SECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549

FORM 10-Q

(MARK ONE)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
FOR THE PERIOD FROM ____________ TO _____________

COMMISSION FILE NUMBER: 000-26109
------------------------------------

RAE Systems Inc.
(Exact name of registrant as specified in its charter)

- ------------------------------------ ---------------------------------
Delaware 77-0588488
- ------------------------------------ ---------------------------------
- ------------------------------------ ---------------------------------
(State or other jurisdiction (I.R.S. Employer
- ------------------------------------ ---------------------------------
- ------------------------------------ ---------------------------------
of incorporation) Identification No.)
- ------------------------------------ ---------------------------------

1339 Moffett Park Drive
Sunnyvale, California 94089
408-752-0723
(Address of registrant's principal executive offices)
--------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the registrant was
required to file such reports, and (2) has been subject to filing requirements
for the past 90 days.
YES [X] NO [ ]

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.

- ------------------------------------------------------------------------------
Class Outstanding at June 30, 2002
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
Common Stock, $0.001 Par Value 44,933,023
- ------------------------------------------------------------------------------

RAE Systems Inc.

INDEX

Part I. Financial Information

Item 1. Financial Statements (Unaudited)

(a) RAE Systems Inc. Condensed Consolidated Balance Sheets at June 30, 2002
and December 31, 2001

(b) RAE Systems, Inc. Condensed Consolidated Statements of Operations for
the three-month and six-month periods ended June 30, 2002 and 2001

(c) RAE Systems Inc. Condensed Consolidated Statements of Cash Flows for
the six-month periods ended June 30, 2002 and June 30, 2001

(d) RAE Systems Inc. Condensed Consolidated Statement of Shareholders'
Equity

(e) RAE Systems Inc. Notes to Condensed Consolidated Financial Statements

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Part II. Other Information

Item 1. Legal Proceedings

Item 4. Submission of Matters to a Vote of Securities Holders

Item 6. Exhibits and Reports on Form 8-K

Signature

Exhibit Index

Exhibits

PART I. Financial Information

The financial statements herein reflect $9.6 million in non-cash merger and
variable accounting charges for the first half of 2002. These charges have
significantly impacted the General and Administrative Expenses, Merger Costs,
Net Loss, and Loss per Share in the Consolidated Statements of Operations, and
the Additional Paid-In-Capital and Retained Earnings in the Consolidated Balance
Sheet.

Item 1: RAE Systems Inc. Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets

June 30, 2002 December 31, 2001
(Unaudited)

Assets
Current Assets:

Cash and cash equivalents 7,311,800 3,742,600
Restricted cash - 3,000,000
Accounts receivable, net of allowance for doubtful accounts
of $175,000 and $200,000, respectively 2,453,800 2,398,100
Inventories 3,183,000 3,715,800
Prepaid expenses and other current assets 342,000 267,100
Deferred income taxes 500,800 500,800

Total Current Assets 13,791,400 13,624,400

Property and Equipment, net 1,835,500 1,202,300

Deposits and Other Assets 300,900 216,500

15,927,800 15,043,200

Liabilities, Convertible Redeemable Preferred Stock, and Shareholders Equity

Current Liabilities:
Note payable and lines of credit - 4,425,800
Accounts payable 793,000 842,200
Accrued expenses 1,165,000 1,234,800
Income taxes payable 1,459,200 1,670,200
Current portion of deferred revenue 271,200 248,900
Current portion of capital lease obligations 205,800 96,600

Total Current Liabilities 3,894,200 8,518,500

Deferred Revenue, net of current portion 33,100 149,900
Capital Leases Obligations, net of current portion 206,900 51,300
Deferred Income Taxes 443,100 443,100
Minority Interest in Consolidated Subsidiary 1,006,000 1,141,900

Total Liabilities 5,583,300 10,304,700

Commitments and Contingencies

Convertible Redeemable Preferred Stock:
Series A, $0.01 par value; 700,000 shares authorized; 0 and 700,000 issued,
and outstanding, respectively, $.40 per share redemption value - 300,000
Series B, $0.01 par value; 1,000,000 shares authorized; 0 and 1,000,000 issued,
and outstanding, respectively, $1.00 per share redemption value - 1,000,000

- 1,300,000

Shareholders Equity
Common stock, $0.001 par value; 200,000,000 shares authorized;
44,933,023 and 25,542,482 shares issued and ourstanding, respectively 44,900 25,500
Additional paid-in capital 17,912,400 1,301,000
Deferred compensation (246,400) (717,800)
(Accumulated deficit) Retained Earnings (7,366,400) 2,829,800

Total Shareholders Equity 10,344,500 3,438,500

15,927,800 15,043,200

(See accompanying notes to condensed consolidated financial statements)

Condensed Consolidated Statements of Operations

Three months ended June 30, Six months ended June 30,
2002 2001 2002 2001
(Unaudited) (Unaudited) (Unaudited) (Unaudited)

Net Sales 5,167,300 4,552,300 9,712,600 9,079,300

Cost of Sales 2,151,400 1,634,900 4,176,200 3,471,400

Gross Margin 3,015,900 2,917,400 5,536,400 5,607,900

Operating Expenses:
Sales and marketing 1,466,300 1,256,600 2,539,600 2,312,400
Research and development 738,400 736,300 1,464,300 1,480,600
General and administrative 1,951,400 762,700 2,796,600 1,521,600
Legal fees and settlement costs 166,100 92,400 244,000 229,100
Merger costs 8,734,700 - 8,734,700 -

Total Operating Expenses 13,056,900 2,848,000 15,779,200 5,543,700

Operating (Loss) Income (10,041,000) 69,400 (10,242,800) 64,200

Other Income (Expense):
Interest income 19,000 29,200 34,500 68,600
Interest expense (40,600) (58,200) (100,100) (118,600)
Other, net (13,500) (2,500) (15,900) (6,900)
Minority interest in loss of consolidated subsidiary 66,700 83,600 135,900 162,300

(Loss) Income Before Income Taxes (10,009,400) 121,500 (10,188,400) 169,600

Income Taxes 7,800 34,400 7,800 48,000

Net (Loss) Income (10,017,200) 87,100 (10,196,200) 121,600

Basic (Loss) Earnings Per Common Share (0.23) 0.00 (0.30) 0.01

Diluted (Loss) Earnings Per Common Share (0.23) 0.00 (0.30) 0.00

Weighted-average common shares outstanding 43,228,593 24,006,707 34,435,323 23,821,719
Convertible preferred stock - 10,531,092 - 10,531,092
Stock options - 2,375,207 - 2,044,756

Diluted weighted-average common shares outstanding 43,228,593 36,913,006 34,435,323 36,397,567

(See accompanying notes to condensed consolidated financial statements)

Condensed Consolidated Statements of Cash Flows

2002 2001
(Unaudited) (Unaudited)

Increase (Decrease) in Cash and Cash Equivalents

Cash Flows From Operating Activities:

Net (Loss) Income (10,196,200) 121,600

Adjustments to reconcile net income to net cash (used in) provided by operating activities
Depreciation and amortization 276,600 295,800

