our Sunnyvale, California; Hong Kong, China; and Copenhagen, Denmark offices. We have worldwide sales and distribution in locations such as the United States, Canada, Western Europe, Mexico, Latin America, Japan, Beijing, Shanghai, and Singapore. As of November 30, 2003, we employed 40 people in sales and marketing. In addition, we had a total of 180 distributors worldwide that accounted for approximately 90% of our revenues.

Currently, our predominant distribution channel is value added business-to-business and business-to-government distribution services companies that focus on the health, safety and security product markets. Many of our distributors are international companies with distribution rights in specific territories. We seek those distributors that have the greatest reach and broadest array of end-user customers. Currently, we benchmark our distributors performance according to pricing policy, volume, payment schedule, training, services, and other support programs.

Our new suite of wireless detection products, specifically the AreaRAE and its peripherals, are sold directly, with customers identified through external manufacturers’ representatives. This channel was established because of the technical expertise required to advise and sell these complex monitoring systems. Commissions are paid to the representatives based on the amount of effort extended in consummating the deal and the amount of training provided after the product is sold.

Our products are distributed globally, with approximately 75% of our revenues derived from sales in North America, approximately 13% of revenues derived from sales in Asia, and approximately 10% of revenues derived from sales in Europe for the period from January 1, 2003 through September 30, 2003.

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CUSTOMERS

Our end-user customers include many U.S. government agencies in the intelligence and law enforcement community as well as all branches of the armed forces, and by numerous local, state and federal agencies and departments. We also have significant numbers of instruments currently in service with many of the world’s leading corporations in the airline, automotive, oil, computer and telecommunications industries. Our products are used in confined space entry monitoring programs throughout the world, and are used in civilian and government atmospheric monitoring programs in over 50 countries. Several government agencies and departments have standardized their programs based on our products for hazardous materials incident response.

The following is a representative list of our end-user customers from whom we believe we have derived the largest portion of our revenues for the last two fiscal years for each of the industries specified:

Airlines and Aerospace	Chemical	Industrial	Petrochemical
Air Canada American Boeing Northwest United	Dow DuPont Oxy Chemical	Burlington Northern Railroad Ford Motor Company General Motors Hewlett-Packard IBM Intel Motorola Proctor & Gamble Texas Instruments	BP Amoco Chevron Phillips Conoco Shell Sun Oil Texaco
Shipping	State and Local Government	U.S. Federal Government
Maersk Stolt-Nielsen	Local fire departments Local police departments State and local emergency response agencies Other emergency response personnel	Army Coast Guard Department of Homeland Security Department of Justice Department of State Marines NASA Navy

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RESEARCH, DEVELOPMENT AND ENGINEERING

We are expanding our product offerings through advances in sensor, wireless, and networking technologies. Examples include:

• a combined radiation/gas monitoring system;

• the AreaRAE Gamma, which provides wireless delivery of remotely sensed gas vapors and gamma radiation (an industry first);

• networking advances, which allow RAE sensors to be connected into industrial networking buses (via Industrial Ethernet connectivity); and

• advanced sensor/wireless solutions, which are available for applications such as cargo container security or inventory and tracking purposes.

The adoption of applicable bus standards with modular product design and flexible rapid manufacturing have resulted in improved system performance as well as advanced scalability thereby allowing rapid development of new products. New portable products have been introduced for use in confined space/hazardous materials applications (EntryRAE, toxiRAE II). We expect to continue to receive governmental and industry certifications for our products in various jurisdictions.

Our research and development process is done in collaboration with our manufacturing department. Such collaboration is designed to ensure the manufacturability of the product, and expedites the transition from the conceptual design phase to actual production.

We are engaged in a collaborative effort with Shanghai University in China, which is known for its research depth in the electronics engineering, telecommunications, and material science fields. This collaboration has enabled cost-efficient and high return research and development activities, including instrument development and sensor technology. We are able to draw on the expertise of the professors at Shanghai University and recruit from the talent pool that the university has to offer.

We employ 49 people in research, development and engineering of which 16 have advanced degrees, including nine PhDs.

MANUFACTURING

We lease a state-of-the-art manufacturing facility in Shanghai, China where the majority of our components and products are manufactured. Our manufacturing capabilities in Shanghai include:

• material planning and production scheduling;

• procurement;

• incoming quality assurance;

• manufacturing process design;

• production, including precision machining, plastic injection, colorimetric tube production, electrochemical sensor manufacturing, and printed circuit board assemblies using surface mount technology;

• final assembly and test; and

• quality control and assurance.

The leased facility consists of 44,000 square feet of manufacturing space and enables us to be cost competitive, while maintaining high quality manufacturing standards. We believe that this facility will allow a significant scaling of production to both meet the needs for and allow us to leverage on future growth.

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We also have a manufacturing, integration and test site in Sunnyvale, California, where we manufacture some of our more complex and sensitive sensors.

