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                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                   FORM 10-K

(Mark one)

      [X]   Annual report pursuant to Section 13 or 15(d) of the Securities
            Exchange Act of 1934


                  For the fiscal year ended December 31, 1999

                                      OR

      [_]   Transition report pursuant to Section 13 or 15(d) of the Securities
            Exchange Act of 1934

                        Commission File Number: 0-27696

                              GENSYM CORPORATION
            (Exact name of registrant as specified in its charter)

           Delaware                                          04-2932756
 (State or other jurisdiction of                          (I.R.S. Employer
 incorporation or organization)                          Identification No.)

         125 CambridgePark Drive
             Cambridge, MA                                      02140-2329
(Address of principal executive offices)                        (Zip Code)

      Registrant's telephone number, including area code: (617) 547-2500

       Securities registered pursuant to Section 12(b) of the Act: None

         Securities registered pursuant to Section 12 (g) of the Act:
                         Common Stock, $.01 par value

     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 period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:

            Yes [X]                                         No [_]

      Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.   [_]

      As of March 14, 2000 there were 6,246,910 shares of the Registrant's
Common Stock outstanding. As of that date, the aggregate market value of the
voting stock held by non-affiliates of the registrant was $85,895,013 based on
the last reported sale price of the registrant's Common Stock on the Nasdaq
National Market as of the close of business on March 14, 2000.


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                      DOCUMENTS INCORPORATED BY REFERENCE

                                                         Part of Form 10-K
Document                                                 into which incorporated
--------                                                 -----------------------

Portions of the Registrant's Proxy Statement
for the 2000 Annual Meeting of Stockholders              Items 10, 11, 12 and 13
to be held on Wednesday, May 17, 2000 at 10:00 A.M.      of Part III
at the offices of Hale and Dorr LLP, 60 State Street,
Boston, MA 02109

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                              GENSYM CORPORATION
                                FORM 10-K INDEX

                                                                        Page No.
                                                                        --------

PART I

Item 1.    Business                                                        4-12
Item 2.    Properties                                                      12
Item 3.    Legal Proceedings                                               12
Item 4.    Submission of Matters to a Vote of Security Holders             13

PART II

Item 5.    Market for Registrant's Common Equity and Related
           Stockholder Matters                                             14
Item 6.    Selected Financial Data                                         15
Item 7.    Management's Discussion and Analysis of Financial
           Condition and Results of Operations                             15-25
Item 7A.   Qualitative and Quantitative Disclosures about Market Risk      25
Item 8.    Financial Statements and Supplementary Data                     27-39
Item 9.    Changes in and Disagreements with Accountants on Accounting
            and Financial Disclosure                                       40

PART III

Item 10.   Directors and Executive Officers of the Registrant              40
Item 11.   Executive Compensation                                          40
Item 12.   Security Ownership of Certain Beneficial Owners and
           Management                                                      40
Item 13.   Certain Relationships and Related Transactions                  40

PART IV

Item 14.   Exhibits, Financial Statements and Reports on Form 8-K          41
           Signatures                                                      42

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PART I.

ITEM 1. BUSINESS

     Gensym Corporation ("Gensym" or "the Company") is a leading supplier of
adaptive software products that model, simulate and manage the e-infrastructure.
The Company has built a unique foundation of reasoning technologies through its
flagship product, G2, and its G2-based products. These products are used to
model, simulate and manage complex operations occurring both on-line and off-
line in manufacturing, telecommunications and other industries. Gensym is
launching two new initiatives to assist its customers in their rapid deployment
of their e-business infrastructure: 1) a reformatting of its basic offering,
with the addition of "out-of-the-box" products to meet the needs of Gensym's
manufacturing clients; and 2) the introduction of a new product, e-SCOR, which
in conjunction with Gensym's OpEx product family, offers customers a unique
capacity to model, simulate and manage their e-infrastructure.

     The Company is reorganizing its field operations into two worldwide units:
1) the Expert Operation product line, which focuses on expanding Gensym's
presence in chemical, oil and gas, pharmaceutical, and other
manufacturing; and 2) the e-Infrastructure product line focuses on building
Gensym's entrance into Business-to-Business electronic infrastructure of
networks, e-marketplace entrants, and Fortune 1000 companies.

STRATEGY

Gensym's objective is to build a leadership position in the Business-to-Business
infrastructure market and in the complimentary expert manufacturing systems
market. To achieve this objective, the Company plans to concentrate on the
following strategies:

          Focus on key accounts: Gensym's account presence in chemical, oil and
     gas, pharmaceutical, and power industries provides Gensym with a solid
     foundation to assist these industries in growing their expert manufacturing
     applications and in launching their new supply chain infrastructure to
     support the Business-to-Business initiatives.

          Expand our worldwide partner programs: While the Company maintains a
     sales and support presence in North America, Europe and Asia, Gensym works
     mostly through system integrators, value added resellers, and OEMs that
     have experience and domain expertise in facilitating the development and
     deployment of new solutions based on G2 products. Gensym will invest in new
     marketing and sales initiatives to build its presence, directly and with
     partners, in the Business-to-Business infrastructure market.

          Enhance ease of use and extend technological leadership: The Company
     will continue to enhance the ease of use of its G2-based products through
     increased use of Webcentric capabilities, Java based development tools and
     packaged "out of the box" product offerings. Gensym will invest in adding
     new features and new functionalities to its existing product families and
     will continue to invest in the development of new products, targeting the
     Business-to-Business infrastructure market.

PRODUCTS

     Gensym sells G2 and a growing number of products used with or based on G2.
The Company has launched a program to restructure its product offerings into
packaged bundles of the following products. These bundles will become available
over the next few months.

     G2

     G2 is a comprehensive development and deployment environment for
intelligent management and optimization of complex, dynamic operations. G2
applies knowledge that represents the experience of the best operations
personnel, combined with analytical models constructed by engineers and business
professionals and models derived from past performance, to real-time or model
data, in order to reach conclusions, provide advice, and take real or simulated
actions in a timely fashion. G2 can follow multiple lines of reasoning based on
this knowledge and consider multiple problems concurrently. G2 maintains an
understanding of the behavior of processes over time and the currency of
information, both of which are important for real-time management of operations.
G2 incorporates a broad array of integrated technologies that allow application
developers to implement object-oriented applications without the need for
conventional computer programming.

Development Features

     G2 allows an application developer to express objects, rules, models and
     procedures using structured natural language so that they can be readily
     understood and modified. The G2 development environment allows a developer
     to test an application using

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     simulated data and to view the results graphically. In this way, an
     application can be tested under various scenarios before deployment. Rapid
     incremental application development can be done interactively, to
     facilitate application improvements during prototyping, during development
     and even while in deployment. Using G2's ability to support rapid
     application development, a developer can show a dynamic, graphically
     animated prototype of an application to an end-user at an early stage.

     Using G2, an application developer can model a process in terms of
     interrelated objects, which may be in graphical or schematic diagram form.
     These object-based graphical connections enable G2 to reason about the
     interdependent behavior of connected process objects. G2's high-level
     representation of knowledge allows persons in many positions and roles in
     an organization to develop applications more quickly and easily, while
     aiding maintainability and reusability. Using Gensym's Telewindows product,
     developers at multiple geographic locations can work in teams to
     concurrently develop applications.

Deployment Features

     Applications built on G2 are portable and interoperable across a number of
     computer platforms, so solutions can be offered on any of a wide range of
     platforms and later migrated to new and more powerful computers and
     operating systems. G2 currently runs on Intel PC's running Windows NT and
     on workstations from Compaq/Digital, Hewlett-Packard, IBM, Sun Microsystems
     and others. G2 currently runs under Windows NT, as well as the UNIX and VMS
     operating systems.

     G2 allows many procedures or rules to be active concurrently. A procedure
     or rule can be executing, suspended to allow other computations to occur,
     or waiting for a triggering event. G2 enhances the reliability of on-line
     applications by its facility to save "snap-shots" of a process state and
     "warm boot" to the last saved state, so that an intelligent real-time
     system can resume after power failures or other interruptions. Applications
     can also be modified without interrupting the running of the application.

     G2 can support concurrent access to multiple sources of data and high-
     performance data exchange. Once an application is deployed, Telewindows and
     Gensym's G2 WebLink allow multiple users to share that application
     concurrently. Telewindows and G2 WebLink are available on all G2 platforms
     as well as on PC's running Windows.

          TELEWINDOWS AND G2 WEBLINK

          Telewindows operates in conjunction with G2 and enables concurrent
     shared access to G2 from multiple geographic locations. Telewindows gives
     each member of a development team full concurrent access to an application
     as a native developer, with immediate awareness of and access to objects
     and other knowledge created by other team members. Telewindows enables
     remote system maintenance by allowing full developer access to on-line
     deployed applications remotely across a network. Once an application is
     deployed, Telewindows allows multiple users to share that application
     concurrently.

          Multiple end-users on a network can access multiple applications via
     Telewindows. Each user is provided with specific capabilities and
     restrictions according to the authorized level of access. For example, in
     typical manufacturing operations, the process or plant operators may have
     access to intelligent diagnostics and other decision support while the
     maintenance group, plant management, plant engineers and others may share
     the knowledge and real-time analysis appropriate to their respective tasks.

          Telewindows2 Toolkit is a component-based version of Telewindows that
     fully utilizes the native graphics capability of the client platform. This
     product complies with Microsoft Windows and MOTIF standards and is designed
     to run concurrently with the Telewindows product. Telewindows2 Toolkit
     permits a G2 client to be developed and deployed within industry standard
     programming environments, such as Microsoft Visual Basic, Microsoft
     Explorer, and Netscape Navigator. G2 programming components such as
     workspaces and editors can be presented in a standards compliant manner.
     Telewindows2 Toolkit also supports the integration of both JavaBean and
     ActiveX components into the client part of a G2 application.

          In addition to Telewindows, G2 WebLink enables users to interact with
     G2 applications remotely from browsers like Netscape and Microsoft
     Explorer. Through support of hypertext transfer protocol (HTTP), this
     product "Web-enables" G2, that is, provides standard user access over
     Internet or Intranet connections.

          CONNECTIVITY PRODUCTS

          The Company and many of its marketing partners offer specific
     interface modules to allow on-line integration of G2 with external
     programs, systems, and databases. The Company offers interfaces to many
     standard databases such as those offered by Informix, Oracle, and Sybase.
     Interfaces to most popular factory control systems are available either
     from the Company and its partners or, in several cases, directly from the
     vendors of these systems.