Provision for doubtful accounts (24,300) 165,900

Compensation expense under variable accounting of common stock options 862,800 148,700

Minority interest in loss of consolidated subsidiary (135,900) (162,300)

Common stock issuance for services 2,121,600 -

Common stock purchase rights granted below fair value 2,308,300 -

Common stock warrant granted for services 4,305,800 -

Changes in operating assets and liabilities:
Accounts receivable (31,400) 21,500
Inventories 532,800 (869,300)
Prepaid expenses and other current assets (74,900) 93,400
Accounts payable (49,200) 75,800
Accrued expenses (69,800) (693,700)
Income taxes payable (211,000) (33,800)
Deferred revenue (94,500) (97,200)

Net Cash Used in Operating Activities (479,300) (933,600)

Cash Flows From Investing Activities:
Restricted cash 3,000,000 -

Acquisition of property and equipment (580,000) (159,900)

Deposits and merger costs (846,400) (36,400)

Net Cash Provided By (Used In) Investing Activities 1,573,600 (196,300)

Cash Flows From Financing Activities:
Proceeds from the sale of common stock 200 50,100

Proceeds from merger/reorganization 6,965,500 -

Payment on capital lease obligation (65,000) (39,400)

Payments on notes payable and lines of credit (4,425,800) 837,500

Net Cash Provided By Financing Activities
2,474,900 848,200

Net Increase (Decrease) in Cash and Cash Equivalents 3,569,200 (281,700)

Cash and Cash Equivalents, beginning of period 3,742,600 3,004,100

Cash and Cash Equivalents, end of period 7,311,800 2,722,400

Supplemental Disclosure of Cash Flow Information:
Cash Paid:
Income taxes 218,800 112,900

Interest 100,100 158,300

Noncash Inventory and Financing Activities:
Capital leases entered into for equipment 329,800 8,800

(See accompanying notes to condensed consolidated financial statements)

Condensed Consolidated Statements of Shareholders' Equity

Additional Retained Earnings
Common Stock Paid-in Deferred (Accumulated
Shares Amount Capital Compensation Deficit) Total

Balances, December 31, 2001 25,542,482 25,500 1,301,000 (717,800) 2,829,800 3,438,500

(the following information is unaudited)

Common stock issuance due to exercise
of option 2,614 - 200 - - 200
Conversion of preferred stock 10,531,092 10,500 1,289,500 - - 1,300,000
Common stock issued in connection with
reorganization, net of offering cost $762,000 7,896,835 7,900 6,195,600 - - 6,203,500
Common stock issued for services 960,000 1,000 2,120,600 - - 2,121,600
Common stock purchase rights granted below fair
value for services - - 2,308,300 - - 2,308,300
Common stock warrant granted for services - - 4,305,800 - - 4,305,800
Common stock option granted for services - - 16,400 (16,400) - -
Compensation expense under variable accounting
of common stock options - - 375,000 487,800 - 862,800
Net Loss - - - - (10,196,200)(10,196,200)

Balances, June 30, 2002 (Unaudited) 44,933,023 44,900 17,912,400 (246,400) (7,366,400) 10,344,500

(See accompanying notes to condensed consolidated financial statements)

Notes to Condensed Consolidated Financial Statements
(Unaudited)

Note 1 - The Company

RAE Systems Inc. ("RAE") is a smart sensing network platform and solution
provider and a leading manufacturer of single and multiple sensor atmospheric
monitors, photo-ionization detectors, gas detection tubes, sampling pumps and
wirelessly connected gas detection and security monitoring devices. RAE's
products and services are designed to enable its customers to monitor gas and
other volatile organic compounds in confined spaces, and to establish a
perimeter security around hazardous material sites and sites of weapons of mass
destruction. RAE's customers operate in such industries as safety and security,
oil and gas, pharmaceuticals, utilities, food, chemical, airlines, military and
hazardous material storage and disposal, and its monitors are used in civilian
and government atmospheric monitoring programs in over 50 countries. RAE's
headquarters are located in Sunnyvale, California. RAE has several manufacturing
sites in Jiading, Shanghai, where it manufactures approximately 25% of its
components and products, and a sales office in Hong Kong, China.

On April 9, 2002, the merger between RAE Systems Inc. and Nettaxi.com was
consummated. Nettaxi was reincorporated under the laws of the state of Delaware,
and the name was changed to RAE Systems Inc. Although the former Nettaxi was the
surviving corporation in the merger transaction, the stockholders and management
of the former RAE acquired control of Nettaxi at the effective time of the
merger. The merger transaction has been treated as a reverse merger for
accounting purposes, whereby RAE is deemed to be the acquirer and Nettaxi is
deemed to be the acquired entity.

RAE generates revenue from the sale of its gas monitoring devices and smart
sensing platform and solutions, as well as through the service and repair of its
equipment. RAE sells its products through a network of approximately 140
distributors, which account for approximately 90% of its sales. RAE's customer
base is varied, spanning a variety of industries, including government,
airlines, oil, industrial, aerospace, chemical and shipping. In the quarter
ended June 30, 2002, approximately 73% of RAE's sales were made to customers in
North America, with the remaining 27% to customers in Europe, Asia and other
countries around the world.

While RAE continues to strengthen its presence in the portable gas
monitoring business, RAE is currently redirecting the company's focus to take
advantage of its smart sensing platform and solutions business, in which
information from the gas detector is transmitted on a real-time basis to a base
controller located up to two miles away. RAE launched several marketing
campaigns geared towards the sale of this technology, and is currently building
its infrastructure to support the emerging opportunities in this area. RAE hired
key individuals in the area of sales and marketing to focus on the smart sensing
platform and solutions business and its application in the weapons of mass
destruction (WMD) market, and research and development, specifically for the
design and development of network technology.

In connection with becoming a public company through a reverse merger
transaction, certain options granted under the 1993 Stock Plan of RAE Systems
Inc., a California corporation ("RAE California"), are subject to variable
accounting in accordance with FASB Interpretation No. 44 "Accounting for Certain
Transactions involving Stock Compensation" (FIN 44). As of June 30, 2002, there
were 2,658,353 options that were outstanding under the Plan that are subject to
variable accounting. During the six months ended June 30, 2002, we recorded
non-cash compensation charges relating to our common stock options of $862,800.

In December 2001, as described in detail in the Company's proxy statement
filed with the Securities and Exchange Commission on March 15, 2002, the Form
10-Q filed May 14, 2002, Form S-1 filed May 31, 2002, and prospectus filed June
24, 2002, the Company 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 using an exchange ratio
of 1.54869 to 1,084,083 shares. Based on the intrinsic or fair value of the
respective equity instruments as of April 9, 2002, the effective date of the
Merger, the company recorded a non-cash compensation charge of $2.3 million.
Additionally, in connection with the closing of the merger, we recorded a $2.1
million non-cash compensation charge for the 960,000 shares of stock that was
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.

As discussed elsewhere in this report on Form 10-Q, RAE is currently
involved in various legal proceedings. RAE expects to incur substantial legal
fees and expenses in connection with these lawsuits, and, regardless of the
eventual outcome, such litigation will likely be costly and time consuming, and
may result in the diversion of our internal resources. Each lawsuit is in a
preliminary stage, therefore the eventual outcome of each is difficult to
determine. Any adverse result in either of the lawsuits could materially affect
RAE's results of operations and financial position.

