##### Table of Contents





UNITED STATES SECURITIES AND
    EXCHANGE COMMISSION
 Washington, D.C.
    20549
  Form 10-K
  þ

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended
    December 31,
    2010ORo

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934For the transition period from
    to   Commission file number:
    001-31783
 RAE Systems Inc.
 (Exact name of registrant as
    specified in its charter)
  Delaware

77-0280662(State or other jurisdiction
    of
    incorporation or organization)

(I.R.S. Employer
    Identification No.)3775 North First Street San Jose, California(Address of principal
    executive offices)

95134(Zip
    Code)   408-952-8200
    (Registrants telephone number, including area code)
    Securities registered pursuant to Section 12(b) of the
    Act:
  Title of Each Class

Name of Each Exchange on Which RegisteredCommon Stock, $0.001 par value per share

NYSE Alternext US   Securities registered pursuant to Section 12(g) of the
    Act:
 None
  o þ
  o þ
  þ o
  Regulation S-K Form 10-K Form 10-K. þ
  Rule 12b-2
  Large
    accelerated
    filer o
    Accelerated
    filer o
    Non-accelerated
    filer þ
    Smaller
    reporting
    company o   Rule 12b-2 o þ
    DOCUMENTS
    INCORPORATED BY REFERENCE
  Form 10-K.




---



##### 





RAE
    SYSTEMS INC.
    INDEX TO
    ANNUAL REPORT ON
    FORM 10-K
    FOR YEAR ENDED DECEMBER 31, 2010
  TABLE OF
    CONTENTS
  PagePART IITEM 1.

BUSINESS


2ITEM 1A.

RISK FACTORS


8ITEM 1B.

UNRESOLVED STAFF COMMENTS


15ITEM 2.

PROPERTIES


15ITEM 3.

LEGAL PROCEEDINGS


15ITEM 4.

RESERVED


18PART IIITEM 5.

MARKET FOR REGISTRANTS COMMON EQUITY,
    RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
    SECURITIES


18ITEM 6.

SELECTED FINANCIAL DATA


20ITEM 7.

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


21ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
    MARKET RISK


34ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


35ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
    ACCOUNTING AND FINANCIAL DISCLOSURE


35ITEM 9A.

CONTROLS AND PROCEDURES


35ITEM 9B.

OTHER INFORMATION


36PART IIIITEM 10.

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
    GOVERNANCE


36ITEM 11.

EXECUTIVE COMPENSATION


36ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
    AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS


36ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
    AND DIRECTOR INDEPENDENCE


36ITEM 14.

PRINCIPAL ACCOUNTANT FEES AND SERVICES


36PART IVITEM 15.

EXHIBITS AND FINANCIAL STATEMENT
    SCHEDULES


37SIGNATURES


38EX-10.17EX-10.18EX-10.19EX-10.20EX-10.21EX-10.22EX-10.23EX-23.2EX-31.1EX-31.2EX-32.1EX-32.2   1




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##### Table of Contents



PART I  In addition to historical information, this Annual Report on
    Form 10-K
    contains forward-looking statements. These statements typically
    are preceded or accompanied by words like believe,
    anticipate, expect, may,
    will, should, intend,
    plan, estimate, potential,
    or continue, and other words of similar meaning.
    These forward-looking statements are subject to certain risks
    and uncertainties that could cause actual results to differ
    materially from those reflected in these forward-looking
    statements. Readers are cautioned not to place undue reliance on
    those forward-looking statements, which reflect
    managements opinions only as of the date hereof. We
    undertake no obligation to revise or update or publicly release
    the results of any revisions or update to these forward-looking
    statements. Readers should carefully review the risk factors
    described herein and in other documents that we file from time
    to time with the Securities and Exchange Commission, including
    the Quarterly Reports on
    Form 10-Q
    that we file for the fiscal year 2011.
  ITEM 1.
    BUSINESS  Overview
  clean-ups.
      Definitive
    Acquisition Agreements with Battery Ventures and Vector
    Capital
   2




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##### Table of Contents



www.raesystems.com Form 10-K, Form 10-Q, Form 8-K
  1-800-SEC-0330. http://www.sec.gov.
  Industry
    Background
        Products
    Sensor
    and Measurement Products
    
    photoionization detectors for the measurement of volatile
    organic compounds, highly toxic chemical warfare agents and
    toxic industrial chemicals;
    catalytic bead pellistors for the detection and measurement of
    combustible gas;
    non-dispersive infrared sensors for the measurement of carbon
    dioxide and hydrocarbons;
    electro-chemical sensors for the measurement of oxygen and toxic
    gases such as ammonia, carbon monoxide, chlorine and hydrogen
    sulfide;
    solid polymer electrode sensors for the measurement of
    oxygen; and
    solid-state scintillation detectors for both neutron and gamma
    radiation. 3




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part-per-billion
  Integrated
    Wireless Products
            Radiation
    Products
    Software
    Solutions
    New
    Product Certifications
  
    Seven products have been certified for Inmetro (Brazil)
    including the ToxiRAE 3, QRAE 2, AreaRAE, MiniRAE 3000, ppbRAE
    3000, UltraRAE3000, and Meshguard. 4




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##### Table of Contents




    IECEX certification for the MiniRAE 3000, ppbRAE 3000,
    UltraRAE3000 to address Australia, New Zealand and other
    international countries.
    ATEX/IECEX certification for the RAELink 3 Z1 for EMEA, Asia
    Pacific, Australia, and New Zealand markets.  Sales,
    Marketing and Distribution
    business-to-business business-to-government
      Customers
    Research,
    Development and Engineering
        
    14 United States patents granted;
    10 China patents granted with 13 pending;
    2 Europe patent granted with 4 pending; and
    1 Japan patent granted. 5




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##### Table of Contents



Manufacturing
    Competition
      and/or
    Employees
   6




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##### Table of Contents



Executive
    Officers of the Registrant
    Name

Age

PositionRobert I. Chen


63


President, Chief Executive Officer and Chairman of the BoardRandall Gausman


61


Vice President and Chief Financial OfficerPeter C. Hsi


60


Chief Technology OfficerMing-Ching Tang


60


Executive Vice President OperationsChristopher Hameister


56


Vice President Asia-Pacific, Europe and Middle East Business
    OperationsFei-Zhou Shen


48


Vice President Corporate DevelopmentRyan Watson


38


Vice President Americas Sales   Robert I. Chen
  Randall Gausman
  Dr. Peter C. Hsi
  Dr. Ming-Ching Tang
  Christopher Hameister
 7




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##### Table of Contents



Fei-Zhou Shen
  Ryan Watson
  Item 1A.
    Risk
    Factors  You should carefully consider the risks described below
    before making a decision regarding an investment in our common
    stock. If any of the following risks actually occur, our
    business could be harmed, the trading price of our common stock
    could decline and you may lose all or part of your investment.
    You should also refer to the other information contained in this
    report, including our financial statements and the related
    notes.
  Although
    we have settled outstanding issues related to our possible
    violations of the Foreign Corrupt Practices Act, we still face
    risks of non-compliance with the FCPA going
    forward.
    Economic
    conditions could materially adversely affect our
    business.
  and/or and/or
  Political
    events, war, terrorism, natural disasters, and other
    circumstances could materially adversely affect
    us.
   8




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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.
  period-to-period
  We may
    have difficulty achieving and sustaining profitability and may
    experience additional losses in the future. If we continue to
    report losses or are marginally profitable, the financial impact
    of future events may be magnified and may lead to a
    disproportionate impact on the trading price of our
    stock.
    We may
    require additional capital in the future, which may not be
    available or may be available only on unfavorable
    terms.
    The
    market for gas and radiation detection monitoring devices is
    highly competitive, and if we cannot compete effectively, our
    business may be harmed.
   9




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##### Table of Contents




    devote greater resources to marketing and promotional campaigns;
    adopt more aggressive pricing policies; or
    devote more resources to technology and systems development.    We may
    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.
        The
    securities laws and regulations have and are likely to continue
    to have a significant effect on our costs.
    In the
    event we are unable to satisfy regulatory requirements relating
    to internal control over financial reporting or, if these
    controls are not effective, our business and financial results
    may suffer.
     10




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We are
    subject to risks and uncertainties of the government
    marketplace, including the risk that the government may not fund
    projects that our products are designed to address and that
    certain terms of our contracts with government agencies may
    subject us to adverse government actions or
    penalties.
    time-to-time i.e.
  We may
    not be successful in promoting and developing our brand, which
    could prevent us from remaining competitive.
    We may
    face risks from our substantial international operations and
    sales.
      