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G2 JavaLink

     G2 JavaLink is a connectivity product that allows G2 applications to
     interoperate with other software components developed using the Java
     programming language and runtime environment. Java is an industry standard
     language developed by SUN Microsystems for implementing software that is
     highly portable across multiple platforms and operating systems. This
     portability is very complementary to G2's portability. Using this product,
     G2 applications can leverage the growing number of available libraries of
     Java component software.

G2 ActiveXLink

     G2 ActiveXLink is a connectivity product that allows G2 applications to
     interoperate with other software components developed to comply with the
     Microsoft DCOM/ActiveX standards. This product allows G2 applications to
     interoperate with such industry standard software as EXCEL, Visual Basic,
     and PowerPoint. Using this product, G2 applications can leverage the
     growing amount of available software that conforms to the Microsoft
     DCOM/ActiveX standards.

G2 CORBALink

     G2 CORBA Link is a connectivity product that allows G2 applications to
     interoperate with other software components in a CORBA compliant network.
     CORBA (Common Object Request Broker Architecture) is an industry standard
     for distributed object technology endorsed by the Object Management Group
     (OMG). OMG membership includes IBM, SUN Microsystems, Oracle, Hewlett
     Packard, and Netscape. Using this product, G2 applications will be able to
     distribute data and request services from other CORBA compliant software in
     a network transparent manner.

     G2-RELATED PRODUCTS

     The Company also offers a number of products that are built on G2 or
commonly operate in conjunction with G2. These G2-related products include the
following.

Operations Expert

     Operations Expert (OPEX) is a family of products designed to add
     intelligence and value to traditional network management systems such as HP
     OpenView and IBM NetView and to provide intelligent operations support
     capable of addressing today's complex communications operations problems.
     With OPEX, users have an enhanced ability to meet service-level agreements,
     to manage growth cost-effectively, to minimize the risks of implementing
     new services and technologies, and to gain competitive advantage. Key
     functional uses include early detection of network problems,
     alarm/message/event filtering, alarm correlation across disparate
     platforms, root cause analysis, anticipating effects of network failures,
     and recommending and/or automating appropriate corrective actions.

     The OPEX product family includes:

     .    OPAC--a general-purpose graphical language designed for easy graphical
          representation of operational procedures

     .    SymCure--introduced in 1999, for building fault models that
          automatically identify root causes of failures

     .    IP Reachability Analyzer (IPRA)--for isolating the sources of network
           outages through model-based reasoning and proactive network probes

G2 Diagnostic Assistant

     G2 Diagnostic Assistant ("GDA") can be used to create diagnostic and
     control applications. GDA is based on functional blocks, which are
     graphical objects that can be selected from menus and connected to create
     an application. The functional blocks include logic and fuzzy logic blocks,
     rule blocks, statistical tests, and alarm actions. New blocks can be
     created by the user and added to the application to address specific needs.
     GDA has built-in facilities for alarm handling and explanations of
     diagnostic conclusions, including the capability to quantify the degree of
     certainty of such conclusions.

NeurOn-Line

     NeurOn-Line allows non-programmers who have little or no experience with
     neural networks to take advantage of this technology, particularly for on-
     line, dynamic applications. NeurOn-Line can identify and generate models of
     the physical behavior of processes and of relationships among process
     variables, when given a sufficient set of data. These models can then be
     used on-line to compare process behavior with the model's prediction and to
     control processes. The development of neural network applications in
     NeurOn-Line is done graphically by selecting objects from menus, connecting
     them, and entering attribute and control information.

NeurOn-Line Studio

     NeurOn-Line Studio is a Windows desktop tool for off-line analysis,
     modeling, and design optimization of processes, based on data from a data
     historian or spreadsheet data arrays. To make the tool easy for process
     engineers to use, many technical

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     decisions such as selection of relevant inputs, time delays, and network
     architecture are automated. Once a model has been built for a process,
     NeurOn-Line Studio allows users to discover more profitable ways to run it
     through simulation and optimization. NeurOn-Line Studio models can be
     deployed either in a G2 environment or as Microsoft ActiveX objects in
     embedded Windows applications.

ReThink

     ReThink supports the design, simulation and operational management of
     processes. Using ReThink, process teams can work together to explore
     alternative business or manufacturing process designs quickly and easily on
     an electronic "canvas". Graphical blocks are connected to describe the
     sequences and interdependencies among processing tasks. ReThink brings
     process designs to life using computer animation, making it easy to
     visualize complex processes and measure their performance. ReThink "what-
     if" analyses can calculate the financial and performance impact of policy
     and process changes. ReThink modelers draw upon G2's strength in
     integration, enabling process models to be put on-line to create process
     monitoring, executive information systems, or workflow control
     applications.

Fermentation Expert

     Fermentation Expert supports the intelligent control and management of
     difficult-to-control fermentation processes. Its out-of-the-box
     application-specific capabilities make it easier for pharmaceutical and
     biochemical companies to develop fermentation control applications than if
     they were to begin with Gensym's G2 and GDA products, as they historically
     have.

e-SCOR

     e-SCOR supports the modeling, simulating and managing of supply chains. It
     is built by following the SCOR standard defined by the Supply Chain
     Council. Its "out-of-the-box" capabilities make it very well suited for
     customers who want to design new supply chain infrastructures. It is a new
     product which permits dynamic creation and evaluation of webcentric supply
     chain models.

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CUSTOMERS AND APPLICATIONS

     The Company's customers include end-users, value-added resellers, systems
integrators and OEMs. Many of the largest industrial corporations in the world
are customers of the Company. The use of Gensym's products in many large
industrial corporations is a key asset to the Company in its ability to build
its new Business-to-Business infrastructure business. For the fiscal year ended
December 31, 1999, sales to one customer, BMC Software, accounted for
approximately 12% of the Company's total revenue. As a result, the loss of BMC
as a customer could materially and adversely affect the Company's business and
results of operations. Listed below is a sampling of the Company's customers, in
their respective industries:

            AEROSPACE               FOOD AND BEVERAGE

            Boeing                  Cargill
            Hughes Aircraft         Nabisco
            Lockheed Martin
            NASA                    GOVERNMENT
            Earthwatch
                                    Defence Education and Research Agency (UK)
            AUTOMOTIVE              US Army AI Center
                                    Raytheon Systems company
            Ford                    TRW
            Nissan
            Toyota (Japan)          MINING

            CEMENT                  Noranda
            Lafarge (France)        Met-Mex Penoles (Mexico)
                                    Anglo American (S. Africa)
            CHEMICAL, OIL AND GAS   IMC Agrico Company

            ABB Simcon              PHARMACEUTICAL
            Amoco Oil
            Data Union              Eli Lilly
            Exxon/Mobile            Pfizer
            BP/Amoco                Glaxo
            Citgo Petroleum         Dow Agrosciences
            PDVSA (Venezuela)
            ICI Chemicals (UK)      TELECOMMUNICATIONS
            Saudi Aramco
            Shell                   AT&T
            Union Carbide           Nokia Telecommunications
                                    Ericsson Hewlett-Packard (Sweden)
            FINANCIAL               EUMETSAT (Germany)
                                    GTE
            Andersen Consulting     MCI
            Fidelity Investments    Motorola
            MBNA                    BMC Software
            SWIFT                   Lockheed Martin

                                    TRANSPORTATION

                                    Aeroport International de Lyon (France)
                                    Serco Systems (UK)
                                    US Dept. of Transportation

The Company has sold more than 13,000 licenses, which include both single-user
and multiple-user site licenses, for its products to over 750 industrial,
service and governmental organizations in more than 70 countries. The Company's
products are used internationally in a broad array of applications throughout
various industries, including the following with industries noted:

BRITISH PETROLEUM, Et Al -- Oil and Gas

     Gensym and Gensym Solution Partner EDS developed an oil field production
     management system for the Eastern Trough Area Project (ETAP) in the North
     Sea. A joint project of British Petroleum, Shell, Esso, Agip, Total,
     Murphy, and Moex, ETAP initially entails the integrated development of
     seven oil and gas accumulations. Gensym's G2 was chosen for the Integrated
     Production Management Environment (IPME) for ETAP's Central Processing
     Facility that acts as an export hub for all the oil and gas produced. G2
     applications are used for an operator advisory system, a production
     forecasting system, and a capacity allocations system.

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COMPUTER SCIENCES CORPORATION -- Communications

     Computer Sciences Corporation (CSC) uses Gensym's products as the "brains"
     of a new class of Information Security Systems (ISS). Combining the output
     from other security tools, network management tools, and systems management
     tools with the knowledge of security experts, CSC's ISS applies the power
     of Gensym's reasoning engines in real time to identify security attacks
     that cannot be detected by any one tool. Once detected, notification of a
     potential attack is broadcast immediately with a format and content
     appropriate to the different audiences receiving it. The system uses
     multiple communications media for notification, including on-screen alarms,
     paging, and e-mail and, in the absence of a response, can automatically
     escalate the problem.

ERICSSON HEWLETT-PACKARD TELECOMMUNICATIONS (EHPT) -- Telecommunications

     As an OEM partner for Gensym, EHPT has chosen Gensym's G2 software as the
     foundation for its Fault Management eXpert (FMX), an add-on to their Fault
     Manager product that intelligently handles network faults. Designed to
     improve network efficiency and service quality, FMX gives operators a way
     to distill network experts' knowledge and use it to automate operator
     tasks. By enabling routine and tedious tasks to be automated, FMX frees
     operators to focus on important problems, detect them sooner, solve them
     quickly, and thereby improve service quality.

Eumetsat -- Telecommunications

     Comprising 17 member states, the European Organization for the Exploitation
     of Meteorological Satellites (Eumetsat) was created to establish, maintain,
     and exploit European meteorological satellite systems. EUMETSAT is
     developing a new family of spacecraft, Meteosat Second Generation (MSG),
     which are designed to provide comprehensive weather data for European
     meteorologists. Using Gensym's G2 software, Gensym Solution partner Science
     Systems is developing an intelligent system for the MSG project that will
     monitor and control both the MSG satellites and the ground control centers.

IMC-AGRICO CO. -- Process/Mining

     IMC-Agrico, is the world-leading phosphate supplier. Using Gensym software,
     IMC-Agrico is developing Web-based applications for information gathering,
     as well as advanced process control of its fertilizer and animal feed
     production.