Note 2 - Summary of Significant Accounting Policies

Management believes the following critical accounting policies affect its more
significant estimates and assumptions used in the preparation of the condensed
consolidated financial statements contained in this Form 10-Q.

Basis of Presentation

The financial information presented in this Form 10-Q is not audited and is not
necessarily indicative of our future consolidated financial position, results of
operations or cash flows. The unaudited financial statements contained in this
Form 10-Q have been prepared on the same basis as the annual financial
statements and, in the opinion of management, reflect all adjustments, which
include only normal recurring adjustments, necessary to present fairly the
Company's financial position, results of operations and its cash flows for the
stated periods, in conformity with accounting principles generally accepted in
the United States of America.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of RAE
Systems Inc. and its subsidiaries as described below. RAE owns 100% of RAE
Systems (Asia) Limited ("RAE Asia"). RAE Asia is a Hong Kong corporation which
distributes RAE's products in Asia and the Pacific Rim. RAE Asia owns (i) 100%
of Wa-RAE Science Instruments, Ltd ("Wa-RAE") and (ii) 47% of REnex Technology
Ltd (REnex). Wa-RAE, which is incorporated in Jiading, Shanghai designs and
manufactures RAE's products for final assembly in the United States. RAE
recently formed a subsidiary in Beijing, China, TangRAE, a sales and
distribution company which is owned 100% by Wa-RAE.

REnex, a Hong Kong based research and development corporation, designs and
develops a wireless platform for detection and monitoring. RAE exercises
managerial control over the day-to-day operations of REnex and holds
approximately 90% of the voting shares. Accordingly, REnex has been consolidated
in the accompanying financial statements. As of June 30, 2002, REnex was in the
process of completing a $3 million private placement of its capital stock and,
in connection therewith, had received a $500,000 deposit from one of its
minority shareholders and $500,000 from RAE Asia. The amount is included in
minority interest in consolidated subsidiary in the consolidated balance sheet
as of June 30, 2002. On July 12, 2002, subsequent to the quarter ending June 30,
2002, REnex received an additional $2 million from another one of its minority
shareholders, thus completing the $3 million private placement. Based on the
terms of the contract, RAE Asia will own approximately 36% of REnex Technology
Ltd, and will hold a similar percent of the voting shares prospectively. The $2
million investment in REnex is not included in the consolidated balance sheet in
this 10-Q.

All intercompany accounts and transactions have been eliminated in the
consolidated financial statements.

The Use of Estimates

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. Actual results could differ from those estimates.

Revenue Recognition

The Company recognizes sales upon shipment, at which time title is transferred
to the customer, provided no significant obligations remain and collection is
probable. A provision for estimated product returns is established at the time
of sale based upon historical return rates adjusted for current economic
conditions. The Company has historically experienced an insignificant amount or
returns. Service revenues relating to maintenance services performed by the
Company, which represent less than 5% of net revenues are recognized as earned
based upon contract terms, which is generally ratable over the term of service.
Net sales includes amounts billed to customers in sales transactions for
shipping and handling, as prescribed by the Emerging Issues Task Force Issue No.
00-10 Accounting for Shipping and Handling Fees and Costs. Shipping fees
represent approximately 2.3% of net revenues.

Stock Based Compensation

In connection with becoming a public company through a reverse merger
transaction, certain options granted under the former RAE California 1993 Stock
Option plan are subject to variable accounting in accordance with FIN 44. The
company could be subject to variable accounting for the next 10 years, the life
of the options.

Warranty Reserve

The company generally provides a one to three year limited liability on its
products and establishes the estimated costs of fulfilling these warranty
obligations at the time the related revenue is recorded. Historically, warranty
costs have been insignificant.

Inventory

Inventories are stated at the lower of cost (moving weighted average method) or
market.

Property Plant and Equipment

Property and equipment are stated at cost net of accumulated depreciation.
Depreciation is provided using the straight-line method over the related
estimated useful lives, as follows:

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

Equipment 5 to 7 years
Furniture and fixtures 5 to 7 years
Computer equipment 5 years
Automobiles 5 years
Building improvements Lesser of 5 years or the remaining lease term
----------------------------------------------------------------------

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 141, "Business Combinations"
("FAS 141") and Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets" ("FAS 142"). FAS 141 requires the purchase method
of accounting for business combinations and prohibits the use of the
pooling-of-interests method. FAS 141 also prescribes new rules for the
measurement and carrying of values of intangible assets. FAS 142 mandates that
goodwill should no longer be amortized, but instead tested for impairment at
least annually. Other intangible assets with indefinite useful lives also should
not be amortized, but tested for impairment. FAS 141 applies to all business
combinations initiated after June 30, 2001, and FAS 142 applies to all fiscal
years beginning after December 15, 2001. The adoption of FAS 141 and FAS 142 did
not have a material impact on the Company's financial statements.

In August 2001, the FASB issued Statement of Financial Accounting Standards No.
143, "Accounting for Obligations Associated with the Retirement of Long-Lived
Assets" (FAS 143). FAS 143 requires that the cost of asset retirement should be
included as part of the overall cost of an asset and that this cost should be
recognized as a liability. The asset retirement liability should be amortized
over time as interest expense. FAS 143 will be effective for fiscal years
beginning after June 15, 2002. Management expects that the implementation of FAS
143 will have no material effect on the Company's financial statements.

In October 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (FAS 144).
FAS 144 supersedes FAS 121 and requires that one accounting model be used for
all long-lived assets to be disposed of and by broadening the concept of
discontinued operations to apply more broadly to asset disposals. FAS 144 is
effective for fiscal years beginning after December 15, 2001. The implementation
of FAS 144 did not have a material impact on the Company's financial statements.

Note 3- Commitments and Contingencies

On November 21, 2001, RAE filed a patent infringement claim in the United States
District Court of the Northern District of California against Ion Science and
its distributors. The suit alleges that Ion Science manufactures, uses, imports
into the United States, offers for sale, and sells photo-ionization detectors,
including but not limited to the "PhoCheck" line of photo-ionization detectors.
The suit further alleges that Ion Science's photo-ionization detectors,
including but not limited to its "PhoCheck" line of photo-ionization detectors,
infringe patents held by RAE. On June 20, 2002, RAE, in principle, entered into
a settlement agreement with Ion Science, requiring Ion Science to re-design
their photo-ionization detectors. The final settlement is being drafted.

On October 23, 2001, the estate of Virgil Johnson filed a products liability and
wrongful death lawsuit against RAE in the District Court of Harris County,
Texas. The plaintiffs allege that RAE's product was defective and unsafe for its
intended purposes at the time it left RAE's premises, and that the product was
defective in that it failed to conform to the product design and specifications
of other gas monitors. Additionally, the plaintiffs allege that the product was
defectively designed and marketed so as to render it unreasonably dangerous to
the plaintiff. In the event that RAE does not have adequate insurance coverage
for the expenses related to the lawsuit, RAE may incur substantial legal fees
and expenses in connection with the litigation. The litigation may also result
in the diversion of RAE's internal resources. RAE's defense of this litigation,
regardless of its eventual outcome, will likely be costly and time consuming.
The litigation is in the preliminary stage, and RAE is unable to predict its
final outcome. However, an adverse outcome could materially affect RAE's results
of operations and financial position.