At our manufacturing facilities in Sunnyvale, our capabilities include:

• material planning and production scheduling;

• procurement;

• sensor manufacturing;

• photo-ionization detection lamp manufacturing;

• prototyping for engineering;

• process design;

• final assembly and test;

• calibration; and

• final quality control and assurance.

We have been ISO 9001 certified since 1998, and were upgraded to ISO 9001:2000 in December 2001. Our international manufacturing subsidiary Wa-RAE was certified to ISO 9002, and was upgraded to ISO 9001 in 2001. As of November 30, 2003, we employed 230 people in manufacturing, of which 181 were located in Shanghai, 46 in the United States, and the remainder in Europe and Hong Kong.

COMPETITION

The market for gas detection monitoring devices is highly competitive and we expect the emerging wireless gas monitoring system market to be equally competitive. Our primary competitors include Industrial Scientific Corporation, Mine Safety Appliances Company, BW Technologies, Ion Science, PerkinElmer, Inc., Draeger Safety Inc., Gastec Corporation and Bacou-Dalloz.

Competitors in the gas monitoring industry differentiate themselves on the basis of their technology, quality of product, service offerings, sales capabilities, cost, and time to market. We believe we compete strongly in these areas, and thus consider ourselves one of the industry leaders in the design, development and manufacture of gas monitoring devices. In particular, we believe our ability to develop products that integrate different chemical detection techniques, such as photo-ionization detectors, electrochemical sensors for specific toxic chemicals, and combustible gas detectors, along with communication technologies that allow wireless data transfer, provide us with a competitive advantage vis-à-vis our competitors. In addition, we believe our training support materials are a valuable resource for our distributors and end-users, which make our products more attractive to customers.

Many of our competitors, however, have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial and marketing resources than us. In addition, some of our competitors may be able to devote greater resources to marketing and promotional campaigns, adopt more aggressive pricing policies, and/or devote more resources to technology and systems development.

EMPLOYEES

As of November 30, 2003, we employed 359 individuals. Of those 359 individuals, 230 were in manufacturing (181 in China; 46 in the United States; two in Hong Kong, and one in Europe), 49 in research, development and engineering, 40 in sales and marketing, and 40 in finance, administration and information technology. Our employees are not covered by a collective bargaining agreement. We have never experienced an employment-related work stoppage and consider our employee relations to be good.

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PROPERTIES

Our corporate headquarters and principal offices are located in a leased facility in Sunnyvale, California. The Sunnyvale facility consists of approximately 25,000 square feet, which includes research and development, sales and marketing, and general and administrative operations, under a lease expiring in October 2009. This facility is adequate to meet the needs of our current operations. Through our wholly-owned subsidiary, Wa-RAE, in Shanghai, China, we lease a state-of-the-art manufacturing facility, consisting of approximately 44,000 square feet, and a research and development facility consisting of approximately 20,000 square feet. The lease on the research and development facility will expire in phases as to portions of the property from March 2004 until March 2008. The lease on the manufacturing facility expires in January 2007 and contains an option to purchase the property.

We maintain a sales office in Fan Ling, Hong Kong, from which we sell our products to Asia. The lease of the Fan Ling office has been renegotiated for a period of three years commencing in January 2002. We also maintain a sales and service center in Copenhagen, Denmark, from which we sell our products to Europe, Australia and New Zealand, the Middle East and Africa.

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MANAGEMENT

The following table sets forth the names, ages and positions held by our directors, executive officers, and other key employees.

Name	Age	Position
Robert I. Chen	56	President, Chairman, Chief Executive Officer and Director
Joseph Ng	55	Vice President, Business Development, Chief Financial Officer
Peter Hsi	53	Vice President, Chief Technology Officer, Director
Hong Tao Sun	40	Vice President, Engineering
Lyle Feisel	68	Director
Neil W. Flanzraich	60	Director
Edward C. Ross	62	Director
Bo Andersson	52	Director

ROBERT CHEN co-founded RAE Systems in 1991 and has served as President, Chief Executive Officer, and as a member of the board of directors since our inception. From 1981 to 1990, Mr. Chen served as President and Chief Executive Officer of Applied Optoelectronic Technology Corporation, a manufacturer of computer-aided test systems, a company he founded and subsequently sold to Hewlett-Packard. Mr. Chen currently serves on the board of directors for the Shanghai Ericsson Simtek Electronics Company, Limited, a telecommunications and electronics company. Mr. Chen received a B.S.E.E. from Taiwan National Cheng Kung University, a M.S.E.E. from South Dakota School of Mines and Technology, and graduated from the Harvard Owner/President program.

JOSEPH NG has served as our Vice President of Business Development and Chief Financial Officer since February 2001. From 1999 to 2001, Mr. Ng was the Marketing Manager for the E-Services Division of Hewlett-Packard, and from 1997 to 1999, the Controller for the Personal Computer and Printer Division of Hewlett-Packard. From 1995 to 1997, Mr. Ng was the Controller for the Computer Division of Hewlett-Packard-Japan, and from 1988 to 1990, the Chief Financial Officer for Applied Optoelectronic Technology Corporation. Mr. Ng received a B.S. in Accounting from Baruch College, and a M.A. in History from Stanford University. Mr. Ng is a certified public accountant in the State of California.