LAFARGE -- Process/Cement

     Lafarge, the world's second largest manufacturer of cement, has G2-based
     intelligent systems at more than 40 cement plants around the world. Lafarge
     started using G2 in 1992 to control its cement kilns. Combining fuzzy logic
     and expert system technology, its advanced kiln control applications allow
     Lafarge to deploy proprietary knowledge enterprise-wide and standardize
     control in its cement plants around the world. Lafarge has now logged more
     than one million hours of on-line cement kiln control using G2. These
     applications have helped the company optimize the cement-producing process,
     saving money, improving product quality, and reducing emissions. Lafarge's
     recent orders for G2 are for intelligent systems to control pre- and post-
     kiln operations, including raw material grinding and clinker grinding. The
     goal of the new applications is to further improve product quality and the
     economics of production.

LOGISTICS INTEGRATION AGENCY -- Government

     The U.S. Army's Logistics Integration Agency (LIA) is using ReThink,
     Gensym's process modeling and simulation tool, to better understand the
     Army's supply chain. The supply chain is complex and prone to inefficient
     use, resulting in inventory tracking problems, long lead times, and
     financial management difficulties. With ReThink, LIA constructed an
     animated model of the entire supply chain, from the retail level to the
     troops in the field. This model supports "what-if" analysis and can measure
     service times and costs, inventory levels, resource requirements, and
     financial performance. ReThink has given senior officers their first end-
     to-end view of the supply process, has become an important training tool
     for military logisticians, and is the key element in a newly-established
     laboratory for logistics policy studies.

MANITOBA -- Government

     The Provincial Government of Manitoba has been using ReThink to support its
     Better Systems Initiative. The purpose of the initiative is to use
     information and Internet technologies to improve government services.
     Manitoba has used Gensym's ReThink to design and re-engineer its core
     business and human services processes in pursuit of the initiative's
     visionary goals.

THE PANAMA CANAL COMMISSION -- Transportation

     The Panama Canal Commission selected Gensym's G2 product to build a
     critical component of its Enhanced Vessel Traffic Management System
     (EVTMS). This system is designed to develop and monitor transit schedules
     for all ships traveling

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      through the canal. The schedules involve the complex coordination of
      resources such as tug boats and locomotives. The location and status of
      all ships and resources are monitored, and schedules are regenerated as
      necessary. EVTMS will provide the canal with Y2K compliant, 24x7 automated
      support for canal operations when control of the canal reverts to Panama.

SALES AND MARKETING

      In order to reach the broadest possible market, the Company's business
units utilize their direct sales resources and over 100 selected marketing
partners.

      The Company markets its products in North America, Europe, Africa, and
parts of Asia through its business units. As of December 31, 1999, the Company
had ten sales offices in North America and direct sales offices in Australia,
France, Germany, Italy, Japan, the Netherlands, Singapore, Sweden, Tunisia and
the United Kingdom. In 1999, 1998, and 1997, the Company received 46%, 47%, and
46% of its total revenues, respectively, from international operations. See Note
8 of Notes to Consolidated Financial Statements for financial information by
geographic area.

      The Company's four strategic business units sell to major accounts and
provide personal contact with customers, both directly and through partners.
Solutions engineers perform demonstrations at customer sites and assist
customers in evaluating their technical requirements and in implementing G2
application prototypes. Regular seminars and workshops are hosted at the
Company's larger offices to demonstrate the Company's products. The Company
offers basic and advanced training courses that teach prospective and new
customers how to build application solutions using the Company's products.

      The Company also distributes its products through a network of more than
50 systems integrators and value-added resellers, who are selected for their
capability to provide end-users with focused application solutions built on G2.
These systems integrators and VARs currently include organizations such as ABB,
EDS, Foxboro, Siemens, Science Systems, and L3 Communications. Product revenues
from systems integrators and value-added resellers represented over 25%, 25%,
and 35% of the Company's product revenues for 1999, 1998, and 1997,
respectively.

      Gensym markets its products in Japan, Brazil, South Africa and certain
other countries through distributors. These distributors have technical
competence in the application of G2, market the Company's products, provide
local training and support assistance to customers, translate documentation,
help localize software, and provide systems integration services.

      Gensym also licenses technology to OEMs, which embed it within their
product offerings . Gensym has established relationships with several OEMs
including Ericsson Hewlett-Packard Telecommunications ("EHPT"), an independent
software company established by Ericsson and Hewlett Packard, and Motorola. EHPT
has chosen Gensym's G2 software as the foundation for its Fault Management
eXpert "FMX" product that intelligently handles network faults. Motorola uses
Gensym's G2 technology for the intelligence within their Network Health Analyzer
"NHA", a new product within their cellular infrastructure family.

      The Company's marketing personnel engage in a variety of activities,
including lead generation, seminars, trade shows, public relations, direct
marketing, advertising, and promotion of customer applications for publication
in industry magazines and journals. More than 300 case studies of successful G2
applications have been documented.

SERVICE AND SUPPORT

      Gensym believes that a high level of customer service and support is
critical to customer satisfaction and project and application success. Most
Gensym customers attend one to three weeks of training and implement their
applications using the development features of Gensym software. The Company
offers a regular schedule of courses in its offices in North America, Europe,
and Asia/Pacific, and special on-site training courses are offered on a demand
basis around the world. Direct application engineering services are available to
customers around the world, to support end-users as well as Gensym marketing
partners.

      The Company offers several customer service options that all include
various levels of telephone support, software updates for major releases, FTP
bulletin board access, membership to Gensym User Society and access to HelpLink,
a workflow enabled web application that greatly enhances the service experience.
The highest level of customer service support includes 24x7 callback service.
Maintenance is mandatory for the first year after purchase and may be renewed in
subsequent years. Gensym typically charges a percentage of the list price
license fee of the underlying product for customer service and offers discounts
for multiple year customer support contracts. The Company has service centers
located in North America and in Europe. Service is also provided by local
marketing partners in Japan and in other areas of the world.

      Gensym offers a variety of application engineering and consulting services
on a fee-for-service basis. Gensym has expertise in applying its software in a
variety of areas including network and systems management; manufacturing process
management; process design, modeling, and simulation; pharmaceutical process
design and control; water treatment; logistics; transportation; and finance. A
key mission of the consulting staff is to assist partners, as well as end-users,
in the successful development and deployment of intelligent systems applications
based on G2.

                                       10
<PAGE>

      The Company offers a progressive series of introductory, intermediate and
advanced training courses for customers, partners and potential users of its
products. The courses are taught at the Company's corporate headquarters in
Cambridge, Massachusetts, at its worldwide sales offices, and at customer
locations.

      Gensym provides continuing support to the Gensym Users Society, an
organization of all G2 users covered by current maintenance contracts. The
Gensym Users Society sponsors an annual worldwide meeting plus additional
regional and local meetings. These meetings are organized as professional
technical conferences, with formal presentations of G2 applications by end-users
and partners, company and product updates by Gensym, product planning forums,
panel discussions, tutorials, workshops, and site visits.

RESEARCH AND DEVELOPMENT

      The Company believes that its future success will depend upon its ability
to enhance existing products as well as to develop and introduce new products
that keep pace with technological developments in the marketplace and address
the increasingly sophisticated needs of its customers. The Company intends to
expand existing product offerings and to introduce new applications. While the
Company expects that certain new products will be developed internally, the
Company may, based on timing and cost considerations, acquire or license
technology and/or products from third parties or consultants.

      New products and enhancements to existing products are typically developed
in response to discussions at user groups and customer feedback obtained by the
Company's customer support and consulting personnel. New product initiatives are
also taken to address targeted markets and industry standards. Recent areas of
focus include conformance to Microsoft Windows and NT standards, CORBA
compliance, component-based product architectures, Internet and World Wide Web
technologies (standard browsers and Java/RMI), and agent-based intelligent
systems.

COMPETITION

      The Company believes that there are no other commercially available
products that offer the full range of capabilities embodied in the Company's
products. While a number of software companies offer products that perform
certain of the functions of G2 for specific applications, the Company believes
that its products offer, as a single seamlessly integrated environment, the most
comprehensive set of software technologies available to build successfully a
broad range of intelligent system applications. Across all of the Company's
markets, competition includes "point solutions," real-time and expert system
products and traditional programming or internally developed software. In
addition, virtually all of the Company's customers have significant investments
in their existing solutions and have the resources necessary to enhance existing
products and to develop future products.

      Certain companies such as Objective Systems Integrators, Inc., Micromuse,
Systems Management Arts (SMARTS), and Pavilion sell "point solutions" that
compete with the Company's products with respect to specific applications or
uses. An intelligent system based on point solutions, however, requires the
integration of various software packages from different vendors, and is often
difficult to maintain. Although our competitors' systems may provide a faster
implementation, such systems may fail to provide the capabilities and
flexibility needed to satisfy the changing requirements of a dynamic complex
environment. Point solutions may also fail to provide the extensibility to add
rules and neural networks, and may be difficult to migrate to more powerful
computers.

      Several companies, including Ilog S.A., offer products with limited
real-time or expert system development capabilities at lower price points than
those provided by the Company. These products often require extensive
programming with languages such as C or C++ for complete implementation. The
Company believes that these products lack the comprehensive capabilities of its
G2 environment and G2-based products, and therefore have limitations in the
types of operational problems that they can address relative to G2.

      Some potential customers opt to build their own intelligent systems using
traditional programming languages. These systems require that knowledge be
programmed, usually at a high cost, and are typically difficult to adapt, reuse,
maintain, and scale up. Building an intelligent system using traditional
programming is a major effort that is often impractical -- particularly for
applications that work in real time.

      The principal competitive factors in all of the Company's markets are
functionality, ease of use, price, distribution capabilities, quality,
performance, customer support, and availability of application software
implementation services. The Company believes that its products are superior in
terms of functionality, ease of use, and performance in the advanced
applications that constitute the Company's principal market, and that it
competes favorably on the basis of these factors. In order to maintain its
competitive position, the Company must continue to enhance its existing products
and introduce new products that meet evolving customer requirements. It must
also maintain a valid perceived value proposition in comparison with its expert
systems competitors. There is no assurance that the market position or the
competitive advantages of the Company will continue. See "Certain Factors That
May Affect Future Results - Competition."