    difficulties with staffing and managing international operations;
    transportation and supply chain disruptions and increased
    transportation expense as a result of epidemics, terrorist
    activity, acts of war or hostility, increased security and less
    developed infrastructure;
    economic slowdown
    and/or
    downturn in foreign markets;
    international currency fluctuations;
    political and economic uncertainty caused by epidemics,
    terrorism or acts of war or hostility; 11




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
    legislative and regulatory responses to terrorist activity such
    as increased restrictions on cross-border movement of products
    and technology;
    legislative, regulatory, police, or civil responses to epidemics
    or other outbreaks of infectious diseases such as quarantines,
    factory closures, or increased restrictions on transportation or
    travel;
    increased costs and complexities associated with complying with
    Section 404 of the Sarbanes-Oxley Act of 2002;
    general strikes or other disruptions in working conditions;
    labor shortages;
    political instability;
    changes in tariffs;
    generally longer periods to collect receivables;
    unexpected legislative or regulatory requirements;
    reduced protection for intellectual property rights in some
    countries;
    significant unexpected duties or taxes or other adverse tax
    consequences;
    difficulty in obtaining export licenses and other trade
    barriers; and
    ability to obtain credit and access to capital issues faced by
    our international customers.  and/or
    The
    loss of Normal Trade Relation status for China,
    changes in current tariff structures or adoption of other trade
    policies adverse to China could have an adverse effect on our
    business.
   12




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##### Table of Contents



The
    government of China may change or even reverse its policies of
    promoting private industry and foreign investment, in which case
    our assets and operations may be at risk.
    Any
    failure to adequately protect and enforce our intellectual
    property rights could harm our business.
      We may
    face intellectual property infringement claims that might be
    costly to resolve and affect our results of
    operations.
   13




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Some
    of our products may be subject to product liability claims which
    could be costly to resolve and affect our results of
    operations.
    We
    sell a majority of our products through distributors, and if our
    distributors stop selling our products, our revenues would
    suffer.
    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.
    Future
    acquisitions that we undertake could be difficult to integrate,
    disrupt our business, dilute shareholder value or harm our
    results of operations.
    Our
    ownership interest in Renex will cause us to incur losses that
    we would not otherwise incur.
   14




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Our
    business could suffer if we lose the services of any of our
    executive officers.
    Our
    officers and directors beneficially own approximately 34% of our
    common stock and, accordingly, may exert substantial influence
    over the Company.
    ITEM 1B.
    UNRESOLVED
    STAFF COMMENTS    ITEM 2.
    PROPERTIES            ITEM 3.
    LEGAL
    PROCEEDINGS  Regulatory
    Compliance
   15




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##### Table of Contents



Polimaster
    Ltd., et al. v. RAE Systems Inc., United States District
    Court for the Northern District of California, Case
    No. 05-CV-01887-JF,
    United States Court of Appeals for the Ninth Circuit, Nos.
    08-15708 and
    09-15369.
  No. 05-CV-01887-JF).
  No. 08-15708.
  No. 09-15369,
  08-15708 09-15369).
 16




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i.e
  Shareholder
    Lawsuits
  The
    California State Court Actions:
  Foley v. RAE Systems Inc., et al. Angles v. RAE Systems Inc., et
    al. Greenbaum v. Chen, et
    al. AC Photonics, Inc. v. RAE
    Systems Inc., et al. Mann v. RAE Systems Inc., et al. In re RAE Systems, Inc. Shareholder Litigation
  The
    Delaware Chancery Court Actions:
  Nelson v. RAE Systems Inc., et al. No. 5848-VCS; Venton v. RAE Systems Inc., et al. No. 5854-VCS; Quintanilla v. RAE Systems Inc., et al. Villeneuve v. RAE Systems Inc., et al. In re RAE Systems, Inc.
    Shareholder Litigation No. 5848-VCS,
   17




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##### Table of Contents



The
    Federal Court Actions:
  and/or LaPlante v. RAE Systems
    Inc., et al. Mabry v. Chen,
    et al. 10-5328. LaPlante Mabry
    ITEM 4.
    RESERVED PART II  ITEM 5.
    MARKET
    FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER
    MATTERS. AND ISSUER PURCHASES OF EQUITY SECURITIES  mark-ups,
  2010


2009High


Low


High


LowFirst Quarter

$
1.26


$
0.76


$
1.00


$
0.28Second Quarter

$
0.91


$
0.66


$
1.70


$
0.42Third Quarter

$
1.59


$
0.63


$
2.23


$
1.00Fourth Quarter

$
1.66


$
1.55


$
1.48


$
0.65      18




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##### Table of Contents



PERFORMANCE
    GRAPH
  3800-3899,
    COMPARISON
    OF 5 YEAR CUMULATIVE TOTAL RETURN* Among
    RAE Systems Inc., the NYSE AMEX Composite Index, the NYSE Amex
    Stock Market (U.S. Companies), and a Peer Group of NYSE AMEX
    stocks for SIC codes 3800  3899 Measuring Instruments
    (photo, med & optical goods)
  
  12/31/05
    2005


2006


2007


2008


2009


2010RAE Systems, Inc.



100.00




91.16




76.92




15.38




31.34




45.87NYSE AMEX Composite Index



100.00




119.86




144.10




85.87




116.29




152.53NYSE AMEX Stock Market (US Companies)



100.00




116.12




120.33




76.70




93.81




119.34Peer Group



100.00




101.78




84.83




50.83




69.72




97.79    19




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##### Table of Contents



ITEM 6.
    SELECTED
    FINANCIAL DATA  Form 10-K.
  2007

20062010

2009

2008

(1)(2)(3)

(4)(5)(6)(7)(In thousands, except share and per share data)Operating Data:Net sales

$
87,053


$
74,993


$
83,045


$
79,038


$
67,721Gross profit

$
52,301


$
39,578


$
44,147


$
36,452


$
35,523Operating income (loss) from continuing operations

$
6,039


$
(3,881
)

$
(4,253
)

$
(3,574
)

$
(2,871
)Income (loss) from continuing operations

$
5,273


$
(3,257
)

$
(5,719
)

$
(9,930
)

$
(1,418
)Basic income (loss) per common share from continuing operations

$
0.09


$
(0.06
)

$
(0.10
)

$
(0.17
)

$
(0.03
)Diluted income (loss) per common share from continuing operations

$
0.09


$
(0.06
)

$
(0.10
)

$
(0.17
)

$
(0.03
)Weighted-average common shares:Basic outstanding shares


59,438,722



59,366,850



59,204,262



58,852,172



58,424,970Diluted outstanding shares


59,575,225



59,366,850



59,204,262



58,852,172



58,424,970Balance Sheet Data:Working capital

$
31,102


$
31,676


$
37,146


$
40,850


$
36,641Total assets

$
72,107


$
78,874


$
81,175


$
85,343


$
89,753Long-term liabilities

$
6,399


$
7,822


$
8,358


$
10,442


$
5,441Total RAE Systems Inc. shareholders equity

$
38,575


$
39,029


$
43,216


$
46,356


$
56,179       (1)
    
    In January 2007, the Company entered into an agreement to
    purchase the intellectual properties of Tianjin Securay
    Technology Ltd. Co. for approximately $1.5 million.
    Including transactions entered into during fiscal 2006, the
    total purchase price was $2.0 million in cash.(2)
    
    In August 2007, the Board of Directors approved the
    discontinuation of the Companys DVR business. Impairment
    expenses recognized in fiscal 2007 totaled $4.2 million.(3)
    
    In December 2007, the Company sold its headquarters building in
    San Jose, California for $12.7 million and leased back
    the facility for a period of 10 years. The Company
    recognized a gain on sale of $0.4 million in 2007 and
    recorded a deferred gain of $6.3 million. The deferred gain
    will be recognized in income straight-line over the life of the
    leaseback beginning in January 2008.(4)
    
    RAE Fushun joint venture was formed in December 2006. The fair
    value of assets acquired and liabilities assumed were included
    in the consolidated balance sheet as of December 31, 2006.
    There were no operating activities recorded in 2006.(5)
    
    The Company purchased an additional 32% ownership in RAE Beijing
    in July 2006. The Company has consolidated RAE Beijing since
    2004. With the purchase in July 2006, minority
    shareholders interest was reduced to 4%.(6)
    