PETER HSI co-founded RAE Systems in 1991 and has served as our Vice President, Chief Technology Officer, and as a member of the board of directors since our inception. Prior to co-founding RAE Systems, Dr. Hsi worked at Applied Optoelectronic Technology Corporation as the chief architect for semiconductor test systems. Dr. Hsi has filed 18 patent applications, of which eight have been granted and ten are pending. Dr. Hsi received a B.S.E.E. from the National Chiao-Tung University, and a M.S. and Ph.D. in Electrical Engineering from Syracuse University.

HONG TAO SUN has served as our Vice President of Engineering since January 2002. Dr. Sun joined RAE Systems in 1997, and has been instrumental in the design and development of key sensor technologies. Prior to joining RAE Systems, Dr. Sun was a research fellow for the Royal Melbourne Institute of Technology in Australia and the University of L’Aquila in Italy. Dr. Sun has over 10 years as a research scientist in the fields of photo-ionization detection and sensor development. Dr. Sun has authored over 60 international research papers, and has written two scientific books. Dr. Sun has developed seven patents, three of which are in the field of photo-ionization detection. In 1990, Dr. Sun received a Ph.D. in Electrical Engineering from Xi’an Jiaotong University.

LYLE FEISEL has served as a member of our board of directors since March 2001. In 2001, he retired as the Dean of the Thomas J. Watson School of Engineering and Applied Science, and Professor of Electrical Engineering at the State University of New York at Binghamton. Dr. Feisel joined the faculty of SUNY Binghamton in 1983. Dr. Feisel is a Life Fellow of the Institute of Electrical and Electronics Engineers and of the American Society for Engineering Education, and is a Fellow of the National Society of Professional Engineers. He is active in the affairs of those organizations and in the development and accreditation of engineering education worldwide. Dr. Feisel received his B.S., M.S. and Ph.D. degrees in Electrical Engineering from Iowa State University.

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NEIL W. FLANZRAICH has served as a member of our board of directors since December 2000. Since May 1998, he served as Vice Chairman and President of IVAX Corporation, a pharmaceutical company. From 1995 to May 1998, Mr. Flanzraich served as Chairman of the Life Sciences Legal Practice Group of Heller Ehrman White and McAuliffe, and from 1981 to 1994, Senior Vice President and member of the corporate Operating Committee at Syntex Corporation, a pharmaceutical company. Mr. Flanzraich is a director of IVAX Diagnostics and Continucare Corporation. He also serves as Chairman of the Israel America Foundation. Mr. Flanzraich received an A.B. from Harvard College and a J.D. from Harvard Law School.

EDWARD C. ROSS has served as a member of our board of directors since March 2001, and is currently the President of TSMC North America, a semiconductor company. From 1998 to 2000, Dr. Ross served as Senior Vice President of the Professional Services Group of Synopsys, Inc., a computer-aided design company, where he was responsible for developing and executing Synopsys’ consulting business practices. From 1995 to 1998, Dr. Ross was the President of the Technology and Manufacturing Group of Cirrus Logic, a semiconductor company. Dr. Ross received a B.S.E.E from Drexel University, and a M.S.E.E., M.A, and Ph.D. from Princeton University.

BO ANDERSSON has served as a member of our board of directors since June 2002. In September 2002, he was appointed President of Ericsson Micro Components, and from May 2000 to August 2002, served as President and CEO of Ericsson Microelectronics. In 1998, Mr. Andersson was appointed Head of the Microelectronics Business Unit and between 1994 to 1998, was the General Manager for the Power Modules Business within the Ericsson Components AB, a telecommunications company. In 1994, Mr. Andersson was the Project Manager for the building of the sub micron facility in Kista, Sweden, and in 1977, he joined Ericsson where he was the Head of Process Technology Development. Mr. Andersson is Chairman of the Board of Ericsson Power Modules AB and Chairman of the Board of Shanghai Ericsson Simtec Electronics Co., Ltd. He is also Chairman of the Steering Committee for the Microtechnologies Centre at Chalmers University in Sweden. Mr. Andersson received a M.S. degree in Physical Engineering from the Royal Institute of Technology in Stockholm, Sweden in 1977.

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PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth, as of December 23, 2003 the ownership of our voting stock by:

• each person or entity who is known by us to beneficially own more than 5% of our outstanding common stock;

• each of our executive officers listed on the Summary Compensation Table in our Definitive Proxy Statement, filed March 31, 2003;

• each of our directors;

• all executive officers and directors as a group; and

• all selling stockholders.

Except as otherwise indicated, and subject to applicable community property laws, the persons named in the table have sole voting and investment power with respect to all shares of common stock held by them.