On March 26, 2002, Straughan Technical Distribution, LLC, filed a lawsuit
against RAE in the Superior Court of the State of California for the County of
Santa Clara. A similar lawsuit pending in District Court of Harris County, Texas
was served on RAE on March 27, 2002. In these nearly identical lawsuits,
Straughan, a distributor of Gastec Gas Detection Devices, claims to have
experienced diminished sales to its customers, loss of profits and other damages
as a result of the stated allegations, which include claims for interference
with present and prospective business relations, false advertising, trade dress
infringement, slander and antitrust violations. On April 17, 2002, RAE removed
the California action to the United States District Court for the Northern
District of California, and on April 18, 2002, RAE removed the Texas action to
the United States District Court for the Southern District of Texas. On May 10,
2002 and again on June 20, 2002, the principals of Straughan and RAE discussed
potential settlement opportunities. The parties agreed to suspend any legal
action for a period of 60 days pending the conclusion of the settlement
agreement. In the event that RAE does not have adequate insurance coverage for
the expenses related to the lawsuit, RAE may incur substantial legal fees and
expenses in connection with the litigation. The litigation may also result in
the diversion of its internal resources. RAE's defense of this litigation,
regardless of its eventual outcome, will likely be costly and time consuming.
The litigation is in the preliminary stage, and RAE is unable to predict its
final outcome. However, an adverse outcome could materially affect RAE's results
of operations and financial position.

On July 31, 2001, Envision Media, Inc. filed a lawsuit against Nettaxi.Com and
Glenn Goelz, the former CFO of Nettaxi in the Superior Court of the State of
California for the County of Santa Cruz. In or about June 1999, Envision Media
entered into a written contract with Nettaxi whereby they agreed to do web
design work for Nettaxi. Envision Media alleges breach of written contract,
stating that they did not receive payments for services they performed. On or
about January 31, 2001, Envision Media entered into a settlement contract with
Nettaxi whereby the Envision Media agreed to accept as partial payment for its
services, options to purchase shares of Nettaxi's common stock. The contract
required Nettaxi to register the shares with the Securities and Exchange
Commission within 15 days of entering into the contract. Envision Media alleges
breach of contract, as Nettaxi failed to register the shares within the time
required under the contract. In or about December 1999, Glenn Goelz represented
to Envision Media's officer, that Nettaxi had received commitments for back up
financing in order to support its growing operation resulting in a stable price
of its shares. Envision Media alleges that the representation made by Glenn
Goelz was false. The litigation is in the preliminary stage, and we are unable
to predict its final outcome. Our defense of this litigation, regardless of its
eventual outcome, will likely be costly and time consuming.

On May 1, 2001, Thomas Lahey et al. filed a lawsuit against Nettaxi, Inc.,
Robert and Dean Rositano and Glenn Goelz, officers of Nettaxi in the United
States District Court of the Central District of California Southern Division.
The premise for this alleged securities fraud action is that Thomas Lahey et al.
purchased shares of Nettaxi as part of a private placement in February 2000
based on misrepresentations and omissions of material information. The complaint
has been amended twice; on July 15, 2002, the Court granted the motions to
dismiss the Second Amended Complaint by defendants Nettaxi, Robert and Dean
Rositano, and Goelz, without prejudice. The Court also ordered the plaintiffs'
Third Amended Complaint filed as of July 15, 2002. Any adverse outcome could
materially affect RAE's results of operations and financial position.

In addition to the litigation described above, from time to time RAE may be
subject to various legal proceedings and claims that arise in the ordinary
course of business.

Item 2. 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, the Company cannot
guarantee future results, performance, or achievements. For further information,
refer to the section entitled "Factors that May Affect Future Results" in this
Form 10-Q. The following discussion should be read in conjunction with the
condensed consolidated financial statements and the notes thereto included
elsewhere in this Form 10-Q.

RESULTS OF OPERATIONS - Quarter Ending June 30, 2002

Net Sales. Net sales increased from $4.6 million for the quarter ended June 30,
2001 to $5.2 million for the quarter ended June 30, 2002, an increase of 13.5%.
This increase was due to an 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. Additionally, we saw in increase in the sales of our
smart sensing solutions. Relative to the quarter ending June 30, 2001, we
experienced significant increases in sales throughout the United States and in
Australia and New Zealand for the quarter ending June 30, 2002.

Cost of Sales. Cost of sales increased from $1.6 million for the quarter ended
June 30, 2001 to $2.2 million for the quarter ended June 30, 2002, an increase
of 31.6%. This increase was primarily due to additional material requirements as
a result of higher volume production as well as additional personnel and related
expenses to support the expanding business opportunities and to bring the
manufacturing of our key components in-house. Gross margins increased from $2.9
million, or 64.1% of revenue, for the quarter ended June 30, 2001 to $3 million,
or 58.4% of revenue, for the quarter ended June 30, 2002. This increase was
primarily due to an increase in the sales volume. The decrease in the margin as
a percent of revenue from the quarter ending June 30, 2001 to the quarter ending
June 30, 2002, however, is attributable to increases in our manufacturing cost
to support the expanding business. It is also attributable to a decrease in the
price of selected products to remain competitive in the marketplace.

Sales and Marketing. Sales and marketing expenses increased from $1.3 million
for the quarter ended June 30, 2001 to $1.5 million for the quarter ended June
30, 2002, an increase of 16.7%. Our sales and marketing cost increased as a
result of an increase in our headcount and sales collateral to support the
wireless systems business. This increase was partially offset by a decrease in
commissions resulting from the elimination of our outside sales representatives.

Research and Development. Research and development expenses remained relatively
constant at $738,400 for the quarter ended June 30, 2002 and $736,300 for the
quarter ended June 30, 2001. We are continuing to invest in research and
development activities, specifically in the area of wireless communications and
sensor development.

General and Administrative. General and administrative expenses increased from
$762,700 for the quarter ended June 30, 2001 to $2 million for the quarter ended
June 30, 2002. Of the $2 million in general and administrative expenses,
$813,600 was attributable to a non-cash stock-based compensation accounting
charge relating to 2,658,353 options granted under the 1993 RAE California Stock
Option Plan that are subject to variable accounting. As a result of being a
public entity, we incurred fees, including those for public relations, SEC
filings, and D&O insurance that we would not have otherwise incurred. We
increased our professional fees by approximately $250,000, of which our
accounting fees accounted for $211,000. The accounting fees were incurred for
tax planning and preparation, and the quarterly review and related accounting
services.

Legal Fees and Settlement Costs. Legal fees and settlement costs increased from
$92,400 for the quarter ended June 30, 2001 to $166,100 for the quarter ended
June 30, 2002, an increase of 79.8%. The increase is attributable to the ongoing
litigation of our current lawsuits described elsewhere in this Form 10-Q.