    In July 2006, the Company purchased Aegison Corporation. The
    fair value of assets acquired and liabilities assumed were
    included in the consolidated balance sheet as of
    December 31, 2006.(7)
    
    As of December 31, 2006, the Company was in the process of
    acquiring Securay. The Company recorded $820,000 of acquisition
    in progress as of December 31, 2006. 20




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##### Table of Contents



ITEM 7.
    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. Factors
    that might cause or contribute to such differences include, but
    are not limited to, those discussed in Item 1A, Risk
    Factors as well as in Item 1, Business
    and Item 7, Managements Discussion and Analysis
    of Financial Condition and Results of Operations in this
    Annual Report on
    Form 10-K.
    You should carefully review these risks and also review the
    risks described in other documents we file from time- to- time
    with the Securities and Exchange Commission, including the
    Quarterly Reports on
    Form 10-Q
    that we will file in fiscal year 2010. You are cautioned not to
    place undue reliance on these forward-looking statements, and we
    expressly assume no obligations to update the forward-looking
    statements in this report that occur after the date hereof.
  Overview
            Critical
    Accounting Policies
   21




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Revenue
    Recognition
  percentage-of-completion
  Accounts
    Receivable, Trade Notes Receivable and Allowance for Doubtful
    Accounts
        Inventories
  first-in,
 22




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Goodwill
      Long-lived
    Assets
        Stock-Based
    Compensation Expense
   23




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##### Table of Contents



Expected Term
  Expected Volatility
  Expected Dividend
  Risk-Free Interest Rate
  Estimated Forfeitures trued-up
  Income
    Taxes
        RESULTS
    OF OPERATIONS
    Net
    Sales
  Percentage







Percentage2010

2009

Change

Change

2009

2008

Change

Change(In thousands)Net sales

$
87,053


$
74,993


$
12,060



16
%

$
74,993


$
83,045


$
(8,052
)


(10
)%    24




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##### Table of Contents



Cost
    of Sales and Gross Profit
  Percentage







Percentage2010

2009

Change

Change

2009

2008

Change

Change(In thousands)Cost of sales

$
34,752


$
35,415


$
(663
)


(2
)%

$
35,415


$
38,898


$
(3,483
)


(9
)%Gross profit

$
52,301


$
39,578


$
12,723



32
%

$
39,578


$
44,147


$
(4,569
)


(10
)%Gross margin


60
%


53
%










53
%


53
%   year-over-year
    Sales
    and Marketing Expense
  Percentage







Percentage2010

2009

Change

Change

2009

2008

Change

Change(In thousands)Sales and marketing

$
19,494


$
16,354


$
3,140



19
%

$
16,354


$
17,943


$
(1,589
)


(9
)%Percentage of net sales


22
%


22
%










22
%


22
%      25




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##### Table of Contents



Research
    and Development Expense
  Percentage







Percentage2010

2009

Change

Change

2009

2008

Change

Change(In thousands)Research and development

$
7,077


$
5,956


$
1,121



19
%

$
5,956


$
5,949


$
7



0
%Percentage of net sales


8
%


8
%










8
%


7
%       General
    and Administrative Expense
  Percentage







Percentage2010

2009

Change

Change

2009

2008

Change

Change(In thousands)General and administrative

$
19,691


$
21,149


$
(1,458
)


(7
)%

$
21,149


$
21,160


$
(11
)


0
%Percentage of net sales


23
%


28
%










28
%


25
%       Impairment
    of Goodwill
  Percentage







Percentage2010

2009

Change

Change

2009

2008

Change

Change(In thousands)Impairment of goodwill

$



$



$




0
%

$



$
3,348


$
(3,348
)


(100
)%Percentage of net sales


0
%


0
%










0
%


4
%    26




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##### Table of Contents



Other
    Income (Expense)
  Percentage











Percentage2010


2009


Change


Change


2009


2008


Change


Change(In thousands)Interest income

$
66


$
46


$
20



43
%

$
46


$
161


$
(115
)


(71
)%Interest expense


(185
)


(390
)


205



(53
)%


(390
)


(397
)


7



(2
)%Other, net


(177
)


277



(454
)


(164
)%


277



(735
)


1,012



(138
)%Equity in loss of unconsolidated affiliate


(173
)


(109
)


(64
)


59
%


(109
)


43



(152
)


(353
)%Total other income (expense)

$
(469
)

$
(176
)

$
(293
)


166
%

$
(176
)

$
(928
)

$
752



(81
)%   construction-in-progress
    Income
    Tax (Expense) Benefit
  Percentage







Percentage2010

2009

Change

Change

2009

2008

Change

Change(In thousands)Income tax (expense) benefit

$
(297
)

$
800


$
(1,097
)


(137
)%

$
800


$
(538
)

$
1,338



(249
)%Effective tax rate


5
%


(20
)%










(20
)%


10
%      27




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##### Table of Contents



Net
    (Income) Loss Attributable to the Noncontrolling
    Interest
  Percentage







Percentage2010

2009

Change

Change

2009

2008

Change

Change(In thousands)Net (income) loss attributable to the noncontrolling interest

$
(42
)

$
3


$
(45
)


(1500
)%

$
3


$
(148
)

$
151



(102
)%       Loss
    From Discontinued Operations
  Percentage











Percentage2010


2009


Change


Change


2009


2008


Change


Change(In thousands)Loss from discontinued operations before income taxes

$
(11,178
)

$
(3,541
)

$
(7,637
)


216
%

$
(3,541
)

$
(1,653
)

$
(1,888
)


114
%Income tax benefit






84



(84
)


(100
)%


84







84



0Loss from discontinued operations, net of tax


(11,178
)


(3,457
)


(7,721
)


223
%


(3,457
)


(1,653
)


(1,804
)


109
%Net loss attributable to the noncontrolling interest,
    discontinued operations


3,342



952



2,390



251
%


952



368



584



159
%Loss from discontinued operations attributable to RAE Systems
    Inc.

$
(7,836
)

$
(2,505
)

$
(5,331
)


213
%


(2,505
)

$
(1,285
)

$
(1,220
)


95
%    28




---



##### Table of Contents



day-to-day
    Liquidity
    and Capital Resources
           29




---



##### Table of Contents



day-to-day
      Year Ended December 31,2010


2009


2008(In thousands)Net cash provided by (used in) :Operating activities

$
3,776


$
7,657


$
3,178Investing activities


(3,421
)


(5,000
)


(3,351
)Financing activities


(2,699
)


954



(1,391
)Effect of exchange rate changes on cash and cash equivalents


146



72



503Net increase (decrease) in cash and cash equivalents

$
(2,198
)

$
3,683


$
(1,061
)   Operating
    Activities
    
    Non-cash charges included in our income from continuing
    operations of $5.3 million totaled $2.5 million. Our
    principal non-cash expenses were as follows: $1.7 million
    depreciation and amortization; $0.8 million provision for
    doubtful accounts; and $1.1 million stock-based
    compensation. These non-cash expenses were partially offset by
    $0.6 million in gains on disposal of property and
    equipment; $0.7 million in deferred income tax benefits;
    and other net losses of $0.2 million.
    The net change in operating assets and liabilities from
    continuing operations which consumed cash flow of
    $3.0 million. Cash was applied to increase inventories by
    $2.0 million, and to reduce accounts payable, accrued
    expense and prepaid expense by $0.4 million,
    $0.8 million and $0.3 million respectively. Cash was
    contributed by the collection of $0.5 million income taxes
    receivable and the $0.4 million increase to income taxes
    payable. The net change in other operating assets and
    liabilities used cash totaling $0.3 million. 30