Applicable percentage ownership in the table is based on 46,731,704 shares of common stock, which is the approximate number of shares of RAE common stock outstanding as of December 23, 2003. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. Shares of common stock subject to options that are presently exercisable or exercisable within sixty (60) days of December 23, 2003 are deemed outstanding and beneficially owned for the purpose of computing the percentage ownership of the person or entity holding such options, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person or entity. To the extent that any shares are issued upon exercise of options, warrants or other rights to acquire our capital stock that are presently outstanding or granted in the future or reserved for future issuance under our stock plans, there will be further dilution to new public investors.

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We cannot estimate the number of shares that will be held by the selling stockholders after the completion of any offering because the selling stockholders may decide to sell all, some or none of the shares they are offering from time to time.

Beneficial Owner (1)	Common Stock Beneficially Owned Prior to the Offering			Shares of Common Stock Sold in the Offering	Common Stock Beneficially Owned FollowingOffering
	Shares (2)	Percentage (3)			Shares (4)	Percentage (3)(4)
5% Stockholders
Michael Gardner (5)	3,086,596	6.6	%	0	3,086,596	6.6	%
Philip J. Sheridan	2,684,261	5.7	%	0	2,684,261	5.7	%
Directors and Executive Officers
Robert I. Chen (6)	17,964,905	38.4	%	1,500,000	16,464,905	35.2	%
Peter H. Hsi	4,336,332	9.3	%	300,000	4,036,332	8.6	%
Neil W. Flanzraich (7)	574,472	1.2	%	0	574,472	1.2	%
Joseph Ng (8)	243,521	*		0	243,521	*
Hong Tao Sun (9)	304,420	*		0	304,420	*
Edward C. Ross (10)	109,865	*		0	109,865	*
Lyle D. Feisel (11)	174,865	*		0	174,865	*
Bo Andersson (12)	39,583	*		0	39,583	*
All directors and executive officers as a group (9 people) (13)	23,747,962	50.8	%	1,800,000	21,891,052	47.0	%

* Less than 1%.

Except as otherwise noted, the address for each person listed above is c/o RAE Systems, 1339 Moffett Park Drive, Sunnyvale, California 94089. The address for Michael Gardner is c/o Baytree Capital Associates, LLC, The Trump Building at 40 Wall Street, New York, New York 10005.

(1) A person is deemed to be the beneficial owner of securities that can be acquired by such person within 60 days upon the exercise of options or warrants. Calculations of percentages of beneficial ownership assume the exercise by the named stockholder of all options and warrants for the purchase of common stock held by such stockholder, which are exercisable within sixty days of December 23, 2003.

(2) Includes shares of common stock that can be acquired upon exercise of warrants and/or options to purchase our common stock exercisable within sixty days of December 23, 2003.

(3) Calculated on the basis of 46,731,704 shares of common stock, which is the approximate number of shares of RAE common stock outstanding as of December 23, 2003, except that shares of common stock underlying options and warrants exercisable within sixty days of December 23, 2003 are deemed outstanding for purposes of calculating the beneficial ownership of the holders of such options and/or warrants.

(4) Assumes the sale of all 1,800,000 shares of common stock offered by the selling stockholders but does not include any sales of securities in connection with the primary offering.

(5) Includes warrants issued to Michael Gardner to purchase 1,212,082 shares of common stock.

(6) Includes 3,097,380 shares of common stock held by Mr. Chen’s spouse, Lien Q.C. Chen, of which he disclaims beneficial ownership, and 11,770,145 shares of common stock held jointly between Robert I. and Lien Q.C. Chen, and by Robert I. Chen as trustee of the Robert I. Chen 2001 Living Trust and held by Lien Q.C. Chen as trustee of the Lien Q.C. Chen 2001 Living Trust.

(7) Includes 47,917 shares issuable upon exercise of outstanding options, including shares subject to options that may be exercised within 60 days after December 23, 2003.

(8) Includes 10,000 shares each held by Dominique Ng, Madeline Ng, and Gabrielle Ng, children of Mr. Ng, and 116,152 shares issuable upon exercise of outstanding options, including shares subject to options that may be exercised within 60 days after December 23, 2003.

(9) Includes 212,472 shares issuable upon exercise of outstanding options, including shares subject to options that may be exercised within 60 days after December 23, 2003.

(10) Includes 47,917 shares issuable upon exercise of outstanding options, including shares subject to options that may be exercised within 60 days after December 23, 2003.

(11) Includes 87,917 shares issuable upon exercise of outstanding options, including shares subject to options that may be exercised within 60 days after December 23, 2003.

(12) Includes 39,583 shares issuable upon exercise of outstanding options, including shares subject to options that may be exercised within 60 days after December 23, 2003.

(13) Includes 551,958 shares issuable upon exercise of outstanding options, including shares subject to options that may be exercised within 60 days after December 23, 2003.