Merger Costs. Merger costs were $8.7 million in the quarter ended June 30, 2002.
Specifically, we recorded a non-cash compensation charge of $2.3 million based
on the 1,084,083 shares issued to Messrs. Ng, Flanzraich and Frost, a non-cash
charge of $2.1 million based on the shares issued to Baytree Capital, 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 the merger between RAE and Nettaxi.

Other Income (Expense), net. Other Income (Expense), net decreased from $52,100
for the quarter ended June 30, 2001 to $31,600 for the quarter ended June 30,
2002, a decrease of 39.3%. This decrease is due primarily to a decrease in
interest income resulting from a decline in interest rates and a decrease in our
minority interest in the losses of the consolidated subsidiary. These decreases
were partially offset by a decrease in interest expense resulting from having
paid off the existing loans.

Net (Loss) Income. Net profit for the quarter ended June 30, 2001 was $87,100.
For the same period in 2002, we had a net loss of $10 million, a decrease of
$10.1 million. The decrease of net income was primarily the result of a $9.6
million non-cash accounting charge, an increase in the cost of sales to support
the expanding business opportunities, and an increase in general and
administrative expenses resulting from an increase in public company activities
and professional services.

Segment Information

We operate in one business segment, and we use one measure of profitability to
manage our business. Approximately 21% of our long-lived assets are located in
China, and approximately 14% of our long-lived assets are located in Hong Kong,
with the remaining long-lived assets located in the United States.

RESULTS OF OPERATIONS - 1st Half of Year 2002

Net Sales. Net sales increased from $9.1 million in the first half of 2001 to
$9.7 million in the first half of 2002, an increase of 7%. This increase was
primarily the result of the increase in the quarter ended June 30, 2002, where
we realized an increase in the sale of our confined space gas monitors and the
sale of our flexible multi-gas monitors with our patented photo-ionization
detector. We also saw in increase in the sale of our wireless products.

Cost of Sales. Cost of sales increased from $3.5 million for the first half of
2001 to $4.2 million for the first half of 2002, an increase of 20.3%. This
increase was primarily due additional material requirements as a result of
higher volume production for the quarter ended June 30, 2002, as well as
additional personnel and related expenses to support the expanding business
opportunities and to bring the manufacturing of our key components in-house.
Gross margins decreased from $5.6 million, or 61.8% of revenue, for the first
half of 2001 to $5.5 million, or 57% of revenue, for the first half of 2002. The
decrease in the margin from the first half of 2001 to the first half of 2002 was
primarily due to increases in our manufacturing cost to support the expanding
business and a decrease in the price of selected products to remain competitive
in the marketplace.

Sales and Marketing. Sales and marketing expenses increased from $2.3 million
for the first half of 2001 to $2.5 million for the first half of 2002, an
increase of 9.8%. We realized an increase in the sales and marketing cost
resulting from an increase in our headcount and sales collateral in support the
wireless systems business. This increase was partially offset by a decrease in
commissions resulting from the elimination of our outside sales representatives.

Research and Development. Research and development expenses remained largely
unchanged at $1.5 million for the first half of 2001 and 2002. We are continuing
to invest in research and development activities, specifically in the area of
wireless communications and sensor development.

General and Administrative. General and administrative expenses increased from
$1.5 million for the first half of 2001 to $2.8 million for the first half of
2002. Of the $2.8 million in general and administrative expenses, $862,800 was
attributable to a non-cash stock-based compensation accounting charge relating
to 2,658,353 options granted under the 1993 RAE California Stock Option Plan
that are subject to variable accounting. As a result of being a public entity,
we incurred fees, including those for public relations, SEC filings, and D&O
insurance, that we would not have otherwise incurred. We increased our
professional fees by approximately $250,000, of which our accounting fees
accounted for $211,000. The accounting fees were incurred for tax planning and
preparation, and the quarterly review and related accounting services.

Legal Fees and Settlement Costs. Legal fees and settlement costs remained
constant for the first half of 2001 and 2001, $229,100 and $244,000,
respectively. The costs are attributable to the ongoing litigation of our
current lawsuits described elsewhere in this Form 10-Q.

Merger Costs. Merger costs were 8.7 million for the first half of 2002.
Specifically, we recorded a non-cash compensation charge of $2.3 million based
on the 1,084,083 shares issued to Messrs. Ng, Flanzraich and Frost, a non-cash
charge of $2.1 million based on the shares issued to Baytree Capital, 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 the merger between RAE and Nettaxi.

Other Income (Expense), net. Other Income (Expense), net decreased from $105,400
for the first half of 2001 to $54,400 for the first half of 2002, a decrease of
48.4%. This decrease is due primarily to a decrease in interest income resulting
from a decline in interest rates and a decrease in our minority interest in the
losses of the consolidated subsidiary. These decreases were partially offset by
a decrease in interest expense resulting from having paid off the existing
loans.

Net (Loss) Income. Net profit for the first half of 2001 was $121,600. For the
same period in 2002, we had a net loss of $10.2 million, a decrease of $10.3
million. The decrease of net income was primarily the result of a $9.6 million
non-cash accounting charge, an increase in the cost of goods to support the
expanding business opportunities, and an increase in general and administrative
expenses resulting from an increase in public company activities and
professional services.

Liquidity and Capital Resources

To date, we have financed our operations primarily through bank
borrowings and revenues from operations. As of June 30, 2002, we had $7.3
million in cash and cash equivalents, of which approximately $903,500 of cash
has been earmarked specifically for research and development activities at
REnex. At June 30, 2002, the Company had $9.9 million of working capital (the
excess of current assets over current liabilities) and has a current ratio of
3.5 to 1.0.

In connection with our merger transaction with Nettaxi.com, we gained
access to approximately $7 million in cash held by Nettaxi.com. This cash was
used to pay off approximately $4.4 million in bank loans and $840,000 in
transaction-related professional fees. The remainder is being used to fund our
growth.

The net loss for the first half of 2002 was comprised primarily of
non-cash stock-based compensation ($9.6 million), substantially all of which was
related to stock and warrant issuances, and non-cash compensation charges
relating to our common stock options. Net cash used in operating activities for
first half of 2002 was $479,300, as compared with net cash used by operating
activities of $933,600 for the first half of 2001. For the first half of 2002,
changes in operating assets and liabilities provided an increase of $2,000 in
operating cash flows, whereas for the first half of 2001, operating assets and
liabilities used $1.5 million in operating cash flows. The favorable effects on
operating cash flows resulting from the change in operating assets and
liabilities is primarily reflected in inventories in the amount of $1.4 million.

Net cash provided by investing activities for the first half of 2002
was $1,573,600, as compared with net cash used in investing activities of
$196,300 for the first half of 2001. Cash provided by investing activities in
the first half of 2002 was due to the release of the restricted cash ($3
million), partially offset by changes in the deposits and merger costs
($846,400) and the acquisition of property and equipment ($580,000). The
investment in property and equipment is for the implementation of our Customer
Relations Management System and the construction of the new Wa-RAE manufacturing
building.