---



##### Table of Contents




    Non-cash charges included in our loss from continuing operations
    of $3.3 million totaled $3.8 million. Our principal
    non-cash expenses were as follows: $2.2 million
    depreciation and amortization; $1.1 million provision for
    doubtful accounts; and $1.3 million stock-based
    compensation and other expenses of $0.2 million. These
    non-cash expenses were partially offset by $0.6 million in
    gains on disposal of property and equipment and
    $0.4 million in deferred income tax benefits.
    The net change in operating assets and liabilities from
    continuing operations which generated cash flow of
    $7.0 million. Cash was primarily provided by the managed
    reduction of $5 million in inventories. Additional cash
    flow was contributed by increases to accounts payable and
    accrued liabilities of $1.4 million, $1.7 million,
    respectively. Cash was applied to reduce accounts payable to
    affiliate by $0.3 million. The net change in other
    operating assets and liabilities used cash totaling
    $0.8 million.    
    Non-cash charges included in our loss from continuing operations
    of $5.7 million totaled $6.1 million. Our principal
    non-cash expenses were as follows: $3.3 million reduction
    in goodwill; $2.4 million depreciation and amortization;
    $1.6 million stock-based compensation; and
    $0.6 million provision for doubtful accounts. These
    non-cash expenses were partially offset by $0.6 million in
    gains on disposal of property and equipment; $1.2 million
    in deferred income tax benefits.
    The net change in operating assets and liabilities from
    continuing operations which generated cash flow of
    $2.0 million. Cash was primarily provided by decline in
    accounts receivable and trade notes receivable of
    $1.3 million and 1.2 million respectively. Other
    operating accounts used net cash of $0.5 million.  Investing
    Activities
        Financing
    Activities
     31




---



##### Table of Contents



Commitments
    and Contingencies
  Summary
    of Obligations
    Less than





3-5


AfterTotal


1 Year


1-3 Years


Years


5 Years(In thousands)Contractual ObligationsAmounts reflected in Consolidated Balance Sheets:Notes payable to related parties(1)

$
278


$
278


$



$



$
Deferred gain on sale of real estate(2)


4,444



635



1,270



1,270



1,269Deferred revenue


1,333



557



605



171



Other long-term liabilities


1,491







20



119



1,352Other cash obligations not reflected in Consolidated Balance
    Sheets:Operating lease obligations(3)


9,153



1,598



2,770



2,435



2,350Open purchase orders(3)(4)


7,212



7,046



166







Total

$
23,911


$
10,114


$
4,831


$
3,995


$
4,971     (1)
    
    For further discussion surrounding notes payable-related
    parties, refer to Note 10. Related Party
    Transactions to the Consolidated Financial Statements.(2)
    
    For further discussion surrounding deferred gain on sale of real
    estate, refer to Note 3. Balance Sheet Details
    to the Consolidated Financial Statements.(3)
    
    For further discussion surrounding purchase and lease
    obligations, refer to Note 7. Commitments and
    Contingencies to the Consolidated Financial statements.(4)
    
    Represents estimated cancelable open purchase orders to purchase
    inventory and other goods and services in the normal course of
    business to meet operational requirements.  Guarantees
   32




---



##### Table of Contents



Product
    Warranties
    Uncertain
    Tax Positions
    Recent
    Accounting Pronouncements
  2009-13, 2009-13) 2009-14, 2009-14). 2009-13 2009-14 2009-13 2009-14
    2010-29, 2010-29
 33




---



##### Table of Contents



2010-28,
  ITEM 7A.
    QUANTITATIVE
    AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK  Concentration
    of Credit Risk
    Interest
    Rate Risk
      Foreign
    Currency Exchange Rate Risk
     34




---



##### Table of Contents



ITEM 8.
    FINANCIAL
    STATEMENTS AND SUPPLEMENTARY DATA  page F-1
  ITEM 9.
    CHANGES
    IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
    FINANCIAL DISCLOSURE    ITEM 9A.
    CONTROLS
    AND PROCEDURES  Evaluation
    of Disclosure Controls and Procedures
    Form 10-K, Rules 13a-15(e) 15d-15(e)
  Managements
    Report on Internal Control over Financial Reporting
  Rules 13a-15(f) 15d-15(f)
    Internal Control 
    Integrated Framework
     35




---



##### Table of Contents



Changes
    in Internal Control Over Financial Reporting
  Rule 13a-15(f)
  Impact of
    2011 Changes to Management and Operational Involvement in RAE
    Fushun
  day-to-day
  ITEM 9B.
    OTHER
    INFORMATION   PART III  ITEM 10.
    DIRECTORS,
    EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE    ITEM 11.
    EXECUTIVE
    COMPENSATION    ITEM 12.
    SECURITY
    OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
    RELATED STOCKHOLDER MATTERS    ITEM 13.
    CERTAIN
    RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
    INDEPENDENCE    ITEM 14.
    PRINCIPAL
    ACCOUNTING FEES AND SERVICES   36




---



##### Table of Contents



PART IV.  ITEM 15.
    EXHIBITS,
    FINANCIAL STATEMENT SCHEDULES  Financial Statements
  Form 10-K.
  Financial Statement Schedules
    Exhibits
   37




---



##### Table of Contents



SIGNATURES      By:
    /s/  Robert
    I. Chen  Robert I. Chen
 President and Chief Executive Officer
  KNOW ALL PERSONS BY THESE PRESENTS Form 10-K,
    Signature

Title

Date/s/  Robert
    I. ChenRobert
    I. Chen

President, Chief Executive Officer and Chairman of the Board
    (Principal Executive Officer)

March 31, 2011/s/  Randall
    GausmanRandall
    Gausman

Vice President and Chief Financial Officer (Principal Financial
    and Accounting Officer)

March 31, 2011/s/  Peter
    C. HsiPeter
    C. Hsi

Chief Technology Officer and Director

March 31, 2011/s/  Lyle
    D. FeiselLyle
    D. Feisel

Director

March 31, 2011/s/  Sigrun
    HjelmqvistSigrun
    Hjelmqvist

Director

March 31, 2011/s/  Keh-Shew
    LuKeh
    Shew Lu

Director

March 31, 2011/s/  James
    W. PowerJames
    W. Power

Director

March 31, 2011/s/  Susan
    WangSusan
    Wang

Director

March 31, 2011  38




---



##### Table of Contents



INDEX TO
    EXHIBITS
  ExhibitNumber

Description of Document3
.1

Certificate of Incorporation of Registrant(1)3
.2

Amended and Restated Bylaws of Registrant(3)4
.1

Specimen certificate representing the common stock of
    Registrant(1)10
.0

Form of Indemnity Agreement between the Registrant and the
    Registrants directors and officers(1)10
.1

RAE Systems Inc. 2007 Equity Incentive Plan(2)10
.2

RAE Systems Inc. 2002 Stock Option Plan(1)10
.3

RAE Systems Inc. 1993 Stock Plan(1)10
.4

Form of Stock Option Agreement under the Registrants 2007
    Equity Incentive Plan(9)10
.5

Lease Agreement by and between Inland American/Stephens (N
    First) Ventures, LLC and RAE Systems Inc., dated December 20,
    2007(9)10
.6

Purchase and Sale Agreement by and between D.R. Stephens &
    Company, LLC and RAE Systems Inc., dated November 9, 2007(9)10
.7

Manufacturing Building Lease Agreement by and between Shanghai
    China Academic Science High Tech Industrial Park Development
    Co., Ltd. and RAE Systems(Asia), Ltd., incorporated in Hong
    Kong, dated September 15, 2001(1)10
.8

Lease Agreement by and between Shanghai Institute of Metallurgy
    Research, Chinese Academy of Sciences and WARAE
    Instrument(Shanghai) Incorporated, incorporated in Jiading,
    Shanghai, dated January 8, 1999(1)10
.9

Form of Share Transfer Agreement by and between RAE-KLH
    shareholders and RAE Systems Asia (Hong Kong) Ltd.(4)10
.10

Separation Agreement and General Release of Claims by and
    between Donald W. Morgan and the Registrant dated August 8,
    2006(5)10
.11

RAE Systems Inc. Management Incentive Plan(6)10
.12

Employment Offer Letter by and between Randall Gausman and the
    Registrant dated October 17, 2006(7)10
.13

Loan and Security Agreement dated as of March 14, 2007 between
    Silicon Valley Bank and the Registrant(8)10
.14

Joint Venture Agreement by and between Liaoning Coal Industry
    Group Co., Ltd. and RAE Systems (Asia), Ltd. dated December 10,
    2006(8)10
.15

Separation Agreement and General Release of Claims by and
    between Rudy Mui and the Registrant dated March 4, 2008(9)10
.16

Form of Indemnity Agreement between RAE Systems Inc. and each of
    its directors and executive officers(10)10
.17

Equity Transfer Contract between RAE Systems (Asia) Limited and
    Shenyang Research Institute of China Coal Research Institute
    dated January 12, 2011(11)10
.18

Settlement Agreement among the Registrant, Shenyang Research
    Institute of China Coal Research Institute, et al.dated
    January 12, 2011(11)10
.19