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DESCRIPTION OF CAPITAL STOCK

Our authorized capital stock consists of 200,000,000 shares of common stock, $0.001 par value per share, and 1,000,000 shares of preferred stock, $0.001 par value per share. As of December 23, 2003, approximately 46,731,704 shares of our common stock were outstanding.

Common Stock

The following description of our common stock is a summary. If we offer common stock, the specific rights will be described in the prospectus supplement relating to the common stock offered. You should be aware that our amended and restated articles of incorporation, as amended, together with our bylaws, and not this summary, define any rights you may have as a holder of our common stock.

Listing

Our outstanding shares of common stock are listed on the American Stock Exchange under the symbol “RAE”. Any additional common stock we issue also will be listed on the American Stock Exchange.

Dividends

Subject to the rights of any series of preferred stock that we may issue, the holders of common stock are entitled to receive ratably any dividends when and as declared by the board of directors. Dividends may be paid in cash, stock or other form out of legally available funds.

Fully Paid

All outstanding shares of common stock are fully paid and non-assessable. Any additional common stock we issue will also be fully paid and non-assessable.

Voting Rights

Subject to any special voting rights of any series of preferred stock that we may issue in the future, the holders of common stock may vote one vote for each share held in the election of directors and on all other matters voted upon by our stockholders.

Other Rights

We will notify common stockholders of any stockholders’ meetings according to applicable law. If we liquidate, dissolve or wind-up our business, either voluntarily or not, common stockholders will share equally in the assets remaining after we pay our creditors and preferred stockholders, if any. The holders of our common stock have no preemptive rights. Shares of common stock are not subject to any redemption provisions and are not convertible into any other securities.

Convertible Preferred Stock and Preferred Stock

Our Board of Directors has the authority, without further action by our stockholders, to issue up to 1,000,000 shares of preferred stock in one or more series subject to any limitations prescribed by law. The Board of Directors may fix the rights, preferences and privileges of any preferred stock it determines to issue. Any or all of these rights may be superior to the rights of the common stock.

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Preferred stock could thus be issued quickly with terms calculated to delay or prevent a change in control of RAE or to make removal of management more difficult. Additionally, the issuance of preferred stock may decrease the market price of our common stock. The number of authorized shares of preferred stock may be increased or decreased, but not decreased below the number of shares then outstanding, by the affirmative vote of the holders of a majority of the common stock without a vote of the holders of preferred stock, or any series of preferred stock, unless a vote of any such holder is required pursuant to the terms of such series of preferred stock.

The following description sets forth certain general terms and provisions of the convertible preferred stock and preferred stock we may issue. If we offer convertible preferred stock, such stock will be convertible into shares of our common stock. With respect to any convertible preferred stock or preferred stock (each referred to herein as preferred stock) we may choose to offer, the specific designations and rights will be described in the prospectus supplement relating to the preferred stock offered, including the following terms:

• the title of the preferred stock;

• the series, the number of shares offered and the liquidation value of the preferred stock;

• the price at which the preferred stock will be issued;

• the dividend rate, the dates on which the dividends will be payable and other terms relating to the payment of dividends on the preferred stock;

• the liquidation preference of the preferred stock;

• the voting rights of the preferred stock;

• whether the preferred stock is redeemable or subject to a sinking fund, and the terms of any such redemption or sinking fund;

• whether the preferred stock is convertible or exchangeable for shares of our common stock, and the terms of any such conversion;

• any listing of the preferred stock on any securities exchange;

• the relative ranking and preferences of the preferred stock as to dividend rights and rights upon liquidation and dissolution or winding up; and

• any additional rights, preferences, qualifications, limitations and restrictions of the preferred stock.

Any prospectus supplement filed in connection with an offering of preferred stock will describe all material terms of such series of preferred stock and all material terms of any common stock, if any, issuable upon conversion of such preferred stock. However, the description of the terms of the preferred stock to be set forth in an applicable prospectus supplement will not be complete and will be subject to and qualified in its entirety by reference to the certificate of amendment to our certificate of incorporation relating to the applicable series of preferred stock, together with our bylaws. The registration statement of which this prospectus forms a part currently does or will in the future include the certificate of amendment and our bylaws as exhibits or incorporate them by reference.

The preferred stock will, if and when issued, be fully paid and non-assessable.

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Antitakeover Provisions

Effect of Delaware Law Statute. We are incorporated under the laws of the state of Delaware and therefore subject to Delaware corporations law, including Section 203 of the Delaware General Corporation Law regulating corporate takeovers, which prohibits a Delaware corporation from engaging in any business combination with an “interested stockholder,” unless:

• prior to the date of the transaction, the Board of Directors of the corporation approved either the business combination or the transaction which resulted in the stockholder becoming an interested stockholder;

• the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstanding (a) shares owned by persons who are directors and also officers and (b) shares owned by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or

• on or subsequent to the date of the transaction, the business combination is approved by the board and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least 66 ²/3% of the outstanding voting stock which is not owned by the interested stockholder.