Net cash provided by financing activities for the first half of 2002
was $2.5 million as compared with $848,200 for the first half of 2001. Cash
provided by financing activities for the first half of 2002 was primarily the
result of the proceeds from the merger transaction of $7 million, partially
offset by the 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 and cash made available to us as
a result of our merger with Nettaxi, 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 it from pursuing our growth strategy.
Any future funding may dilute the ownership of our shareholders.

Item 3. Quantitative and Qualitative Disclosures About 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 three large United
States financial institutions and one large Hong Kong financial institution. Our
deposits may exceed the amount of insurance available to cover such deposits. To
date, we have not experienced any losses of deposit of cash and cash
equivalents. Management regularly reviews our deposit amounts and the credit
worthiness of the financial institution which holds our deposits.

Interest Rate Risk

As of June 30, 2002, we had cash and cash equivalents of $7.3 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, substantially all 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.
We expect, however, that future products and service revenue may also be derived
from international markets and may be denominated in the currency of the
applicable market. As a result, 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.

Factors that May Affect Future Results

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.

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 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 securities analysts and investors. In this event, the
trading price of our common stock would significantly decline.

Because our expense levels are based in large part on estimates of future
revenues, an unexpected shortfall in revenue would significantly harm our
results of operations.

Our expense levels are based largely on our investment plans and estimates
of future revenue. We may be unable to adjust our spending to compensate for an
unexpected shortfall in revenue. Accordingly, any significant shortfall in
revenue relative to our planned expenditures in a particular quarter would harm
our results of operations and could cause our stock price to fall sharply,
particularly following quarters in which our operating results fail to meet the
expectations of securities analysts or investors.

The consolidation of REnex will cause us to incur losses that we would not
otherwise incur.

We own approximately 47 percent of, and have management control over,
REnex, a wireless systems development company. As such, we are required to
consolidate REnex's financial statements. REnex is still in the research and
development stage, and to date, REnex has not generated any revenues. 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.

Variable accounting related to past option grants under the 1993 RAE California
Stock Option Plan may impact our earnings for the next ten years.

In connection with becoming a public company through a reverse merger
transaction, certain options under the RAE California 1993 Stock Plan are
subject to variable accounting in accordance with FASB Interpretation No. 44
(FIN 44). As of June 30, 2002, there were 2,658,353 options outstanding under
the 1993 Plan that are subject to variable accounting. During the six months
ended June 30, 2002, we recorded non-cash compensation charges relating to our
common stock options of $862,800. Based on the life of these options, the
variable accounting treatment may result in unpredictable stock-based
compensation dependent on fluctuations in quoted prices of our common stock for
the next ten years.

We may be unable to meet our future capital requirements. Any attempts to raise
additional capital in the future may cause substantial dilution to our
stockholders.

We may need to seek additional funding in the future and it is uncertain
whether we will be able to obtain additional financing on favorable terms, if at
all. Further, if we issue equity securities in connection with additional
financing, our stockholders may experience dilution and/or the new equity
securities may have rights, preferences or privileges senior to those of
existing holders of common stock. If we cannot raise funds on acceptable terms,
if and when needed, we may not be able to develop or enhance our products and
services, take advantage of future opportunities or respond to competitive
pressures or unanticipated requirements, any of which could seriously harm our
business.

Should the benefits of our inventory procurement strategy in Asia not
materialize as we anticipate, our results of operations may suffer

As part of our overall strategy to increase gross margins and improve
operating results, we are executing on a strategy to procure a number of our
component parts closer to our production source in Asia. In the past, our
strategy involved the purchase of parts in, and delivery of parts from our
vendors, to the United States. The parts were then kitted, and shipped to
Shanghai, where the subassemblies were made. The current strategy involves the
procurement of component parts in Asia, where the effective price is much lower.
The parts would be shipped directly to Shanghai, thereby reducing the transit
time and shipping cost of the inventory. The execution of the current strategy
may have some adverse consequences. Our vendors have to be qualified to ensure
that the parts are of acceptable quality and meet the requisite specifications
called for by engineering drawings. A significant amount of time and funding may
be required to complete the analysis. Should we fail to execute on the currently
procurement strategy in an effective manner, our results of operations may
suffer.

We depend on our distributors

We derive approximately 90% of our revenues via our sales distribution
channels, and therefore are dependant on our distributors. Should any of our
principal distributors, or a significant group of our distributors, experience
financial difficulties or become unwilling to promote and sell our products, our
business and results of operations could be materially harmed.

We depend on third party suppliers.

We are dependent on third party suppliers for our component parts,
including various sensors, microprocessors and other material components. Should
there be any interruption in the supply of these component parts, our business
could be adversely affected.

If our expansion from a gas detection instrument manufacturer to a wireless
systems company is unsuccessful, our business and results of operations will
suffer

We are in the process of expanding our current business of providing gas
detection instruments to include wireless systems for local and remote security
monitoring. The pricing of our wireless products and services may be subject to
rapid and frequent change. We may be forced for competitive or technical reasons
to reduce prices for our wireless products, which would reduce our revenue and
could harm our business. Further, the wireless systems market is still evolving,
and we have little basis to assess the demand for our wireless products and
services or to evaluate whether our wireless products and services will be
accepted by the market. If our wireless products and services do not gain broad
market acceptance, our business and results of operations will be harmed.

The economic downturn in the United States and abroad could have a material
adverse impact on our business and results of operations

While our business to date has been minimally impacted by the current
economic downturn in the United States and abroad, it could eventually succumb
to such conditions. Many of our customers have already experienced severe
declines in their revenues, which could impact the size and frequency of their
purchases of our products and services. Although we routinely perform credit
checks on our customer base to assess their creditworthiness, there can be no
assurance that we will be able to collect payments from our customers as they
become due. Any decrease in the size or frequency of purchases by our customers,
or a failure by us to collect payments as they become due could have a material
adverse impact on our business and results of operations.

Compliance with safety regulations could delay new product delivery and
adversely affect our results of operations

Compliance with safety regulations, specifically the need to obtain UL,
CUL, ATEX and EEX approvals, could delay the introduction of new products by us.
As a result, we may experience delays in realizing revenues from our new
products, which could have an adverse effect on our results of operations.

A deterioration in trade relations with China could have a material adverse
effect on our business and results of operations

A significant portion of our products and components are manufactured at
our wholly-owned facility in Shanghai, China. Should trade relations between the
United States and China deteriorate, our ability to transfer products between
China and other regions of the world, including the United States, Asia and
Europe, could be significantly impacted. As a result, our business and results
of operations would suffer.

We are involved in pending legal proceedings

On November 21, 2001, we filed a patent infringement claim in the United
States District Court of the Northern District of California against Ion Science
and its distributors. The suit alleges that Ion Science manufactures, uses,
imports into the United States, offers for sale, and sells photo-ionization
detectors, including but not limited to the "PhoCheck" line of photo-ionization
detectors. The suit further alleges that Ion Science's photo-ionization
detectors, including but not limited to its "PhoCheck" line of photo-ionization
detectors, infringe patents held by us. On June 20, 2002, RAE, in principle,
entered into a settlement agreement with Ion Science, requiring Ion Science to
re-design their photo-ionization detectors. The final settlement is being
drafted.