Amendment No. 9 to Loan and Security Agreement between the
    Registrant and Silicon Valley Bank dated September 1, 2010(11)10
.20

Amendment No. 10 to Loan and Security Agreement between the
    Registrant and Silicon Valley Bank dated January 12, 2011(11)10
.21

Amendment No. 11 to Loan and Security Agreement between the
    Registrant and Silicon Valley Bank dated March 28, 2011(11)10
.22

Final Judgment as to Defendant RAE Systems Inc. (vs. the
    Securities and Exchange Commission) dated December 14, 2010(11)10
.23

Settlement Agreement between the Department of Justice and the
    Registrant dated December 10, 2010(11) 39




---



##### Table of Contents



ExhibitNumber

Description of Document21
.1

Subsidiaries of the Registrant(9)23
.2

Consent of Deloitte & Touche LLP(11)24
.1

Power of Attorney(11) (included on signature page)31
.1

Certifications of Robert I. Chen, President and Chief Executive
    Officer of Registrant, pursuant to Rule 13a-14 adopted under the
    Securities Exchange Act of 1934, as amended, and Section 302 of
    the Sarbanes-Oxley Act of 2002(11)31
.2

Certifications of Randall Gausman, Vice President and Chief
    Financial Officer of Registrant, pursuant to Rule 13a-14 adopted
    under the Securities Exchange Act of 1934, as amended, and
    Section 302 of the Sarbanes-Oxley Act of 2002(11)32
.1

Certification pursuant to 18 U.S.C. Section 1350, as
    adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
    2002(11)32
.2

Certification pursuant to 18 U.S.C. Section 1350, as
    adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
    2002(11)     (1)
    
    Previously filed as an exhibit to the Registrants
    quarterly report on
    Form 10-Q,
    for the quarter ended March 31, 2002 and incorporated
    herein by reference.(2)
    
    Previously filed as an exhibit to the Registrants current
    report on
    Form 8-K
    on June 19, 2007 and incorporated herein by reference.(3)
    
    Previously filed as an exhibit to the Registrants current
    report on
    Form 8-K
    on December 21, 2007 and incorporated herein by reference.(4)
    
    Previously filed on August 8, 2006 as an exhibit to the
    Registrants quarterly report on
    Form 10-Q
    for the quarter ended June 30, 2006 and incorporated herein
    by reference.(5)
    
    Previously filed as an exhibit to the Registrants current
    report on
    Form 8-K
    on August 8, 2006 and incorporated herein by reference.(6)
    
    Previously filed as an exhibit to the Registrants current
    report on
    Form 8-K
    on August 16, 2006 and incorporated herein by reference.(7)
    
    Previously filed as an exhibit to the Registrants current
    report on
    Form 8-K
    on October 18, 2006 and incorporated herein by reference.(8)
    
    Previously filed as an exhibit to the Registrants annual
    report on
    Form 10-K
    for the year ended December 31, 2006 and incorporated
    herein by reference.(9)
    
    Previously filed as an exhibit to the Registrants annual
    report on
    Form 10-K
    for the year ended December 31, 2007 and incorporated
    herein by reference.(10)
    
    Previously filed as an exhibit to the Registrants
    quarterly report on
    Form 10-Q
    for the quarter ended June 30, 2009 and incorporated herein
    by reference.(11)
    
    Filed herewith. 40




---



##### Table of Contents



RAE
    Systems Inc.
  Consolidated
    Financial Statements
 As of
    December 31, 2010 and 2009
  Report of Independent Registered Public
    Accounting Firm


42Consolidated Financial Statements


43Consolidated balance sheets


43Consolidated statements of operations


44Consolidated statements of shareholders
    equity and comprehensive loss


45Consolidated statements of cash flows


46Notes to consolidated financial statements


47  41




---



##### Table of Contents



Report of
    Independent Registered Public Accounting Firm           
    42




---



##### Table of Contents



RAE
    SYSTEMS INC.
  CONSOLIDATED
    BALANCE SHEETS
  December 31,


December 31,2010


2009(In thousands, except share and par value data)ASSETSCurrent assets:Cash and cash equivalents

$
16,296


$
17,153Restricted cash


2,000



2,000Trade notes receivable


2,018



1,527Accounts receivable, net of allowances of $3,539 and $2,675,
    respectively


14,286



14,735Accounts receivable from affiliate


200



322Inventories


11,546



9,308Prepaid expenses and other current assets


4,557



3,339Income taxes receivable


130



659Current assets of discontinued operation


6,093



10,130Total current assets


57,126



59,173Property and equipment, net


10,730



7,582Intangible assets, net


196



544Investments in unconsolidated affiliates


184



358Other assets


393



1,325Noncurrent assets of discontinued operation


3,478



9,892Total assets

$
72,107


$
78,874LIABILITIES AND EQUITYCurrent liabilities:Accounts payable

$
5,475


$
5,725Accounts payable to affiliate


25



92Bank lines of credit


1,814



4,026Accrued liabilities


11,957



11,962Notes payable to related parties, current


278



370Income taxes payable


128



Deferred revenue, current


557



603Current liabilities of discontinued operation


5,790



4,719Total current liabilities


26,024



27,497Deferred revenue, non-current


776



615Deferred tax liabilities, non-current


141



Deferred gain on sale of real estate


3,809



4,444Other long-term liabilities


1,491



761Notes payable to related parties, non-current






363Noncurrent liabilities of discontinued operation


182



1,639Total liabilities


32,423



35,319COMMITMENTS AND CONTINGENCIES (NOTE 7)EQUITY:Common stock, $0.001 par value, 200,000,000 shares
    authorized; 59,512,064 and 59,438,328 shares issued and
    outstanding as of December 31, 2010 and 2009, respectively


59



59Additional paid-in capital


65,041



63,832Accumulated other comprehensive income


7,786



6,844Accumulated deficit


(34,311
)


(31,706
)Total RAE Systems Inc. shareholders equity


38,575



39,029Noncontrolling interest


1,109



4,526Total equity


39,684



43,555Total liabilities and equity

$
72,107


$
78,874    43




---



##### Table of Contents



RAE
    SYSTEMS INC.
   CONSOLIDATED
    STATEMENTS OF OPERATIONS  Year Ended December 31,2010


2009


2008(In thousands, except per share data)Net sales

$
87,053


$
74,993


$
83,045Cost of sales


34,752



35,415



38,898Gross profit


52,301



39,578



44,147Operating expenses:Sales and marketing


19,494



16,354



17,943Research and development


7,077



5,956



5,949General and administrative


19,691



21,149



21,160Impairment of goodwill










3,348Total operating expenses


46,262



43,459



48,400Operating income (loss) from continuing operations


6,039



(3,881
)


(4,253
)Other income (expense):Interest income


66



46



161Interest expense


(185
)


(390
)


(397
)Other, net


(177
)


277



(735
)Equity in (loss) gain of unconsolidated affiliates


(173
)


(109
)


43Income (loss) from continuing operations before income taxes


5,570



(4,057
)


(5,181
)Income tax (expense) benefit


(297
)


800



(538
)Income (loss) from continuing operations


5,273



(3,257
)


(5,719
)Loss from discontinued operations, net of tax


(11,178
)


(3,457
)


(1,653
)Net loss


(5,905
)


(6,714
)


(7,372
)Net (income) loss attributable to the noncontrolling interest,
    continuing operations


(42
)


3



(148
)Net loss attributable to the noncontrolling interest,
    discontinued operations


3,342



952



368Net loss attributable to the noncontrolling interest


3,300



955



220Net loss attributable to RAE Systems Inc.