                                       11
<PAGE>

PROPRIETARY RIGHTS

      The Company relies primarily on a combination of patent law, copyright law
and trade secret law to protect its proprietary technology. The Company also has
internal policies and systems to limit access to and keep confidential its trade
secrets. The Company distributes its products under software license agreements
that contain various provisions to protect the Company's ownership of and the
confidentiality of the underlying technology. The Company also requires its
employees and other parties with access to its confidential information to
execute agreements prohibiting the unauthorized use or disclosure of the
Company's technology. In addition, the Company periodically reviews its
proprietary technology for patentability and has one patent covering specific
aspects of G2. The Company has also placed technical inhibitors in its software
that prevent the software from running on unauthorized computers. Despite these
precautions, it may be possible for a third party to misappropriate the
Company's technology or to develop similar technology independently. In
addition, effective patent, copyright and trade secret protection may not be
available in every foreign county in which the Company's products are
distributed.

      Certain technology used in the Company's products is licensed from third
parties. The Company believes that, in general, comparable licenses are
available on commercially comparable terms from a number of licensors and does
not believe that any of the Company's products are significantly dependent upon
such licensed technologies.

      Despite the Company's efforts to protect its proprietary rights, attempts
may be made to copy or reverse engineer aspects of the Company's products or to
obtain and use information that the Company regards as proprietary. There can be
no assurance that others will not develop products that infringe the Company's
proprietary rights or are similar or superior to those developed by the Company.
Policing the unauthorized use of the Company's products is difficult. Litigation
may be necessary in the future to enforce the Company's intellectual property
rights, to protect the Company's trade secrets or to determine the validity and
scope of the proprietary rights of others. Such litigation could result in
substantial costs and diversion of resources and could have a material adverse
effect on the Company's business, results of operations and financial condition.
Also, there can be no assurance that third parties will not assert infringement
claims against the Company in the future with respect to current or future
products. Any such assertion could require the Company to enter into royalty
arrangements or result in costly litigation, which could have a material adverse
effect on the Company's business, results of operations and financial condition.

      Gensym(R), G2(R), NeurOn-Line(R), ReThink(R), and Operations Expert(R) are
registered trademarks of the Company. The Gensym logo, GDA, ReThink, G2 WebLink,
and OPEX are trademarks of the Company. The Company has filed applications to
register Gensym, G2, NeurOn-Line, and OPEX in certain foreign jurisdictions. In
addition, the Company has an exclusive, worldwide, royalty-free, perpetual
license from Microsoft Corporation to use the trademark Telewindows.

BACKLOG

      The Company ships software products within a short period after receipt of
an order and typically does not have a material backlog of unfilled orders of
software products. Therefore, revenues from software licenses in any quarter are
substantially dependent on orders booked in that quarter.

EMPLOYEES

      As of December 31, 1999, the Company had 230 full-time employees,
including 84 in sales and marketing, 46 in product development, 40 in consulting
services, 35 in customer support, production and licensing, and educational
services, and 25 in general and administrative functions. None of the Company's
employees is represented by a labor union, and the Company believes that its
employee relations are good.

ITEM 2. PROPERTIES

      The Company's headquarters and principal operations are located in a
leased facility with 52,322 square feet in Cambridge, Massachusetts. The
Company's lease expires on December 31, 2000, with an option to renew for an
additional term of five years . In addition to rental expenses, the Company must
also pay an allocated portion of operating expenses and taxes each year. The
Company also leases sales office space in the metropolitan areas of several
cities throughout North America, as well as Australia, France, Germany, Italy,
the Netherlands, Singapore, Sweden, Tunisia and the United Kingdom. The Company
has its European headquarters in Leiden, The Netherlands, where it leases over
9,000 square feet of office space. The Company's aggregate facilities rental
expense, net of rental income from sub-leases, for all facilities during
1999 was $1.8 million. Gensym believes that its existing facilities are
adequate for its current needs and that suitable additional space will be
available as required.

ITEM 3. LEGAL PROCEEDINGS

      In April 1999, Special Situations Fund III, L.P. ("SSF"), a Gensym
stockholder, filed a complaint in the Court of Chancery of the State of Delaware
in and for New Castle County seeking an order directing Gensym to provide
specified information concerning the identity of Gensym's stockholders, Gensym's
by-laws, and other documents. SSF also sought reimbursement of its costs,
expenses and attorneys' fees. On June 7, 1999, SSF dismissed its complaint
without prejudice pursuant to Court of Chancery Rule 41(a)(1)(I).

                                       12
<PAGE>

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

      No matter was submitted to a vote of the Company's securityholders during
the fourth quarter of 1999.

EXECUTIVE OFFICERS OF THE COMPANY

      The executive officers of the Company and their respective ages as of
March 10, 2000 as follows:

          Name        Age                                             Position

Patrick Courtin        56   Chairman of the Board of Directors, Chief Executive
                              Officer and President
Robert L. Moore        57   Senior Vice President
William H. Wood        61   Senior Vice President, Communications Business Unit
Jeffery  A. Weber      53   Vice President, Finance and Administration and Chief
                              Financial Officer
Mark H. Whitworth      48   Vice President, Advanced Systems Business Unit
James J. Slane         45   Vice President, Corporate Marketing
Carl Davies            38   Vice President and Managing Director, EMA

Mr. Courtin has served as Chairman of the Board, Chief Executive Officer and
President since November 1999. Mr. Courtin has been a member of Gensym's board
of directors since May 1999. From February 1996 to May 1999, he was president
and chief executive officer of M3i Systems Inc. Prior to joining M3i Systems,
Mr. Courtin served as chairman and chief executive officer of Comstream Inc.
from February 1994 to August 1995. Mr Courtin has previously held senior
executive positions at SPAR Aerospace, Proteon Inc., TIE Communications, and
Digital Equipment Corporation.

Dr. Moore, a founder of the Company, has served as Senior Vice President since
November 1999. On March 31, 2000 Dr. Moore plans to resign as Senior Vice
President of the Company. From 1986 to November 1999, Dr. Moore served as
President and Director of the Company. Prior to founding the Company, Dr. Moore
founded and was Vice President of the Process Systems Division of Lisp Machines
Inc. from 1983 to 1986. From 1981 to 1983, Dr. Moore was President of Sentrol
Systems Inc., a supplier of process control systems. Dr. Moore received his
undergraduate degrees in Electrical Engineering and Engineering Mathematics from
the University of Michigan, his Ph.D. degree from the Massachusetts Institute of
Technology, with a major in Automatic Control and a minor in Industrial
Management.

Mr. Wood has served as Vice President, Communications Business Unit since March
1997. From July 1995 through December 1996 Mr. Wood was Vice President and
General Manager, North American Operations of Information Systems Management at
Bull Information Systems. Mr. Wood held various senior management positions at
Candle Corporation from 1984 to July 1995, where he most recently served as Vice
President of Worldwide Marketing. His prior sales and marketing experience
includes positions with IBM and Xerox. Mr. Wood has a B.S. in Mechanical
Engineering from University of Cincinnati.

Mr. Weber joined the Company in February 2000 as Vice President, Finance and
Chief Financial Officer. From June 1999 to January 2000, Mr. Weber provided
management consulting services to several companies. From July 1997 to June
1999, Mr. Weber was Vice President, Finance and Chief Financial Officer of Summa
Four, a manufacturer of open programmable telephony switches and which was
acquired by Cisco Systems in November 1998. From June 1994 to June 1997, Mr.
Weber was Senior Vice President, Operations and Finance and Chief Financial
Officer of Computer Identics, a manufacturer of bar code data collection
products and which was acquired by Robotic Vision Systems in August 1996.

Mr. Whitworth joined the Company in July 1992 as its Director of Consulting
Services and has served as Vice President, Advanced Systems Business Unit since
January 1997. From May 1995 to December 1996 Mr. Whitworth served as the Vice
President of Consulting Services. Prior to joining the Company, Mr. Whitworth
was Director of Consulting Services at MainStream Software Company from 1990 to
1992. Mr. Whitworth has an A.B. in Mathematics from Colby College and an M.S. in
Computer Science from the University of Oregon.

Mr. Slane joined the Company in February 2000, as Vice President, Marketing.
From March 1998 to February 2000 Mr. Slane was vice president of marketing for
PictureTel Corporation responsible for all marketing and product management.
Prior to joining PictureTel, Mr. Slane was the vice president of marketing and
director with Onsett International, an IT technology consulting firm from March
1995 to March 1998. Mr. Slane earned a bachelor's degree from Saint Michael's
College, an MBA from American International University and he has completed
executive technical and management programs at the Wharton School and Babson
College.

Mr. Davies joined the Company in 1993 as an Area Sales Manager for the United
Kingdom region. He was promoted in 1996 to Director of Sales for EMA
(Europe/Middle East/Africa) and in 1998 to Vice President of Operations for EMA.
Previously, Mr. Davies worked with British Petroleum as a software and systems
engineer, two years of which were spent working with BP Ventures. Mr. Davies
holds a B.S. degree in Mechanical Engineering and a Masters degree in Systems
Engineering from the University of Wales Institute of Science and Technology,
Cardiff, Wales.

                                       13
<PAGE>

PART II.

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
        MATTERS

(a) Market Information

      The Common Stock of the Company is traded on The Nasdaq Stock Market
("Nasdaq") under the symbol "GNSM". The Common Stock was first traded on Nasdaq
on February 16, 1996. Prior to the Company's initial public offering of Common
Stock ("the Offering") there was no established public trading market for the
Company's shares of Common Stock.

      The table below sets forth the high and low sales prices of the Company's
Common Stock by quarter, for the years 1998 and 1999.

                      1998               High        Low
            ------------------------   --------   ---------

            First quarter                8 7/8     4 9/16
            Second quarter               8 3/4     4 5/16
            Third quarter              4 11/16    2 15/16
            Fourth quarter             4 11/16      1 3/4

                      1999               High        Low
            ------------------------   --------   ---------

            First quarter                3 7/8      2 5/8
            Second quarter               4 1/8     2 9/16
            Third quarter               4 7/16      3 1/4
            Fourth quarter             6 11/16      3 1/8

      The Company has never declared or paid cash dividends on its capital
stock. The Company does not anticipate paying any cash dividends in the
foreseeable future. Payment of future dividends, if any, will be at the
discretion of the Company's Board of Directors after taking into account various
factors, including the Company's financial condition, operating results, current
and anticipated cash needs and plans for expansion.