On October 23, 2001, the estate of Virgil Johnson filed a products
liability and wrongful death lawsuit against us in the District Court of Harris
County, Texas. The plaintiffs allege that our product was defective and unsafe
for its intended purposes at the time it left our premises, and that the product
was defective in that it failed to conform to the product design and
specifications of other gas monitors. Additionally, the plaintiffs allege that
the product was defectively designed and marketed so as to render it
unreasonably dangerous to the plaintiff. In the event that we do not have
adequate insurance coverage for the expenses related to the lawsuit, we may
incur substantial legal fees and expenses in connection with the litigation. The
litigation may also result in the diversion of our internal resources. Our
defense of this litigation, regardless of its eventual outcome, will likely be
costly and time consuming. The litigation is in the preliminary stage, and we
are unable to predict its final outcome. However, an adverse outcome could
materially affect our results of operations and financial position.

On March 26, 2002, Straughan Technical Distribution, LLC, filed a lawsuit
against us in the Superior Court of the State of California for the County of
Santa Clara. A similar lawsuit pending in District Court of Harris County, Texas
was served on us on March 27, 2002. In these nearly identical lawsuits,
Straughan, a distributor of Gastec Gas Detection Devices, claims to have
experienced diminished sales to its customers, loss of profits and other damages
as a result of the stated allegations, which include claims for interference
with present and prospective business relations, false advertising, trade dress
infringement, slander and antitrust violations. On April 17, 2002, we removed
the California action to the United States District Court for the Northern
District of California, and on April 18, 2002, we removed the Texas action to
the United States District Court for the Southern District of Texas. On May 10,
2002 and again on June 20, 2002, we met with the principal of Straughan to
discuss potential settlement opportunities. We agreed to suspend any legal
action for a period of 60 days pending the conclusion of the settlement
agreement. In the event that we do not have adequate insurance coverage for the
expenses related to the lawsuit, we may incur substantial legal fees and
expenses in connection with the litigation. The litigation may also result in
the diversion of our internal resources. Our defense of this litigation,
regardless of its eventual outcome, will likely be costly and time consuming.
The litigation is in the preliminary stage, and we are unable to predict its
final outcome. However, an adverse outcome could materially affect our results
of operations and financial position.

On July 31, 2001, Envision Media, Inc. filed a lawsuit against Nettaxi.Com
and Glenn Goelz, the former CFO of Nettaxi in the Superior Court of the State of
California for the County of Santa Cruz. In or about June 1999, Envision Media
entered into a written contract with Nettaxi whereby they agreed to do web
design work for Nettaxi. Envision Media alleges breach of written contract,
stating that they did not receive payments for services they performed. On or
about January 31, 2001, Envision Media entered into a settlement contract with
Nettaxi whereby the Envision Media agreed to accept as partial payment for its
services, options to purchase shares of Nettaxi's common stock. The contract
required Nettaxi to register the shares with the Securities and Exchange
Commission within 15 days of entering into the contract. Envision Media alleges
breach of contract, as Nettaxi failed to register the shares within the time
required under the contract. In or about December 1999, Glenn Goelz represented
to Envision Media's officer, that Nettaxi had received commitments for back up
financing in order to support its growing operation resulting in a stable price
of its shares. Envision Media alleges that the representation made by Glenn
Goelz was false. The litigation is in the preliminary stage, and we are unable
to predict its final outcome. Our defense of this litigation, regardless of its
eventual outcome, will likely be costly and time consuming.

On May 1, 2001, Thomas Lahey filed a lawsuit against Nettaxi, Inc., Robert
and Dean Rositano and Glenn Goelz, officers of Nettaxi in the United States
District Court of the Central District of California Southern Division. The
premise for this alleged securities fraud action is that Thomas Lahey purchased
shares of Nettaxi as part of a private placement in February 2000 based on
misrepresentations and omissions of material information. The complaint has been
amended twice; on July 15, 2002, the Court granted the motions to dismiss the
Second Amended Complaint by defendants Nettaxi, Robert and Dean Rositano, and
Goelz, without prejudice. The Court also ordered the plaintiffs' Third Amended
Complaint filed as of July 15, 2002. Any adverse outcome could materially affect
our results of operations and financial position.

In addition to the litigation described above, from time to time we may be
subject to various legal proceedings and claims that arise in the ordinary
course of business.

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. 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. In the market for gas detection monitoring devices, our
primary competitors include Industrial Scientific Corporation, Mine Safety
Appliances Company, BW Technologies, PerkinElmer, Inc., Drager Safety Inc.,
Gastec Corporation, and Bacou-Dalloz. 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 may not be successful in 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 may not be able to recruit or retain qualified personnel

Our future success depends on our ability to attract, retain and motivate
highly skilled employees. Despite the recent economic slowdown, competition for
qualified employees in the Silicon Valley, particularly management, technical,
sales and marketing personnel, is intense. Although we provide compensation
packages that include stock options, cash incentives and other employee
benefits, we may be unable to retain our key employees or to attract, assimilate
and retain other highly qualified employees in the future, which could harm our
business.

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
Robert Henderson. The loss of the services of any of our executive officers
could harm our business.

We might not be successful in the development or introduction of new products
and services in a timely and effective manner

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, product innovations may not
achieve the market penetration or price stability necessary for profitability.

Our officers, directors and principal stockholders beneficially own
approximately 52% 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 52% 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.

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
connection with this offering could reduce the prevailing market prices for our
common stock. We registered the resale of approximately 42,671,491 shares of
common stock (including shares underlying outstanding warrants to purchase our
common stock) on a registration statement on Form S-1. Of these shares,
approximately 12,680,080 are subject to six month lock-up agreements set to
expire on October 9, 2002 and 23,261,326 are subject to one year lock-up
agreements set to expire on April 9, 2003. Upon the expiration of the lock-up
agreements, these shares will be eligible for resale. Future sales by the
holders of such shares could adversely affect the trading price of our common
stock.

Our facilities and operations are vulnerable to natural disasters and other
unexpected losses

Our success depends on the efficient and uninterrupted operation of our
business. Our facilities in Sunnyvale, California, are in an area that is
susceptible to earthquakes. We do not have a backup facility to provide
redundant capacity in the event of a natural disaster or other unexpected damage
from fire, floods, power loss, telecommunications failures, break-in and similar
events. If we seek to replicate our operations at other locations, we will face
a number of technical as well as financial challenges, which we may not be able
to address successfully. Although we carry property and business interruption
insurance, our coverage may not be adequate to compensate us for all losses that
may occur.

Our business is subject to risks associated with conducting business
internationally.

Our business is subject to risks normally associated with conducting
business outside the United States, such as foreign government regulations,
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, our business and results of operations could be adversely affected.

We may be unable to adequately protect our intellectual property rights

We regard our intellectual property as critical to our success. We rely on
patent, trademark, copyright and trade secret laws 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. Our ability to compete is affected by our ability to protect
the company's intellectual property rights. We rely on a combination of patents,
trade secrets, non-disclosure agreements and confidentiality procedures.
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. Specifically, 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, including the
patent infringement claim we have filed against Ion Science described above,
could, regardless of the outcome, have a materially adverse impact our business
and results of operations.