$
(2,605
)

$
(5,759
)

$
(7,152
)Earnings per common share  basic:Continuing operations

$
0.09


$
(0.06
)

$
(0.10
)Discontinued operations


(0.13
)


(0.04
)


(0.02
)Net loss per common share  basic

$
(0.04
)

$
(0.10
)

$
(0.12
)Earnings per common share  diluted:Continuing operations

$
0.09


$
(0.06
)

$
(0.10
)Discontinued operations


(0.13
)


(0.04
)


(0.02
)Net loss per common share  diluted

$
(0.04
)

$
(0.10
)

$
(0.12
)Weighted average common shares outstanding  basic


59,439



59,367



59,204Dilutive stock options


136







Weighted average common shares outstanding  diluted


59,575



59,367



59,204    44




---



##### Table of Contents



RAE
    SYSTEMS INC.
  CONSOLIDATED
    STATEMENTS OF SHAREHOLDERS EQUITY
 AND
    COMPREHENSIVE LOSS
  AccumulatedAdditional


OtherCommon Stock


Paid-in


Comprehensive


Accumulated


NoncontrollingShares


Amount


Capital


Income


Deficit


Interest


Total(In thousands, except share data)January 1, 2008


59,171,980


$
59


$
60,957


$
4,135


$
(18,795
)

$
5,385


$
51,741Components of comprehensive loss:Net loss


















(7,152
)


(220
)


(7,372
)Foreign currency translation adjustments














2,420







316



2,736Total comprehensive loss


























(4,636
)Exercise of stock options


149,458







43















43Repurchase of restricted common stock


(27,524
)






(44
)














(44
)Stock issued for services


150,000







210















210Stock-based compensation expense










1,383















1,383December 31, 2008


59,443,914



59



62,549



6,555



(25,947
)


5,481



48,697Components of comprehensive loss:Net loss


















(5,759
)


(955
)


(6,714
)Foreign currency translation adjustments














289











289Total comprehensive loss


























(6,425
)Repurchase of restricted common stock


(5,586
)






(7
)














(7
)Stock-based compensation expense










1,290















1,290December 31, 2009


59,438,328



59



63,832



6,844



(31,706
)


4,526



43,555Components of comprehensive loss:Net loss


















(2,605
)


(3,300
)


(5,905
)Foreign currency translation adjustments














942











942Total comprehensive loss


























(4,963
)Dividend paid






















(117
)


(117
)Exercise of stock options


85,822







76















76Repurchase of restricted common stock


(12,086
)






(10
)














(10
)Stock-based compensation expense










1,143















1,143December 31, 2010


59,512,064


$
59


$
65,041


$
7,786


$
(34,311
)

$
1,109


$
39,684    45




---



##### Table of Contents



RAE
    SYSTEMS INC.
  CONSOLIDATED
    STATEMENTS OF CASH FLOWS
  Year Ended December 31,2010


2009


2008(In thousands)CASH FLOWS FROM OPERATING ACTIVITIES:Net loss

$
(5,905
)

$
(6,714
)

$
(7,372
)Loss from discontinued operations


(11,178
)


(3,457
)


(1,653
)Income (loss) from continuing operations


5,273



(3,257
)


(5,719
)Adjustments to reconcile net loss to net cash provided by (used
    in) operating activities:Depreciation and amortization


1,683



2,219



2,381Provision for doubtful accounts


768



1,145



606Gain on disposal of property and equipment


(624
)


(632
)


(586
)Stock-based compensation expense


1,143



1,290



1,593Equity in loss (gain) of unconsolidated affiliates


173



109



(43
)Deferred income tax (benefit) expense


(667
)


(380
)


(1,221
)Amortization of discount on notes payable to related parties


40



85



52Impairment of goodwill










3,348Changes in operating assets and liabilities:Accounts receivable


(239
)


129



1,268Accounts receivable from affiliate


127



(221
)


(77
)Trade notes receivable


(434
)


(314
)


1,157Inventories


(2,048
)


5,018



1,050Prepaid expenses and other current assets


(284
)


95



17Income taxes receivable


529



237



1,167Other assets


192



3



557Accounts payable


(375
)


1,385



(1,357
)Accounts payable to affiliate


(69
)


(290
)


(52
)Accrued liabilities


(822
)


1,715



(1,757
)Income taxes payable


359



(439
)


(287
)Deferred revenue


114



(98
)


314Other liabilities


(6
)


(198
)


(32
)Net cash provided by operating activities of continuing
    operations


4,833



7,601



2,379Net cash (used in) provided by operating activities of
    discontinued operations


(1,057
)


56



799Net cash provided by operating activities


3,776



7,657



3,178CASH FLOWS FROM INVESTING ACTIVITIES:Changes in restricted cash






(2,000
)


Acquisition of property and equipment


(3,192
)


(1,842
)


(896
)Proceeds from sale of net assets


78



73



65Net cash used in investing activities of continuing operations


(3,114
)


(3,769
)


(831
)Net cash used in investing activities of discontinued operations


(307
)


(1,231
)


(2,520
)Net cash used in investing activities


(3,421
)


(5,000
)


(3,351
)CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from the exercise of stock options


76







43Repurchases of common stock


(11
)


(7
)


(44
)Dividends paid


(117
)






Borrowings from bank lines of credit






4,092



4,961Payments on bank lines of credit


(2,248
)


(2,649
)


(5,195
)Payments on payables to related parties


(399
)


(1,880
)


(573
)Net cash used in financing activities of continuing operations


(2,699
)


(444
)


(808
)Net cash provided by (used in) financing activities of
    discontinued operations






1,398



(583
)Net cash (used in) provided by financing activities


(2,699
)


954



(1,391
)Effect of exchange rate changes on cash and cash equivalents


146



72



503(Decrease) increase in cash and cash equivalents


(2,198
)


3,683



(1,061
)Cash and cash equivalents at beginning of year


18,528



14,845



15,906Cash and cash equivalents at end of year


16,330



18,528



14,845Less cash and cash equivalents of discontinued operations at end
    of year


34



1,375



1,149Cash and cash equivalents of continuing operations at end of year

$
16,296


$
17,153


$
13,696Supplemental disclosure of cash flow information:Cash paid for taxes, net

$
(166
)

$
(10
)

$
687Cash paid for interest by continuing operations, net of amounts
    capitalized


281



729



325Cash paid for interest by discontinued operations, net of
    amounts capitalized


122



21



8Non-cash investing and financing activities:Unpaid property and equipment of continuing operations


456



1,264



1,082Unpaid property and equipment of discontinued operations






10



18    46




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
  Note 1.
    Summary
    of Significant Accounting Policies  The
    Company
      Principles
    of Consolidation
    Use of
    Estimates
    Revenue
    Recognition
   47




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  percentage-of-completion
    Cash
    and Cash Equivalents
    Allowance
    for Doubtful Accounts
      Trade
    Notes Receivable
    Concentration
    of Credit Risk
    Inventories
  first-in,
 48




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Property
    and Equipment
    Buildings


20 to 25 yearsEquipment


3 to 10 yearsFurniture and fixtures


3 to 7 yearsComputers and software


3 to 7 yearsAutomobiles


3 to 5 yearsBuilding improvements


Lesser of useful life or remaining lease term   Warranty
    Repairs
    Research
    and Development
    Advertising
    Costs
    Income
    Taxes
       49




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Goodwill
    and Other Intangible Assets
      Long-Lived
    Assets
    Fair
    Values of Financial Instruments
    
    Cash and Cash Equivalents, Accounts Receivable, Trade Notes
    Receivables, Accounts Receivable from Affiliate, Accounts
    Payable, Accrued Expenses, Inventory Purchase Obligations:    
    Notes Payable to Related Parties:    Translation
    of Foreign Currencies
  non-U.S. subsidiaries non-U.S. subsidiaries.
  Stock-Based
    Compensation Expense
   50




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Net
    Earnings Per Share
      Retained
    Earnings
      Variable
    Interest Entities
   51




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    December 31,


December 31,2010


2009(In thousands)Cash and cash equivalents

$
194


$
299Accounts receivable


584



438Inventories


209



198Prepaid expenses and other current assets


119



142Total current assets


1,106



1,077Other non-current assets


40



77Total assets

$
1,146


$
1,154Accounts payable

$
25


$
24Accrued liabilities


339



332Total current liabilities

$
364


$
356     Segment
    Reporting
  Segment Reporting,
  Recent
    Accounting Pronouncements
  2009-13, 2009-13) 2009-14, 2009-14). 2009-13 2009-14 2009-13 2009-14
 52




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    2010-29, 2010-29
  2010-28,
  Note 2.
    Discontinued
    Operation    day-to-day
 53




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      205-20,
  Year Ended December 31,2010


2009


2008(In thousands)Net sales

$
3,845


$
8,180


$
12,340Loss from discontinued operations before income taxes


(11,178
)


(3,541
)


(1,653
)Income tax benefit






84



Loss from discontinued operations


(11,178
)


(3,457
)


(1,653
)Net loss attributable to the noncontrolling interest


3,342



952



368Net loss from discontinued operations attributable to RAE
    Systems Inc.