      The number of holders of record of the Company's Common Stock at March 14,
2000 was 107. This number does not include stockholders for whom shares are held
in a "nominee" or "street" name.

(b) Stock Repurchase Program

      In the third quarter of 1998, the Company began a program to repurchase up
to 650,000 shares of its Common Stock on the open market. As of December 31,
1999, 501,300 shares had been repurchased at a cost of $1,869,000. No shares
have been repurchased since March 31, 1999.

                                       14
<PAGE>

ITEM 6. SELECTED FINANCIAL DATA

      The selected consolidated balance sheet data presented below as of
Decembers 31, 1999 and 1998 and the selected consolidated statement of
operations data for each of the three years in the period ended December 31,
1999 are derived from the Company's Consolidated Financial Statements, included
elsewhere in this Annual Report, and have been audited by Arthur Andersen LLP,
independent public accountants (the "Consolidated Financial Statements"). The
selected consolidated balance sheet data presented below as of December 31,
1997, 1996, and 1995, and the selected consolidated statement of operations data
for the years ended December 31, 1996 and 1995, are derived from the Company's
Consolidated Financial Statements, not included in this Annual Report on Form
10-K, all of which have been audited by Arthur Andersen LLP, independent public
accountants. These data should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements and related Notes included elsewhere in
this Annual Report on Form 10-K.

<TABLE>
<CAPTION>
                                                                     YEAR ENDED DECEMBER 31,
                                                      1999        1998        1997        1996       1995
                                                    --------    --------    --------    --------   --------
<S>                                                  <C>         <C>         <C>         <C>        <C>
CONSOLIDATED STATEMENT OF                                    (In thousands, except per share data)
     OPERATIONS DATA:
Revenues:
     Product                                         $19,628     $16,911     $18,433     $21,358    $16,438
     Service                                          16,799      18,067      17,076      15,877     11,703
                                                    --------    --------    --------    --------   --------
          Total revenues                              36,427      34,978      35,509      37,235     28,141

Cost of Revenues                                       8,574       8,698       9,352       7,385      5,315
                                                    --------    --------    --------    --------   --------
Gross profit                                          27,853      26,280      26,157      29,850     22,826
                                                    --------    --------    --------    --------   --------

Operating expenses:
     Sales and marketing                              18,214      18,276      18,802      17,433     14,568
     Research and development                          6,470       6,023       6,977       5,984      5,267
     General and administrative                        5,288       4,134       4,528       3,699      2,619
     Restructuring charge                                 --          --       1,558          --         --
                                                    --------    --------    --------    --------   --------
          Total operating expenses                    29,972      28,433      31,865      27,116     22,454
                                                    --------    --------    --------    --------   --------

Operating income (loss)                               (2,119)     (2,153)     (5,708)      2,734        372
Other income, net                                        503         715         779         518        236
                                                    --------    --------    --------    --------   --------

Income (loss) before provision for income taxes       (1,616)     (1,438)     (4,929)      3,252        608
Provision for income taxes                               336          50          40       1,204        411
                                                    --------    --------    --------    --------   --------

Net income (loss)                                    $(1,952)    $(1,488)    $(4,969)     $2,048       $197
                                                    ========    ========    ========    ========   ========

Basic income (loss) per share (1)                     $(0.32)     $(0.23)     $(0.79)      $0.35      $0.05
                                                    ========    ========    ========    ========   ========

Diluted income (loss) per share (1)                   $(0.32)     $(0.23)     $(0.79)      $0.33      $0.04

                                                    ========    ========    ========    ========   ========
Weighted average common shares outstanding (1)         6,149       6,371       6,310       5,910      3,994
                                                    ========    ========    ========    ========   ========
Weighted average common shares outstanding
     assuming dilution (1)                             6,149       6,371       6,310       6,286      4,762
                                                    ========    ========    ========    ========   ========

CONSOLIDATED BALANCE SHEET DATA:

Cash, cash equivalents and short-term investments    $11,685     $14,534     $15,801     $19,590     $5,092
Working capital                                       12,814      14,650      15,149      20,470      6,176
Total assets                                          26,934      28,268      31,517      36,258     17,846
Total stockholders' equity                            14,922      17,483      19,828      24,068      8,611
</TABLE>

(1)   Computed as described in Note 1(i) of Notes to Consolidated Financial
      Statements.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

OVERVIEW

      The Company was incorporated in 1986 to provide software products for
intelligent operations management. The Company's core product, G2, and G2-based
products are sold to customers for a broad array of intelligent operations
management applications in a wide range of industries, including manufacturing,
telecommunications, government, aerospace, transportation, and financial
services. In addition, the Company derives significant service revenues from
maintenance contracts, consulting services, and training courses related to its
software products.

      The Company markets and sells its products through its direct sales force
in the United States, Europe, Africa, and Asia, as well as through selected
distributors in other countries, including Japan. The Company also sells its
products through value-added

                                       15
<PAGE>

resellers and systems integrators, which provide consulting services and
integrated solutions to their customers. The Company further licenses technology
to OEMs, which embed it within their product offerings.

      Throughout 1999 the Company was organized into four business units:
Manufacturing, Communications, Advanced Systems, and EMA (Europe/Middle
East/Africa). These business units generally have their own specialized sales,
business development, consulting, and product development resources to provide
the level of application and industry specific knowledge needed to achieve
sustained growth, and profitability in their respective markets.

      This Annual Report on Form 10-K contains forward-looking statements. For
this purpose, any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Without limiting
the foregoing, the words "believes," "anticipates," "plans," "expects,"
"intends" and similar expressions are intended to identify forward-looking
statements. There are a number of important factors that could cause the
Company's actual results to differ materially from those indicated by such
forward-looking statements. These factors include, without limitation, those set
forth below under the caption "Certain Factors That May Affect Future Results".

RESULTS OF OPERATIONS

      The following table sets forth, as a percentage of total revenues,
consolidated statements of operations data for the periods indicated:

                                                      Year ended December 31,
                                                     1999      1998      1997
                                                     -----     -----     -----

            Revenues:
                   Product                            53.9 %    48.3 %    51.9 %
                   Service                            46.1      51.7      48.1
                                                     -----     -----     -----
                         Total revenues              100.0     100.0     100.0

            Cost of revenues                          23.5      24.9      26.3
                                                     -----     -----     -----

            Gross margin                              76.5      75.1      73.7
                                                     -----     -----     -----

            Operating expenses:
                   Sales and marketing                50.0      52.3      53.0
                   Research and development           17.8      17.2      19.6
                   General and administrative         14.5      11.8      12.8
                   Restructuring charge                 --        --       4.4
                                                     -----     -----     -----
                         Total operating expenses     82.3      81.3      89.8
                                                     -----     -----     -----

            Operating loss                            (5.8)     (6.2)    (16.1)

            Other income, net                          1.4       2.0       2.2
                                                     -----     -----     -----

            Loss before provision for income taxes    (4.4)     (4.2)    (13.9)

            Provision for income taxes                 0.9       0.1       0.1
                                                     -----     -----     -----

            Net loss                                  (5.3)%    (4.3)%   (14.0)%
                                                     =====     =====     =====

YEARS ENDED DECEMBER 31, 1999 AND 1998

Revenues

      The Company's operating revenues are derived from two sources: product
licenses and services. Product revenues include revenues from sales of licenses
for use of the Company's software products. Service revenues consist of fees for
maintenance contracts, consulting services, and training courses related to the
Company's products.

      Total revenues were $36.4 million for the year ended December 31, 1999 as
compared to $35.0 million for 1998, an increase of $1.4 million or 4.1%. The
increase in total revenues was attributable to increased sales of product
licenses, partially offset by a decrease in service revenues. International
revenues accounted for 46% and 47% of total revenue in 1999 and 1998,
respectively.

                                       16
<PAGE>

      Product. Product revenues increased to $19.6 million for the year ended
December 31, 1999 from $16.9 million in 1998, an increase of 16.1%. The increase
in product revenues primarily reflects an increased demand for the Company's
products in the telecommunications industry. Product revenues increased year
over year in both North America (up $1.1 million) and Europe (up $1.5 million);
product revenues were unchanged year over year in the Asia-Pacific region.

      Service. Service revenues decreased to $16.8 million for the year ended
December 31, 1999 from $18.1 million in the same period in 1998, a decrease of
7.0%. The decrease in service revenues was primarily due to a decrease in
application consulting revenues and, to a lesser extent, decreased educational
services fees. Maintenance revenues increased to $9.4 million for the year ended
December 31, 1999 from $9.2 million in the same period in 1998, an increase of
2.2%. Consulting revenue decreased to $6.4 million for the year ended December
31, 1999 from $7.6 million in the same period in 1998, a decrease of 15.8%. Fees
for educational services decreased to $1.1 million for the year ended December
31, 1999 from $1.3 million in the same period in 1998, a decrease of 15.4%.

Cost of Revenues

      Cost of revenues primarily consists of consulting labor, technical support
costs, and the costs of material and labor involved in producing and
distributing the Company's software. Total Cost of revenues decreased slightly
for 1999 to $8.6 million (23.5% of total revenue) compared to $8.7 million
(24.9% of total revenue) for 1998. Gross margin on revenue increased to 76.5%
for the period ended December 31, 1999 from 75.1% in the same period for 1998.
The increase in gross margin resulted from greater product revenue and lower
infrastructure costs.

Operating Expenses

      Total operating expenses increased to $30.0 million (82.3% of total
revenue) for the year ended December 31, 1999 from $28.4 million (81.3% of total
revenue) in the same period in 1998, an increase of 5.4%. The increase in
spending was in general and administrative and research and development.

      Sales and Marketing. Sales and marketing expenses consist primarily of
costs associated with personnel involved in the sales and marketing process,
sales commissions, sales facilities, travel and lodging, trade shows and
seminars, advertising, and promotional materials. Total expenses remained
relatively unchanged at $18.2 million (50.0% of total revenue) for year ended
December 31 1999, from $18.3 million (52.3% of total revenue) for the comparable
period in 1998. The decrease as a percent of revenue was due to higher revenues
in 1999 compared to 1998.