Except as otherwise specified in Section 203, an “interested stockholder” is defined to include (a) any person that is the owner of 15% or more of the outstanding voting securities of the corporation, or is an affiliate or associate of the corporation and was the owner of 15% or more of the outstanding voting stock of the corporation at any time within three years immediately prior to the date of determination and (b) the affiliates and associates of any such person.

Certificate of Incorporation and Bylaw Provisions. Provisions of our certificate of incorporation and bylaws may have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire or gain control of us. These provisions could cause the price of our common stock to decrease. Some of these provisions allow us to issue preferred stock without any vote or further action by the stockholders. Moreover, our bylaws have eliminated the right of stockholders to act by written consent and do not allow for cumulative voting in the election of directors. These provisions may make it more difficult for stockholders to take specific corporate actions and could have the effect of delaying or preventing a change in control of us.

Classified Board of Directors. Our certificate of incorporation provides that the Board of Directors will be divided into three classes of directors, with each class serving a staggered three-year term. The classification system of electing directors may discourage a third party from making a tender offer or otherwise attempting to obtain control of us and may maintain the incumbency of the Board of Directors, because the classification of the Board of Directors generally increases the difficulty of replacing a majority of the directors.

Notice Procedures. Our bylaws establish advance notice procedures with regard to all stockholder proposals to be brought before meetings of our stockholders, including proposals relating to nomination of candidates for election as directors, the removal of directors and amendments to our certificate of incorporation or bylaws. These procedures provide that notice of such stockholder proposals must be timely given in writing to the secretary of RAE Systems prior to the meeting. To be timely, notice must be received by our secretary not less than 120 calendar days prior in advance of the anniversary date that the our proxy statement was released to stockholders in connection with the previous year’s annual meeting of stockholders. The notice must contain information specified in the bylaws.

Limitation of Director Liability. Our certificate of incorporation limits the liability of our directors to us or our stockholders to the fullest extent permitted by Delaware law. Specifically, directors will not be personally liable for monetary damages for breach of a director’s fiduciary duties as a director, except for liability

• for any breach of the director’s duty of loyalty to us or our stockholders;

• for acts of omissions not in good faith or which involve intentional misconduct or a knowing violation of law;

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• under Section 174 of the Delaware General Corporation Law, which relates to unlawful payments of dividends or unlawful stock repurchases or redemptions; or

• for any transaction from which the director derived an improper personal benefit.

Indemnification Arrangements. Our bylaws provide that our directors and officers shall be indemnified and provide for the advancement to them of expenses in connection with actual or threatened proceedings and claims arising out of their status as such to the fullest extent by the Delaware General Corporation Law. We have entered into indemnification agreements with each of our directors and executive officers which will provide them with rights to indemnification and expense advancement to the fullest extent permitted under the Delaware General Corporation Law.

Transfer Agent and Registrar

The transfer agent and registrar for our common stock is the Interwest Transfer Company, Inc. Its address is 1981 East 4800 South, Suite 100, Salt Lake City, Utah, 94117, and its telephone number at this location is (801) 272-9294.

DESCRIPTION OF SECURITIES WARRANTS

The following description sets forth certain general terms and provisions of our securities warrants. If we offer securities warrants, the specific terms of the securities warrants offered will be described in the prospectus supplement relating to such offered securities warrants.

We may issue warrants for the purchase of preferred stock or common stock. Securities warrants may be issued alone or together with preferred stock or common stock offered by any prospectus supplement and may be attached to or separate from those securities. Each series of securities warrants will be issued under a separate warrant agreement between us and a bank or trust company, as warrant agent, which will be described in the applicable prospectus supplement. The securities warrant agent will act solely as our agent in connection with the securities warrants and will not act as an agent or trustee for any holders of securities warrants.

We have summarized the material terms and provisions of the securities warrant agreements and securities warrants below. The applicable prospectus supplement will describe the material terms and provisions of the securities warrants offered through that prospectus supplement as well as the material terms of the securities issuable upon exercise of the securities warrants. The registration statement of which this prospectus forms a part will include the securities warrant agreements and certificates as exhibits or incorporate them by reference.

General

If we offer securities warrants, the applicable prospectus supplement will describe their terms.

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If securities warrants for the purchase of preferred stock or common stock are offered, the applicable prospectus supplement will describe the terms of those securities warrants, including the following where applicable:

• the offering price;

• the total number of shares that can be purchased if a holder of the securities warrants exercises them and, in the case of securities warrants for preferred stock, the designation, total number and terms of the series of preferred stock that can be purchased upon exercise;

• the designation and terms of the series of preferred stock or common stock with which the securities warrants are being offered and the number of securities warrants being offered with each share of preferred stock or share of common stock;

• the date on and after which the holder of the securities warrants can transfer them separately from the related preferred stock or common stock;

• the number of shares of preferred stock or shares of common stock that can be purchased if a holder exercises the securities warrant and the price at which the preferred stock or common stock may be purchased upon each exercise;

• the date on which the right to exercise the securities warrants begins and the date on which the right expires;

• United States federal income tax consequences; and

• any other terms of the securities warrants.