$
(7,836
)

$
(2,505
)

$
(1,285
)      54




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    December 31,


December 31,2010


2009(In thousands)Cash & cash equivalents

$
34


$
1,375Restricted cash


151



146Trade notes receivable


106



512Accounts receivable, net of allowances of $3,591 and $2,705,
    respectively


2,533



4,693Inventories


2,551



2,760Prepaid expenses and other current assets


718



644Total current assets


6,093



10,130Property and equipment, net


3,478



8,008Intangible assets, net






1,884Total assets

$
9,571


$
20,022Accounts payable

$
1,122


$
729Bank line of credit


1,512



Accrued liabilities


3,156



3,990Total current liabilities


5,790



4,719Other long-term liabilities


182



176Long-term debt






1,463Total liabilities

$
5,972


$
6,358     Note 3.
    Balance
    Sheet Details  Allowance
    for Doubtful Accounts:
    Year Ended December 31,2010


2009


2008(In thousands)Allowance for doubtful accounts at beginning of year

$
2,675


$
1,532


$
871Charges to expense


816



1,405



590Write-offs of uncollectible accounts, net of recoveries


(48
)


(260
)


16Foreign currency translation effects


96



(2
)


55Allowance for doubtful accounts at end of year

$
3,539


$
2,675


$
1,532  55




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Inventories:
    December 31,


December 31,2010


2009(In thousands)Raw materials

$
6,770


$
5,467Work-in-progress


2,396



1,920Finished goods


2,380



1,921Total inventories

$
11,546


$
9,308     Prepaid
    Expenses and Other Current Assets:
    December 31,


December 31,2010


2009(In thousands)Supplier advances and deposits

$
971


$
1,210Amounts receivable from employees


368



41Prepaid insurance


269



275Deferred tax assets, current


1,595



757Other current assets


1,354



1,056Total prepaid expenses and other current assets

$
4,557


$
3,339   Property
    and Equipment, net:
    December 31,


December 31,2010


2009(In thousands)Buildings and improvements

$
6,404


$
6,197Equipment


4,489



4,346Computer equipment


5,003



4,780Automobiles


488



1,044Furniture and fixtures


408



411Construction in progress


5,478



1,60122,270



18,379Less: Accumulated depreciation


(11,540
)


(10,797
)Total property and equipment, net

$
10,730


$
7,582  56




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        Accrued
    Liabilities:
    December 31,


December 31,2010


2009(In thousands)Compensation and related benefits

$
4,249


$
3,345Accrued commissions


938



484Accrued FCPA settlement (see Note 7)


1,700



3,500Customer deposits


730



572Accrued professional fees


1,014



422Other


3,326



3,639Total accrued liabilities

$
11,957


$
11,962    57




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 4.
    Goodwill
    and Intangible Assets    (In thousands)Balance as of January 1, 2008

$
3,143Currency translation adjustment


205Impairment charges


(3,348
)Balance as of December 31, 2008

$
           December 31, 2010


December 31, 2009Gross





Net


Gross





NetCarrying


Accumulated


Carrying


Carrying


Accumulated


CarryingAmount


Amortization


Amount


Amount


Amortization


Amount(In thousands)Customer list

$
1,730


$
(1,693
)

$
37


$
1,677


$
(1,481
)

$
196Trade name


1,402



(1,243
)


159



1,356



(1,008
)


348Total intangible assets, net

$
3,132


$
(2,936
)

$
196


$
3,033


$
(2,489
)

$
544    58




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Years EndedDecember 31,2011

$
1422012


362013


18Total amortization

$
196   Note 5.
    Income
    Taxes    Year Ended December 31,2010


2009


2008(In thousands)United States

$
1,689


$
(4,526
)

$
(4,934
)Foreign


3,881



469



(247
)Income (loss) from continuing operations before income taxes

$
5,570


$
(4,057
)

$
(5,181
)     Year Ended December 31,2010


2009


2008(In thousands)Current:Federal

$
829


$
(1,072
)

$
(91
)State


(25
)


23



18Foreign


91



545



1,832895



(504
)


1,759Deferred:Federal










State










(48
)Foreign


(598
)


(380
)


(1,173
)(598
)


(380
)


(1,221
)Total income tax expense (benefit)

$
297


$
(884
)

$
538Continuing operations

$
297


$
(800
)

$
538Discontinued operations






(84
)


Total income tax expense (benefit)

$
297


$
(884
)

$
538    59




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Year Ended December 31,2010


2009


2008(In thousands)Federal income tax expense (benefit) at statutory rate

$
1,894


$
(1,380
)

$
(1,762
)State income tax expense, net of federal benefit


13



13



18Foreign tax expense (benefit)


(1,828
)


(794
)


551Nondeductible expenses


60



1,281



90Subpart F










320Contingencies released


(186
)


(799
)


Net operating loss carryback






65



Other


374



870



363Change in valuation allowance


(30
)


(56
)


958Total income tax expense (benefit)

$
297


$
(800
)

$
538     December 31,


December 31,2010


2009(In thousands)Deferred tax assets:Fixed assets

$



$
90Other temporary differences


517



477Other accruals


2,975



3,380Capitalized research and development


11



76Unrealized foreign losses & temporary differences


3,037



2,721Federal and state tax credits


553



611Stock-based compensation


2,557



2,208Valuation allowance


(8,064
)


(8,552
)Total deferred tax assets


1,586



1,011Deferred tax liabilities:Fixed assets


(19
)


Intangibles


(47
)


(88
)Total deferred tax liabilities


(66
)


(88
)Net deferred tax assets

$
1,520


$
923     non-U.S. subsidiaries. non-U.S. subsidiaries
 60




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    2010-2011
           61




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      (In thousands)Balance at January 1, 2008

$
1,193Positions taken related to prior years


Positions taken during the current year


(64
)Reduction to UTB due to settlement with tax authories


(12
)Balance at December 31, 2008


1,117Positions taken related to prior years


Positions taken during the current year


(6
)Reduction to UTB due to settlement with tax authories


102Balance at December 31, 2009


1,213Positions taken related to prior years


Positions taken during the current year


26Reduction to UTB due to settlement with tax authories


(200
)Balance at December 31, 2010

$
1,039     non-U.S. income
    United States  Federal


2003 - presentUnited States  State


2005 - presentChina


2006 - presentHong Kong


2005 - presentDenmark


2008 - present   Note 6.
    Bank
    Debt     62




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
          Note 7.
    Commitments
    and Contingencies  Legal
    Proceedings
  Regulatory
    Compliance
    Legal
    Proceedings
  Polimaster Ltd. et al. v. RAE Systems Inc., United
    States District Court for the Northern District of California,
    Case
    No. 05-CV-01887-JF,
    United States Court of Appeals for the Ninth Circuit, Nos.
    08-15708 and
    09-15369
 63




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  No. 05-CV-01887-JF).
  No. 08-15708.
  No. 09-15369,
  08-15708 09-15369). i.e
  Shareholder
    Lawsuits
  The California State Court Actions:
  Foley v. RAE Systems Inc., et al.
 64




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Angles v. RAE Systems Inc., et
    al. Greenbaum v. Chen , et
    al. AC Photonics, Inc. v. RAE
    Systems Inc., et al. Mann v. RAE Systems Inc., et al. In re RAE Systems, Inc. Shareholder Litigation
  The Delaware Chancery Court Actions:
  Nelson v. RAE Systems Inc., et al. No. 5848-VCS; Venton v. RAE Systems Inc., et al. No. 5854-VCS; Quintanilla v. RAE Systems Inc., et al. Villeneuve v. RAE Systems Inc., et al. In re RAE Systems, Inc.
    Shareholder Litigation No. 5848-VCS,
   65




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    The Federal Court Actions:
  and/or LaPlante v. RAE Systems
    Inc., et al. Mabry v. Chen,
    et al. 10-5328. LaPlante Mabry
    Leases
  (in thousands)
  Years Ended December 31,2011

$
1,5982012


1,3952013


1,3752014


1,2962015


1,139Thereafter


2,350Total minimum lease payments

$
9,153    66




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Purchase
    obligations
      Guarantees
      Product
    Warranties
    Year Ended December 31,2010

2009

2008(In thousands)Balance at beginning of year

$
695


$
599


$
653Provision for warranty


1,039



951



795Utilization of reserve


(757
)


(857
)


(855
)Foreign currency translation effects


(1
)