      Research and Development. Research and development expenses consist
primarily of costs of personnel, equipment, and facilities. Research and
development expenses increased 7.4% to $6.5 million (17.8% of total revenues)
for the year ended December 31, 1999 from $6.0 million (17.2% of total revenues)
for the comparable period in 1998. The increase in spending was primarily due to
the cost associated with the hiring and retaining of engineering personnel.

      General and Administrative. General and administrative expenses consist
primarily of personnel costs for finance, administration, operations,
information systems, and general management, as well as legal and accounting
expenses. These expenses increased 27.9% to $5.3 million (14.5% of total
revenues) for the year ended December 31, 1999 from $4.1 million (11.8% of total
revenues) for the comparable period in 1998. The increase in expenses was due to
increased personnel recruiting costs, severance costs, and costs associated with
accounting and legal services.

Other Income

      For the year ended December 31, 1999, other income was $503,000 compared
to $715,000 for the comparable period in 1998. The decrease was due to decreased
interest income due to lower cash balances. The Company has historically
experienced nominal net foreign exchange transaction gains or losses.

Income Taxes

      The Company recorded a provision for income taxes of $336,000 and $50,000,
for the years ended December 31, 1999 and 1998, respectively. The provision in
both years represents income taxes on income generated in foreign jurisdictions
and revenue withholding tax on sales in certain foreign jurisdictions. The
Company generated significant tax loss carryforwards during the years ended
December 31, 1999, 1998, and 1997. The tax loss carryforwards can be carried
forward for 15 to 20 years. Under SFAS No. 109, the Company cannot recognize a
deferred tax asset for the future benefit of its tax loss carryforward unless it
concludes that it is "more likely than not" that such deferred tax asset would
be realized. Accordingly, the Company has established a valuation allowance
against a portion of its deferred tax asset to the extent that it cannot
demonstrate that it is "more likely than not" that these assets will be
realized. In determining the amount of valuation allowance required, the Company
considers numerous factors, including historical profitability, estimated future
taxable income, the volatility of its historical earnings and of the industry in
which

                                       17
<PAGE>

it operates, and its assessment of the likelihood that the deferred tax asset
derived from its net operating losses will be realized in the carryforward
period. See Note 4 of Notes to Consolidated Financial Statements.

YEARS ENDED DECEMBER 31, 1998 AND 1997

Revenues

      Total revenues were $35.0 million for the year ended December 31, 1998 as
compared to $35.5 million for 1997, a decrease of $500,000 or 1.5%. The decrease
in total revenues was attributable to decreased sales of product licenses,
partially offset by an increase in service revenues. International revenues
accounted for 47% and 46% of total revenue in 1998 and 1997, respectively.

      Product. Product revenues decreased to $16.9 million for the year ended
December 31, 1998 from $18.4 million in 1997, a decrease of 8.3%. The decrease
in product revenues reflects, in large part, decreased demand for the Company's
products in the Asia-Pacific region and in the petrochemical industry where low
oil prices have resulted in tighter budgets and delayed purchase decisions. The
Company has historically derived a significant percentage of its revenue from
the petrochemical industry. Also contributing to decreased revenue was the
decision made by some customers and prospective customers to address Y2K issues,
resources that might otherwise have been used to develop and deploy G2-based
solutions.

      Service. Service revenues increased to $18.1 million for the year ended
December 31, 1998 from $17.1 million in the same period in 1997, an increase of
5.8%. The increase in service revenues was primarily due to an increase in
application consulting revenues and, to a lesser extent, increased maintenance
fees derived from an increased customer base, partially offset by a decrease in
educational services. Maintenance revenues increased to $9.2 million for the
year ended December 31, 1998 from $9.0 million in the same period in 1997, an
increase of 2.2%. Consulting fees increased to $7.6 million for the year ended
December 31, 1998 from $6.5 million in the same period in 1997, an increase of
16.9%. Fees for educational services decreased to $1.3 million for the year
ended December 31, 1998 from $1.6 million in the same period in 1997, a decrease
of 18.8%.

Cost of Revenues

      Cost of revenues decreased to $8.7 million in 1998 from $9.4 million in
1997, a decrease of 7.0%. This decrease was primarily due to a decrease in
consulting labor costs. Gross margin on revenues increased to 75.1% for the year
ended December 31, 1998 from 73.7% in the same period in 1997. The increase in
gross profit resulted primarily from improved utilization of consulting
personnel coupled with higher consulting revenues and lower product distribution
costs.

Operating Expenses

      Total operating expenses decreased to $28.4 million for the year ended
December 31, 1998 from $31.9 million in the same period in 1997, a decrease of
10.8%, due principally to cost reduction measures that were implemented in 1997.
Such reductions included a 15% reduction in staff as well as reduced facilities
and related costs.

      Sales and Marketing. For the year ended December 31, 1998, sales and
marketing expenses decreased 2.8% to $18.3 million (52.3% of total revenues)
from $18.8 million (53.0% of total revenues) for the comparable period in 1997.
The decrease in absolute dollars was primarily a result of a decrease in sales
and marketing personnel and the closing and consolidation of several field sales
offices.

      Research and Development. Research and development expenses decreased
13.7% to $6.0 million (17.2% of total revenues) for the year ended December 31,
1998 from $7.0 million (19.6% of total revenues) for the comparable period in
1997. The decrease in absolute dollars was primarily due to a reduction in
personnel, the consolidation of headquarter facilities, and other actions taken
in connection with the Company's restructuring implemented in 1997.

      General and Administrative. General and administrative expenses decreased
8.7% to $4.1 million (11.8% of total revenues) for the year ended December 31,
1998 from $4.5 million (12.8% of total revenues) for the comparable period in
1997. The decrease in absolute dollars was primarily due to a reduction in
personnel, the consolidation of headquarters facilities, and other actions taken
in connections with the Company's restructuring plan implemented in 1997.

      Restructuring Charge. In June 1997, the Company implemented a plan of
restructuring intended to lower operating expenses in subsequent periods by
reducing its workforce by approximately 15%, closing and consolidating several
field sales offices, and consolidating office space in its corporate
headquarters. Accordingly, the Company recorded a restructuring charge of
approximately $2.0 million in the quarter ended June 30, 1997. In 1998, no
provision for a restructuring charge was made. As of June 30, 1998, the Company
had taken actions in all intended areas consistent with its restructuring plan
of June 1997 and had substantially completed that plan.

                                       18
<PAGE>

Other Income

      For the year ended December 31, 1998, other income decreased to $715,000
from $779,000 for the comparable period in 1997. The decrease was primarily due
to the Company's recording of a one-time benefit in 1997 relating to the
recovery of its interest in a joint venture. The reduction was partially offset
by an increase in investment income from $591,000 in 1997 to $678,000 in 1998.

Income Taxes

      The Company recorded a provision for income taxes of $50,000 and $40,000,
for the years ended December 31, 1998 and 1997, respectively. The provision in
both years represents income taxes on income generated in foreign jurisdictions.
The Company generated a significant tax loss carryforward during the years ended
December 31, 1998 and 1997.

Selected Quarterly Operating Results

      The Company's operating results have fluctuated in the past and may
fluctuate significantly in the future. Because the Company ships software
products within a short period after receipt of an order, the Company typically
does not have a material backlog of unfilled orders for software products.
Accordingly, revenues from software licenses in any quarter are substantially
dependent on orders for software products booked in the quarter.

      The revenues for a quarter typically include a number of large orders. If
the timing of any of these orders is delayed, it could result in a substantial
reduction in revenues for that quarter. Historically, a majority of each
quarter's revenues from software licenses has come from license contracts that
have been effected in the final weeks of that quarter. Since the Company's
expense levels are based in part on its expectations as to future revenues, the
Company may be unable to adjust spending in a timely manner to compensate for
any revenue shortfall. Accordingly, any revenue shortfalls would likely have a
disproportionate adverse effect on net income.

      The following tables present unaudited financial information for the
Company's eight most recent quarters. The following selected quarterly
information includes all adjustments (consisting only of normal recurring
adjustments) that the Company considers necessary for a fair presentation. The
Company believes that quarter-to-quarter comparisons of its financial results
are not necessarily meaningful and that such comparisons should not be relied
upon as an indication of future performance.

<TABLE>
<CAPTION>
                                                                        Quarter Ended
                                     Dec. 31,   Sept. 30,  June 30,    Mar. 31,     Dec. 31,    Sept. 30,     June 30,     Mar. 31,
                                       1999        1999      1999        1999         1998         1998         1998         1998
                                     -------     ------    --------    --------     --------     --------     --------     --------
                                                                           (In thousands)
<S>                                  <C>         <C>         <C>         <C>         <C>           <C>          <C>          <C>
Revenues:
      Product                         $5,026     $5,205      $5,337      $4,060       $3,509       $4,258       $4,520       $4,624
      Service                          4,119      3,980       4,404       4,296        4,614        4,489        4,504        4,460
                                     -------     ------    --------    --------     --------     --------     --------     --------
          Total revenues               9,145      9,185       9,741       8,356        8,123        8,747        9,024        9,084

Cost of revenues                       2,136      2,113       2,180       2,145        2,130        2,193        2,127        2,248
                                     -------     ------    --------    --------     --------     --------     --------     --------

Gross margin                           7,009      7,072       7,561       6,211        5,993        6,554        6,897        6,836
                                     -------     ------    --------    --------     --------     --------     --------     --------

Operating expenses:
      Sales and marketing              4,786      4,421       4,529       4,478        4,764        4,563        4,686        4,263
      Research and development         1,514      1,631       1,768       1,557        1,517        1,516        1,532        1,459
      General and administrative       2,081        926       1,121       1,160        1,123          934        1,002        1,074
                                     -------     ------    --------    --------     --------     --------     --------     --------
          Total operating expenses     8,381      6,978       7,418       7,195        7,404        7,013        7,220        6,796
                                     -------     ------    --------    --------     --------     --------     --------     --------

Operating  income (loss)              (1,372)        94         143        (984)      (1,411)        (459)        (323)          40

Other income, net                        161        114         117         111          203          179          171          162
                                     -------     ------    --------    --------     --------     --------     --------     --------

Income (loss) before provision for
       income taxes                   (1,211)       208         260        (873)      (1,208)        (280)        (152)         202

Provision for income taxes               209         45          37          45           --           --           --           50
                                     -------     ------    --------    --------     --------     --------     --------     --------

Net income (loss)                    $(1,420)      $163        $223       $(918)     $(1,208)       $(280)       $(152)      $  152
                                     =======     ======    ========    ========     ========     ========     ========     ========
</TABLE>