Securities warrants for the purchase of preferred stock or common stock will be represented by one or more warrant agreements. In order to exercise the warrants, the holder of the warrant must present an exercise notice to the Company and accompany such notice with the underlying warrant agreement.

A holder of securities warrant certificates may:

• exchange them for new certificates of different denominations;

• present them for registration of transfer; and

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• exercise them at the corporate trust office of the securities warrant agent or any other office indicated in the applicable prospectus supplement.

Until any securities warrants to purchase preferred stock or common stock are exercised, holders of these securities warrants will not have any rights of holders of the underlying preferred stock or common stock, including any right to receive dividends or to exercise any voting rights.

Exercise of Securities Warrants

Each holder of a securities warrant is entitled to purchase the principal number of shares of preferred stock or shares of common stock, as the case may be, at the exercise price described in the applicable prospectus supplement. After the close of business on the day when the right to exercise terminates (or a later date if we extend the time for exercise), unexercised securities warrants will become void.

A holder of securities warrants may exercise them by following the general procedure outlined below:

• delivering to the securities warrant agent the payment required by the applicable prospectus supplement to purchase the underlying security;

• properly completing and signing the reverse side of the securities warrant certificate representing the securities warrants; and

• delivering the securities warrant certificate representing the securities warrants to the securities warrant agent within five business days of the securities warrant agent receiving payment of the exercise price.

If a holder complies with the procedures described above, his securities warrants will be considered to have been exercised when the securities warrant agent receives payment of the exercise price. After the holder has completed those procedures, we will, as soon as practicable, issue and deliver to the holder the preferred stock or common stock that he purchased upon exercise. If the holder exercises fewer than all of the securities warrants represented by a securities warrant certificate, the securities warrant agent will issue to the holder a new securities warrant certificate for the unexercised amount of securities warrants. Holders of securities warrants will be required to pay any tax or governmental charge that may be imposed in connection with transferring the underlying securities in connection with the exercise of the securities warrants.

Amendments and Supplements to Securities Warrant Agreements

We may amend or supplement a securities warrant agreement without the consent of the holders of the applicable securities warrants if the changes are not inconsistent with the provisions of the securities warrants and do not materially adversely affect the interests of the holders of the securities warrants. We, along with the securities warrant agent, may also modify or amend a securities warrant agreement and the terms of the securities warrants if a majority of the then-outstanding unexercised securities warrants affected by the modification or amendment consent. However, no modification or amendment that accelerates the expiration date, increases the exercise price, reduces the majority consent requirement for any such modification or amendment, or otherwise materially adversely affects the rights of the holders of the securities warrants may be made without the consent of each holder affected by the modification or amendment.

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Securities Warrant Adjustments

Unless the applicable prospectus supplement states otherwise, the exercise price of, and the number of shares of common stock or preferred stock covered by, a securities warrant will be adjusted in the manner set forth in the applicable prospectus supplement if certain events occur, including:

• if we issue capital stock as a dividend or distribution on the common stock or preferred stock;

• if we subdivide, reclassify or combine the common stock preferred stock;

• if we issue rights or warrants to all holders of common stock or preferred stock entitling them to purchase common stock or preferred stock at less than the current market price; or

• if we distribute to all holders of common stock or preferred stock evidences of our indebtedness or our assets, excluding certain cash dividends and distributions described below, or if we distribute to all holders of common stock or preferred stock rights or warrants, excluding those referred to in the bullet point above.

Except as stated above, the exercise price and number of shares of common stock or preferred stock covered by a securities warrant will not be adjusted if we issue common stock or preferred stock or any securities convertible into or exchangeable for common stock or preferred stock, or securities carrying the right to purchase common stock or preferred stock or securities convertible into or exchangeable for common stock or preferred stock.

Holders of securities warrants may have additional rights under the following circumstances:

• a reclassification or change of the common stock;

• a consolidation or merger involving our company; or

• a sale or conveyance to another corporation of all or substantially all of our property and assets.

If one of the above transactions occurs and holders of our common stock or preferred stock are entitled to receive stock, securities, other property or assets, including cash, with respect to or in exchange for common stock or preferred stock, the holders of securities warrants then outstanding will be entitled to receive upon exercise of their securities warrants the kind and amount of shares of stock and other securities or property that they would have received upon the reclassification, change, consolidation, merger, sale or conveyance if they had exercised their securities warrants immediately before the transaction.

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PLAN OF DISTRIBUTION

We or the selling stockholders, as the case may be, may sell securities pursuant to this prospectus, as supplemented or amended, (1) through agents designated by us, (2) through underwriters or dealers, or (3) through a combination of these methods. All participating underwriters, dealers and agents will be registered broker-dealers or associated persons of registered broker-dealers. The prospectus supplement will include the following information:

• the terms of the offering;

• the names of any underwriters or agents;

• the name or names of any managing underwriter or underwriters;

• the purchase price or public offering price of the securities to be offered;

• the use of net proceeds from the sale of the securities;

• any underwriting discounts, commissions and other items constituting underwriters’ compensation;

• any discounts or concessions allowed or reallowed or paid to dealers; and

• any commissions paid to agents.