2



6Balance at end of year

$
976


$
695


$
599   Note 8.
    Employee
    Benefit Plan   67




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Note 9.
    Stock-Based
    Compensation  Stock
    Option Plans
          in
    thousands, except weighted-average amounts
  Options OutstandingNumber


Weighted-Averageof Shares


Exercise PriceBalance as of January 1, 2008


3,723


$
3.05Granted


1,299



1.51Exercised


(149
)


0.29Canceled


(680
)


3.83Balance as of December 31, 2008


4,193



2.55Granted


1,870



1.03Exercised






Canceled


(670
)


2.96Balance as of December 31, 2009


5,393



1.97Granted


135



0.78Exercised


(92
)


0.90Canceled


(170
)


1.21Balance as of December 31, 2010


5,266



1.99  68




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Options Outstanding


Options ExercisableWeighted











WeightedAverage











AverageNumber


Remaining


Weighted


Aggregate


Number


Remaining


Weighted


Aggregateof


Contractual Life


Average


Intrinsic


of


Contractual Life


Average


IntrinsicRange of Exercise Prices

Shares


(in years)


Exercise Price


Value (000)


Shares


(in years)


Exercise Price


Value (000)$0.00 - 0.50


90,666



0.77


$
0.08


$
139



90,666






$
0.08


$
1390.51 - 1.00


1,278,771



8.17



0.94



857



506,467







0.93



3441.01 - 1.50


1,865,593



5.27



1.27



621



1,194,540







1.26



4161.51 - 2.00


200,000



7.28



1.87







133,333







1.87



2.01 - 2.50


259,167



6.65



2.26







212,552







2.26



2.51 - 3.00


430,000



6.23



2.88







397,081







2.88



3.01 - 3.50


220,824



3.71



3.18







220,824







3.18



3.51 - 4.00


573,500



5.54



3.79







573,500







3.794.01 - 5.00


152,500



3.38



4.81







152,500







4.815.01 - 6.50


195,000



3.32



5.44







195,000







5.44



5,266,021



5.96



1.99


$
1,617



3,676,463



5.42



2.32


$
899   in-the-money
    Non-Plan
    Stock Options
   69




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Options Outstanding

Options ExercisableWeightedWeighted Average







AverageRemaining

Weighted

Aggregate



Remaining

Weighted

AggregateContractual

Average

Intrinsic

Number

Contractual

Average

IntrinsicRange of

Number

Life

Exercise

Value

of

Life

Exercise

ValueExercise Prices

of Shares

(in years)

Price

(000)

Shares

(in years)

Price

(000)$
1.06



100,000



1.41


$
1.06


$
55



100,000



1.41


$
1.06


$
55   Non-Plan
    Restricted Stock
      in thousands, except per share amounts
  Restricted Stock AwardsWeighted-AverageNumber


Grant-Dateof Shares


Fair ValueBalance as of January 1, 2008


182


$
2.81Granted






Vested


(73
)


2.81Forfeited






Balance as of December 31, 2008


109



2.81Granted






Vested


(62
)


2.81Forfeited






Balance as of December 31, 2009


47



2.81Granted






Vested


(47
)


2.81Forfeited






Balance as of December 31, 2010






   Stock-Based
    Compensation Expense
   70




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Year Ended December 31,2010


2009


2008(In thousands)Cost of sales

$
92


$
80


$
66Sales and marketing


132



(43
)


61Research and development


126



143



348General and administrative


793



1,110



1,118Total

$
1,143


$
1,290


$
1,593     Valuation
    Assumptions
    Year Ended December 31,2010

2009

2008Expected volatility


110
%


85
%


60-65
%Expected dividend yield


0.0
%


0.0
%


0.0
%Risk-free interest rate


1.9-2.8
%


2.0-3.0
%


2.7-3.6
%Expected term in years


6.0



6.0



5.5-6.0Weighted-average grant date fair value

$
0.65


$
0.73


$
0.89   Expected Volatility
  Expected Dividend
  Risk-Free Interest Rate
  Expected Term
  Estimated Forfeitures trued-up
 71




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 10.
    Related
    Party Transactions            Year Ended December 31,




December 31,


December 31,2010


2009


2008




2010


2009(In thousands)Sales:













Accounts receivable:Renex

$
345


$
509


$
282


Renex

$
200


$
322RAE Australia


1,116



714






RAE Australia


131



59RAE Benelux


2,730



2,698



2,287


RAE Benelux


268



253RAE Spain


361



429



604


RAE Spain


123



119$
4,552


$
4,350


$
3,173




$
722


$
753Purchases:













Accounts payable:Renex

$
314


$
256


$
677


Renex

$
25


$
92    72




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 11.
    Fair
    Value Measurements            Level 1:
  Level 2:
  Level 3:
  Note 12.
    Geographic
    Information    Year Ended December 31,2010


%


2009


%


2008


%(In thousands)Net sales:Americas

$
47,351



54


$
34,935



47


$
38,467



46Asia


24,279



28



25,570



34



29,084



35Europe


15,423



18



14,488



19



15,494



19Total net sales

$
87,053



100


$
74,993



100


$
83,045



100   December 31,2010


%


2009


%


2008


%(In thousands)Property and equipment, net:Americas

$
333



3


$
317



4


$
533



6Asia


10,298



96



7,095



94



8,072



92Europe


99



1



170



2



214



2Total property and equipment, net

$
10,730



100


$
7,582



100


$
8,819



100      73




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Note 13.
    Subsequent
    Event    Note 14.
    Quarterly
    Information  (Unaudited)    First


Second


Third


FourthQuarter


Quarter


Quarter


Quarter


2010(In thousands, except per share data)Net sales

$
16,855


$
22,459


$
24,398


$
23,341


$
87,053Gross profit


9,496



13,698



14,903



14,204



52,301Operating (loss) income from continuing Operations


(81
)


2,717



2,463



940



6,039(Loss) income from continuing Operations


(213
)


2,517



1,054



1,915



5,273Loss from discontinued Operations, net of tax


(194
)


(735
)


(2,918
)


(7,331
)


(11,178
)Net (loss) income attributable to RAE Systems Inc.


(364
)


1,973



(1,477
)


(2,737
)


(2,605
)Basic net income (loss) per common share:Continuing Operations

$
(0.01
)

$
0.05


$
0.01


$
0.04


$
0.09Discontinued Operations






(0.01
)


(0.04
)

$
(0.08
)

$
(0.13
)Basic net income (loss) per common share

$
(0.01
)

$
0.04


$
(0.03
)

$
(0.04
)

$
(0.04
)Diluted net income (loss) per common share:Continuing Operations

$
(0.01
)

$
0.05


$
0.01


$
0.04


$
0.09Discontinued Operations






(0.01
)


(0.04
)


(0.08
)


(0.13
)Diluted net income (loss) per common share

$
(0.01
)

$
0.04


$
(0.03
)

$
(0.04
)

$
(0.04
)   74




---



##### Table of Contents



RAE
    SYSTEMS INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  First


Second


Third


FourthQuarter


Quarter


Quarter


Quarter


2009Net sales

$
17,345


$
18,329


$
18,181


$
21,138


$
74,993Gross profit


9,213



9,310



9,917



11,138



39,578Operating (loss) income from continuing Operations


(16
)


(1,107
)


(3,196
)


438



(3,881
)(Loss) income from continuing Operations


(201
)


(1,517
)


(3,008
)


1,469



(3,257
)Loss from discontinued Operations, net of tax


(1,082
)


(1,036
)


(656
)


(683
)


(3,457
)Net (loss) income attributable to RAE Systems Inc.


(988
)


(2,250
)


(3,489
)


968



(5,759
)Basic net income (loss) per common share:Continuing Operations

$
(0.01
)

$
(0.02
)

$
(0.05
)

$
0.02


$
(0.06
)Discontinued Operations


(0.01
)


(0.01
)


(0.01
)


(0.01
)


(0.04
)Basic net loss per common share

$
(0.02
)

$
(0.03
)

$
(0.06
)

$
0.01


$
(0.10
)Diluted net income (loss) per common share:Continuing Operations

$
(0.01
)

$
(0.02
)

$
(0.05
)

$
0.02


$
(0.06
)Discontinued Operations


(0.01
)


(0.01
)


(0.01
)


(0.01
)


(0.04
)Diluted net loss per common share

$
(0.02
)

$
(0.03
)

$
(0.06
)

$
0.01


$
(0.10
)  75