                                       19
<PAGE>

<TABLE>
<CAPTION>
                                                                          Quarter Ended
                                     Dec. 31,   Sept. 30,  June 30,    Mar. 31,     Dec. 31,    Sept. 30,     June 30,     Mar. 31,
                                       1999        1999      1999        1999         1998         1998         1998         1998
                                     -------     ------    --------    --------     --------     --------     --------     --------
                                                                           (In thousands)
<S>                                  <C>         <C>         <C>         <C>         <C>           <C>          <C>          <C>
Revenues:
     Product                            55.0 %     56.7%       54.8%       48.6 %       43.2 %       48.7 %       50.1 %       50.9%
     Service                            45.0       43.3        45.2        51.4         56.8         51.3         49.9         49.1
                                     -------     ------    --------    --------     --------     --------     --------     --------
          Total revenues               100.0      100.0       100.0       100.0        100.0        100.0        100.0        100.0

Cost of revenues                        23.4       23.0        22.4        25.7         26.2         25.1         23.6         24.7

Gross margin                            76.6       77.0        77.6        74.3         73.8         74.9         76.4         75.3
                                     -------     ------    --------    --------     --------     --------     --------     --------

Operating expenses:

     Sales and marketing                52.3       48.1        46.5        53.6         58.7         52.1         51.9         47.0
     Research and development           16.5       17.8        18.1        18.6         18.7         17.3         17.0         16.1
     General and administrative         22.8       10.1        11.5        13.9         13.8         10.7         11.1         11.8
                                     -------     ------    --------    --------     --------     --------     --------     --------
          Total operating expenses      91.6       76.0        76.1        86.1         91.2         80.1         80.0         74.9
                                     -------     ------    --------    --------     --------     --------     --------     --------

Operating income (loss)                (15.0)       1.0         1.5       (11.8)       (17.4)        (5.2)        (3.6)         0.4

Other income, net                        1.8        1.2         1.2         1.3          2.5          2.0          1.9          1.8
                                     -------     ------    --------    --------     --------     --------     --------     --------

Income (loss) before provision for
     income taxes                      (13.2)       2.2         2.7       (10.5)       (14.9)        (3.2)        (1.7)         2.2

Provision for income taxes               2.3        0.5         0.4         0.5           --           --           --          0.5
                                     -------     ------    --------    --------     --------     --------     --------     --------

Net income (loss)                      (15.5)%      1.7%        2.3%      (11.0)%      (14.9)%       (3.2)%       (1.7)%        1.7%
                                     =======     ======    ========    ========     ========     ========     ========     ========
</TABLE>

LIQUIDITY AND CAPITAL RESOURCES

      The Company currently finances its operations, along with capital
expenditures, primarily through cash flows from operations and its current cash
and short-term investment balances. The Company's lease commitments consist of
operating leases primarily for the Company's facilities and computer equipment.

      At December 31, 1999, the Company had cash, cash equivalents, and
short-term investments of $11.7 million. The Company regularly invests excess
funds in highly-rated money market funds, government securities, and commercial
paper.

      Cash and cash equivalents decreased $8.0 million from $13.7 million at
December 31, 1998 to $5.7 million at December 31, 1999.

      Cash used for operations in 1999 was $2.1 million: $2.0 million was used
for the funding of the Company's operating loss, $2.1 million was used to fund
accounts receivables, $1.0 million was provided by depreciation and amortization
expense, and $1.0 million was provided by an increase in accrued liabilities.

      Cash used for investing activities in 1999 was $5.4 million: $5.1 million
was used to purchase short-term investments and $260,000 was used to purchase
equipment and other assets.

      Cash used in financing activities was $93,000: $591,000 was used to
purchase treasury stock, partially offset by proceeds of $498,000 from the
exercise of stock options and issuance of common stock under the employee stock
purchase plan.

      Cash decreased $437,000 in 1999 due to the effect of currency fluctuation.

      The Company believes that its available funds and cash generated from
operations will be sufficient to meet the Company's business requirements at
least through December 31, 2000.

                                       20
<PAGE>

Stock Repurchase Program

      In the third quarter of 1998, the Company began a program to repurchase up
to 650,000 shares of its Common Stock on the open market. As of December 31,
1999, 501,300 shares had been repurchased at a cost of $1,869,000. There has
been no repurchase of shares since March 31, 1999.

Year 2000 Disclosure

      Many currently installed computer systems and software products are coded
to accept or recognize only two digit entries in the date code field. These
systems and software products will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, computer
systems and software used by many companies and governmental agencies may need
to be upgraded to comply with these Year 2000 requirements or risk system
failure or miscalculations causing disruptions of normal business activities. To
date, the Company has not experienced any material Year 2000 problems in its
computer systems or operations. However, other companies, including Gensym,
could experience latent Year 2000 problems.

      The Company developed a phased Year 2000 readiness plan for the current
versions of its products. The plan included development of corporate awareness,
assessment, implementation (including remediation, upgrading and replacement of
certain product versions), validation testing, and contingency planning. To
date, the Company has experienced no problems related to Year 2000 compliance.

      The Company has defined "Year 2000 compliant" as the ability to (i)
correctly handle date information needed for the December 31, 1999 to January 1,
2000 date change; (ii) function according to the product documentation provided
for this date change, without changes in operation resulting from the advent of
a new century, assuming correct configuration; (iii) where appropriate, respond
to two-digit date input in a way that resolves the ambiguity as to century in a
disclosed, defined, and predetermined manner; (iv) if the date elements in
interfaces and data storage specify the century, store and provide output of
date information in ways that are unambiguous as to century; and (v) recognize
year 2000 as a leap year. The Company has not tested its products on all
platforms or all versions of operating systems that it currently supports and
has advised its customers to verify that their platforms and operating systems
support the transition to the year 2000.

      The Company completed a review and assessment of its products and, with
the exception of the products discussed below, the Company believes that its
current products are Year 2000 compliant. However, there can be no assurance
that the Company's products contain and will contain all features and
functionality considered necessary by customers, including ISVs, end users and
distributors, to be Year 2000 compliant. In addition, there can be no assurances
that the Company's current products do not contain undetected errors or defects
associated with Year 2000 date functions that may result in material costs to
the Company.

      While the Company believes that current versions of its products are Year
2000 compliant, other factors may result in an application created using the
Company's products not being Year 2000 compliant. Some of these factors include
improper programming techniques used by customers or third parties in creating
the application or non-compliance of the underlying hardware, operating system,
or software on which the application runs. Known or unknown errors or defects in
the Company's products could result in delay or loss of revenue, diversion of
development resources, damage to the Company's reputation, or increased service
and warranty costs, any of which could materially adversely affect the Company's
business, operating results or financial condition. Some commentators have
predicted significant litigation regarding Year 2000 compliance issues, and the
Company is aware of such lawsuits against other software vendors. Because of the
unprecedented nature of such litigation, it is uncertain whether or to what
extent the Company may be affected by it.

      Testing has revealed that in versions of G2 prior to Rev. 3, a specific G2
system procedure and the use of two-digit years in the built-in displays are not
Year 2000 compliant. These problems were fixed in G2 5.0 Rev. 3 released in June
1998.

      To date, the Company has not incurred any material expenditures in
connection with identifying or evaluating Year 2000 compliance issues. Most of
its expenses have related to, and are expected to continue to relate to, the
operating costs associated with time spent by employees in the evaluation
process and Year 2000 compliance matters generally. At this time, the Company
does not possess the information necessary to estimate the potential costs of
revisions to its proprietary software should any revisions be required or the
replacement of third-party software, hardware or services that are determined
not to be Year 2000 compliant. Although the Company does not anticipate that
these expenses will be material, such expenses, if higher than anticipated,
could have a material adverse effect on the Company's business, results of
operations and financial condition.

      To date, the Company has not experienced, and is not currently aware of
any Year 2000 compliance problems relating to its proprietary software or its IT
or non-IT systems that would have a material adverse effect on the Company
without taking into account its efforts to avoid or fix such problems. There can
be no assurance that the Company will not discover Year 2000 compliance problems
in its proprietary software that will require substantial revisions. In
addition, there can be no assurance that third-party software, hardware or
services incorporated into its material IT and non-IT systems will not need to
be revised or replaced, all of which could be time consuming and expensive.

                                       21
<PAGE>

      In the event of any Year 2000 problems, the Company's contingency plan
included the following components:

 .     Deploying all necessary internal resources to tackle the issues as swiftly
      as possible;

 .     Calling upon the Company's relationships with its commercial partners, to
      enable suitable escalation of issues with any third party; and

 .     Calling upon technical assistance from the Company's technology partners.

      Additionally, there can be no assurance that the Company will not be the
subject of lawsuits regarding the failure of the Company's products (former or
present) in the event they are not Year 2000 compliant. Despite the testing and
remediation efforts undertaken by the Company, the Company's products may
contain errors or defects associated with the year 2000. Known or unknown errors
or defects in the Company's products could result in delay or loss of revenue,
diversion of development resources, damage to the Company's reputation or
increased service and warranty costs, any of which could materially adversely
affect the Company's business, operating results and financial condition. In
addition, because the computer system in which the Company's products are used
involve different hardware, software and firmware components from different
manufacturers, it may be difficult to determine which component in a system
caused a Year 2000 issue. As a result, the Company may be subjected to Year
2000-related lawsuits independent of whether its products are Year 2000
compliant. Any Year 2000-related suits, if adversely determined, could have a
material adverse effect on the Company's business, operating results and
financial conditions.

RECENT ACCOUNTING PRONOUNCEMENTS

      In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 133, Accounting for
Derivative Instruments and Hedging Activities. This statement establishes
accounting and reporting standards for derivative instruments, including
derivative instruments embedded in other contracts, and for hedging activities.
SFAS No. 133, as amended by SFAS No. 137, is effective for all fiscal quarters
of fiscal years beginning after June 15, 2000. SFAS No. 133 is not expected to
have a material impact on the Company's consolidated financial statements.

      In December 1998, the AICPA issued Statement of Position 98-9,
Modification of SOP 97-2 Software Revenue Recognition, With Respect to Certain
Transactions. SOP 98-9 requires use of the residual method of recognition of
revenues when vendor-specific objective evidence exists for undelivered elements
but does not exists for delivered elements of a software arrangement. The
Company will be required to comply with the provisions of SOP 98-9 for
applicable transactions entered into beginning January 1, 2000. The Company does
not expect the adoption of SOP 98-9 will have a material effect on its financial
position or operating results.