Unless otherwise indicated in an applicable prospectus supplement, selling agents, if any, will act on a best efforts basis for the period of its appointment.

If underwriters are used in the sale, the offered securities will be acquired by the underwriters for their own account. The underwriters may resell the securities in one or more transactions, including negotiated transactions, at a fixed public offering price or at varying prices determined at the time of sale. The obligations of the underwriters to purchase the securities will be subject to certain conditions. Unless otherwise indicated in the prospectus supplement, the underwriters must purchase all the securities offered by a prospectus supplement if any of the securities are purchased. Any initial public offering price and any discounts or concessions allowed or re-allowed or paid to dealers may be changed from time to time.

During and after an offering through underwriters, the underwriters may purchase and sell the securities in the open market. These transactions may include overallotment and stabilizing transactions and purchases to cover syndicate short positions created in connection with the offering. The underwriters may also impose a penalty bid, which means that selling concessions allowed to syndicate members or other broker-dealers for the securities sold for their account may be reclaimed by the syndicate if the securities are repurchased by the syndicate in stabilizing or covering transactions. These activities may stabilize, maintain or otherwise affect the market price of the securities, which may be higher than the price that might otherwise prevail in the open market. If commenced, the underwriters may discontinue these activities at any time.

If dealers are used in the sale the securities, we or the selling stockholders, as the case may be, will sell the securities to them as principals. They may then resell such securities to the public at varying prices determined by the dealers at the time of resale. We will include in the prospectus supplement the names of the dealers and the terms of the transaction.

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We or the selling stockholders, as the case may be, may authorize agents, underwriters or dealers to solicit offers by certain institutional investors to purchase securities providing for payment and delivery on a future date specified in the prospectus supplement. Institutional investors to which such offers may be made, when authorized, include commercial and savings banks, insurance companies, pension funds, investment companies, education and charitable institutions and such other institutions as may be approved by us. If we and/or the selling stockholders sell securities under such delayed delivery contracts, the prospectus supplement will state that as well as the conditions to which these delayed delivery contracts will be subject and the commission payable for that solicitation. In addition, each delayed delivery contract, when issued, will contain definite fixed price and quantity terms. The obligations of any purchaser pursuant to a delayed delivery contract will not be subject to any market outs or other conditions other than it will not violate applicable law, and in the event that the underlying securities are also being sold to underwriters at the time of performance under the delayed delivery contract, the conditions that those securities are in fact sold to those underwriters. The underwriters and such agents will not have any responsibility with respect to the validity or performance of such contracts.

Underwriters, dealers and agents and selling stockholders that participate in the distribution of the securities may be underwriters as defined in the Securities Act, and any discounts or commissions received by them from us and any profit on the resale of the securities by them may be treated as underwriting discounts and commissions under the Securities Act. Any underwriters or agents will be identified and their compensation described in the applicable prospectus supplement.

We or the selling stockholders, as the case may be, may have agreements with the underwriters, dealers and agents to indemnify them against certain civil liabilities, including liabilities under the Securities Act of 1933, as amended, or to contribute with respect to payments that the underwriters, dealers or agents may be required to make.

Underwriters, dealers and agents may engage in transactions with, or perform services for, us, our subsidiaries, or the selling stockholders in the ordinary course of their businesses.

During such time as we and the selling stockholders may be engaged in a distribution of the securities covered by this prospectus, we and the selling stockholders are required to comply with Regulation M promulgated under the Exchange Act. With certain exceptions, Regulation M precludes us, the selling stockholders, any affiliated purchasers, and any broker-dealer or other person who participates in such distribution from bidding for or purchasing, or attempting to induce any person to bid for or purchase any security which is the subject of the distribution until the entire distribution is complete. Regulation M also restricts bids or purchases made in order to stabilize the price of a security in connection with the distribution of that security. All of the foregoing may affect the marketability of our common stock.

There can be no assurance that the selling stockholders will sell any or all of their shares of common stock covered by this prospectus.

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LEGAL MATTERS

The validity of the securities issued hereunder will be passed upon for us by our counsel, Gray Cary Ware & Freidenrich LLP, East Palo Alto, California. Any underwriters will be advised about other issues relating to any offering by their own legal counsel.

EXPERTS

The financial statements of RAE Systems Inc. as of December 31, 2002 and 2001 and for each of three years in the period ended December 31, 2002 included in this prospectus have been audited by BDO Seidman, LLP, independent certified public accountants, and are included herein in reliance on such reports given upon the authority of said firm as experts in accounting and auditing.

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8,800,000 Shares

RAE SYSTEMS Inc.

Common Stock

PROSPECTUS SUPPLEMENT

Jefferies Quarterdeck Merriman Curhan Ford & Co.