We might face intellectual property infringement claims that might be costly to
resolve

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.

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.

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 acquirors 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. In addition, provisions of Delaware law may discourage, delay
or prevent a third party from acquiring or merging with us. 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 acquiror from offering our stockholders a
premium over the prevailing trading price of our common stock.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

On March 26, 2002, Straughan Technical Distribution, LLC, filed a lawsuit
against us in the Superior Court of the State of California for the County of
Santa Clara. A similar lawsuit pending in District Court of Harris County, Texas
was served on us on March 27, 2002. In these nearly identical lawsuits,
Straughan, a distributor of Gastec Gas Detection Devices, claims to have
experienced diminished sales to its customers, loss of profits and other damages
as a result of the stated allegations, which include claims for interference
with present and prospective business relations, false advertising, trade dress
infringement, slander and antitrust violations. On April 17, 2002, we removed
the California action to the United States District Court for the Northern
District of California, and on April 18, 2002, we removed the Texas action to
the United States District Court for the Southern District of Texas. On May 10,
2002 and again on June 20, 2002, we met with the principal of Straughan to
discuss potential settlement opportunities. In the event that we do not have
adequate insurance coverage for the expenses related to the lawsuit, we may
incur substantial legal fees and expenses in connection with the litigation. The
litigation may also result in the diversion of our internal resources. Our
defense of this litigation, regardless of its eventual outcome, will likely be
costly and time consuming. The litigation is in the preliminary stage, and we
are unable to predict its final outcome. However, an adverse outcome could
materially affect our results of operations and financial position.

On July 31, 2001, Envision Media, Inc. filed a lawsuit against Nettaxi.Com
and Glenn Goelz, the former CFO of Nettaxi in the Superior Court of the State of
California for the County of Santa Cruz. In or about June 1999, Envision Media
entered into a written contract with Nettaxi whereby they agreed to do web
design work for Nettaxi. Envision Media alleges breach of written contract,
stating that they did not receive payments for services they performed. On or
about January 31, 2001, Envision Media entered into a settlement contract with
Nettaxi whereby the Envision Media agreed to accept as partial payment for its
services, options to purchase shares of Nettaxi's common stock. The contract
required Nettaxi to register the shares with the Securities and Exchange
Commission within 15 days of entering into the contract. Envision Media alleges
breach of contract, as Nettaxi failed to register the shares within the time
required under the contract. In or about December 1999, Glenn Goelz represented
to Envision Media's officer, that Nettaxi had received commitments for back up
financing in order to support its growing operation resulting in a stable price
of its shares. Envision Media alleges that the representation made by Glenn
Goelz was false. The litigation is in the preliminary stage, and we are unable
to predict its final outcome. Our defense of this litigation, regardless of its
eventual outcome, will likely be costly and time consuming.

In addition to the litigation described above, from time to time we may be
subject to various legal proceedings and claims that arise in the ordinary
course of business.

Item 2. Changes in Securities and Use of Proceeds

None

Item 3. Defaults upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Securities Holders

We held a Special Meeting of Stockholders on April 5, 2002 for the
following purposes:

1. To consider and vote upon the Merger Agreement and Plan of
Reorganization, dated as of January 9, 2002, by and among Nettaxi.com, RAE
California and RAES Acquisition Corporation, a California corporation and a
wholly-owned subsidiary of Nettaxi.com, as amended (the "Merger Agreement"), and
the transactions contemplated thereby (collectively, the "Merger").

2. In connection with the proposed Merger, to approve the reverse stock
split of our issued and outstanding shares of common stock, par value $0.001 per
share, such that each five and sixty-seven hundredths (5.67) shares of our
issued and outstanding shares of common stock would be converted into one (1)
share of our issued and outstanding common stock, as contemplated by the Merger
Agreement.

3. In connection with the proposed Merger, to consider and vote upon a
proposal to approve the reincorporation of Nettaxi from the State of Nevada to
the State of Delaware, as contemplated by the Merger Agreement.

4. To consider and vote upon a proposal to ratify our 1999 Stock Option
Plan, as amended.

5. To consider and vote upon a proposal to adopt the 2002 Stock Option
Plan.

The following were the votes for, against and abstaining regarding the
above items:

- -------------------- --------------- ----------------- ------------------
Proposal For Against Abstain
- -------------------- --------------- ----------------- ------------------
- -------------------- --------------- ----------------- ------------------
1 23,395,358 316,222 4,850
- -------------------- --------------- ----------------- ------------------
- -------------------- --------------- ----------------- ------------------
2 23,251,827 421,312 52,291
- -------------------- --------------- ----------------- ------------------
- -------------------- --------------- ----------------- ------------------
3 23,449,643 248,997 17,790
- -------------------- --------------- ----------------- ------------------
- -------------------- --------------- ----------------- ------------------
4 21,069,119 2,508,159 139,152
- -------------------- --------------- ----------------- ------------------
- -------------------- --------------- ----------------- ------------------
5 20,491,139 3,089,139 136,152
- -------------------- --------------- ----------------- ------------------

As a result of the above votes, proposals 1, 2 and 3 were approved and
proposals 4 and 5 were not approved.

Item 5. Other Information

None

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits. The following is a list of exhibits filed as part of this
Report on Form 10-Q.

- ------------------------- -----------------------------------------------------
Exhibit Number Description of Document
- ------------------------- -----------------------------------------------------
- ------------------------- -----------------------------------------------------
99.1 Certification pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
- ------------------------- -----------------------------------------------------
- ------------------------- -----------------------------------------------------
99.2 Certification pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
- ------------------------- -----------------------------------------------------

Reports on Form 8-K:

(1) On April 8, 2002, Nettaxi.com file a report on Form 8-K announcing the
approval of the merger of RAE California and Nettaxi.com.

(2) On April 24, 2002, RAE filed a report on Form 8-K announcing the
consummation of the merger of RAE California and Nettaxi.com and the change of
control of Nettaxi.com.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized on August 8, 2002.

RAE SYSTEMS INC.

By: /s/ Joseph Ng
-----------------------------------
Joseph Ng
Chief Financial Officer and
Vice President, Business Development

EXHIBIT INDEX

99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002

99.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002

EXHIBIT 99.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of RAE Systems Inc. (the
"Company") on Form 10-Q for the period ended June 30, 2002, as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Robert
I. Chen, President, Chief Executive Officer and Chairman of the Board of the
Company, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of
the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and

(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.

By: /s/ Robert I.Chen

August 8, 2002 Robert I. Chen
President, Chief Executive Officer
and Chairman of the Board

EXHIBIT 99.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of RAE Systems Inc. (the
"Company") on Form 10-Q for the period ended June 30, 2002, as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Joseph
Ng, Chief Financial Officer and Vice President, Business Development of the
Company, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of
the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and

(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.

By: /s/ Joseph Ng
-----------------------------------

August 8, 2002 Joseph Ng
Chief Financial Officer
and Vice-President, Business Development