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

A number of uncertainties exist that could affect the Company's operating
results, including, without limitation, the following:

      Emerging Market for Intelligent Operations Management Systems.
Substantially all of the Company's revenues are derived from the licensing and
support of software products that enable organizations to implement intelligent
operations management systems for decision support and control. Although many
organizations have begun to deploy, or have announced plans to deploy,
intelligent operations management systems, these systems are different from the
basic monitoring and control systems that are traditionally employed by these
organizations. There can be no assurance that these organizations will be able
to introduce intelligent operations management systems successfully, nor that
such systems will gain widespread acceptance. In addition, the timing of the
implementation of intelligent operations management systems by organizations may
be affected by economic factors, government regulations, and other factors.
Delays in the introduction of intelligent operations management systems or the
failure of these systems to gain widespread market acceptance would materially
and adversely affect the Company's business, results of operations, or financial
condition. In addition, the Company believes that end-users in its markets are
increasingly seeking application-specific products and components as well as
complete solutions, rather than general software tools with which to develop
application-specific functionality and solutions. Meeting this demand has
required the Company to modify its sales approach. The Company is also
increasingly reliant on value-added resellers and systems integrators to satisfy
market requirements. The modified sales approach may also lengthen the Company's
average sales cycle. Failure by the Company to respond appropriately to shifts
in market demand could have a material adverse effect on the Company's business,
results of operations, or financial condition.

      Dependence Upon Development of Sales and Marketing Force. The Company's
future success will depend, in part, upon the productivity of its sales and
marketing personnel and the ability of the Company to continue to attract,
integrate, train, motivate and retain new sales and marketing personnel. There
can be no assurance that the Company's investment in sales and marketing will
ultimately prove to be successful. In addition, there can be no assurance that
the Company's sales and marketing personnel will be able to compete successfully
against the significantly more extensive and better funded sales and marketing
operations of many of the

                                       22
<PAGE>

Company's current and potential competitors. The Company's inability to manage
its sales and marketing personnel effectively could have a material adverse
effect on the Company's business, operating results and financial condition.

      Variability of Quarterly Operating Results. The Company has experienced,
and may experience in the future, significant quarter-to-quarter fluctuations in
its operating results. The Company has, on occasion, recorded quarterly losses,
and there can be no assurance that revenue growth or profitable operations can
be attained on a quarterly or annual basis in the future. The Company's sales
cycle typically ranges from six to 12 months, and the cost of acquiring the
Company's software, building and deploying applications, and training users
represents a significant expenditure for customers. The Company's relatively
long sales cycle and high license fees, together with fixed short-term expenses,
can cause significant variations in operating results from quarter to quarter,
based on a relatively small variation in the timing of major orders. Factors
such as the timing of new product introductions and upgrades and the timing of
significant orders could contribute to this quarterly variability. In addition,
the Company ships software products within a short period after receipt of an
order and typically does not have a material backlog of unfilled orders of
software products. Therefore, revenues from software licenses in any quarter are
substantially dependent on orders booked in that quarter. Historically, a
majority of each quarter's revenues from software licenses has come from license
contracts that have been effected in the final weeks of that quarter. The
revenues for a quarter typically include a number of large orders. If the timing
of any of these orders is delayed, it could result in a substantial reduction in
revenues for that quarter. The Company's expense levels are based in part on
expectations of future revenue levels. A shortfall in expected revenues could
therefore result in a disproportionate decrease in the Company's net income. The
Company's financial performance has generally been somewhat weaker in the first
quarter than in the other fiscal quarters, due to customer purchasing patterns.

      Economic Factors. Because capital expenditures are often viewed as
discretionary by organizations, sales of the Company's products for capital
budget projects are subject to general economic conditions. Future recessionary
conditions in the industries which use the Company's products may adversely
affect the Company's business, results of operations, or financial condition.

      Product Concentration. The Company's main product offerings are G2, an
object-oriented development and deployment environment for building intelligent
operations management systems, and software application products which operate
in conjunction with G2. Accordingly, the Company's business and financial
results are substantially dependent upon the continued customer acceptance and
deployment of G2 and related products. The timing of major G2 releases may
affect the timing of purchases of the Company's products. The Company has
introduced several G2-based products for building applications and is developing
others. The Company believes that market acceptance of these products will be
important to the Company's future growth. There can be no assurance that such
products will achieve market acceptance or that new products will be
successfully developed. In addition, the Company relies on many of its marketing
partners to develop G2-based products for specialized markets. Accordingly, the
Company's business and financial results are also linked to the continued
successful product development by its marketing partners and market acceptance
of such G2-based products. Any decline in the demand for G2 and related
products, whether as a result of competitive products, price competition, the
lack of success of the Company's marketing partners, technological change, the
shift in customer demand toward complete solutions, or other factors, could have
a material adverse effect on the Company's business, results of operations, or
financial condition.

      New Products and Rapid Technological Change. The market for the Company's
products is relatively new and is characterized by rapid technological change,
evolving industry standards, changes in end-user requirements, and frequent new
product introductions and enhancements. The Company's future success will depend
in part upon its ability to enhance its existing products, to introduce new
products and features to meet changing customer requirements and emerging
industry standards, and to manage transitions from one product release to the
next. The Company has from time to time experienced delays in introducing new
products and product enhancements. There can be no assurance that the Company
will not experience difficulties that could delay or prevent the successful
development, introduction and marketing of these new products and product
enhancements. There also can be no assurance that the Company will successfully
complete the development of new or enhanced products, that the Company will
successfully manage the transition to future versions of G2, or to successor
technology, or that the Company's future products will achieve market
acceptance. In addition, the introduction of products embodying new technologies
and the emergence of new industry standards could render the Company's existing
products and products currently under development obsolete and unmarketable.
From time to time, new products, capabilities, or technologies may be announced
that have the potential to replace or shorten the life cycle of the Company's
existing product offerings. There can be no assurance that announcements of
currently planned or other new product offerings will not cause customers to
defer purchasing existing Company products. See "Emerging Market for Intelligent
Operations Management Systems."

      Migration to Microsoft Windows and Object Exchange Standards. The Company
believes that client user interfaces compliant with Microsoft Windows and MOTIF
are increasingly the preferred choice of its customers. In order to gain wider
customer penetration, the Company must respond to this market choice.
Accordingly, the Company has developed and achieved initial commercial release
of a client access product that is Microsoft Windows and MOTIF compliant. There
can be no assurance that the Company will be successful in further developing
and marketing this new product. Any delay or failure to meet market expectations
with this product could affect the Company's competitive position or limit its
growth opportunities.

      Reliance Upon Indirect Distribution Channels and Risks Associated with
Strategic Partner Relationships. The Company sells its products in part through
value-added resellers, systems integrators, OEMs and distributors, which are not
under the control of the Company. Sales of the Company's products by value-added
resellers and systems integrators represented 25%, 25%, and 35% of the

                                       23
<PAGE>

Company's product revenues in the first nine months of 1999, 1998, and 1997,
respectively. The loss of major OEMs or resellers of the Company's products, a
significant decline in their sales, or difficulty on the part of such
third-party developers or resellers in developing successful G2-based products
and applications could have a material adverse effect on the Company's business,
results of operations, or financial condition. There can be no assurance that
the Company will be able to attract or retain additional qualified third-party
resellers, or that third-party resellers will be able to effectively sell and
implement the Company's products. In addition, the Company relies on third-party
resellers to provide post-sales service and support to its customers, and any
deficiencies in such service and support could adversely affect the Company's
business, results of operations, or financial condition.

      Concentration of Credit Risk. For the fiscal year ended December 31, 1999,
sales to one customer, BMC Software, accounted for approximately 12% of the
Company's total revenue. As a result, the loss of BMC as a customer could
materially and adversely affect the Company's business and results of
operations. No single customer accounted for greater than 10% of total revenues
or represented a significant credit risk to the Company in 1998 or 1997. No
single customer accounted for greater than 10% of accounts receivable at
December 31, 1999 or 1998.

      Risks Associated With International Operations. The Company's
international revenues represented 46%, 47%, and 46%, of total revenues in 1999,
1998, and 1997, respectively. Revenues are categorized by the Company according
to product shipment destination and therefore do not necessarily reflect the
ultimate country of installation. The international portion of the Company's
business is subject to a number of inherent risks, including difficulties in
building and managing international operations, difficulties in localizing
products and translating documentation into local languages, fluctuations in the
value of international currencies including the euro, fluctuating import/export
duties and quotas, and unexpected regulatory, economic, or political changes in
international markets. In particular, the continuing economic problems in Asia
pose challenges to the Company's sales and marketing operations in that region.
There can be no assurance that these factors will not adversely affect the
Company's business, results of operations, or financial condition.

      Competition. Although the Company believes that there are no other
commercially available products that offer the full range of high-level
capabilities embodied in the Company's products, a number of companies offer
products that perform certain functions of G2 for specific applications. In all
of the Company's markets, there is competition from "point solutions", real-time
and expert system products, and internally developed software. At the
fundamental level, there are commercially available software development tools
that software application developers or potential customers could use to build
software having functionality similar to the Company's products.

      Certain companies such as Objective Systems Integrators, Inc., Micromuse,
and Systems Management Arts (SMARTS), sell "point solutions" that compete with
the Company's products with respect to specific applications or uses. Several
companies, including Ilog S.A. and System Management Arts, offer products with
limited real-time, expert system, or fault isolation capabilities at lower price
points than those provided by the Company. These products often require
extensive programming with languages such as C or C++ for complete
implementation. Although the Company believes that these products offer a less
productive development environment than G2 and that they lack the comprehensive
capabilities of G2-based products, certain competitors in this category have
greater financial and other resources than the Company and might introduce new
or improved products to compete with G2, possibly at lower prices.

      The Company's software is also integrated into industry-specific solutions
by value-added resellers. A number of software companies offer products that
compete in specific application areas addressed by these value-added resellers,
such as cement kiln control and refinery scheduling, and they could be
successful in supplying alternatives to products based on the Company's
software.

      Many of the Company's customers have significant investments in their
existing solutions and have the resources necessary to enhance existing products
and to develop future products. These customers may develop and incorporate
competing technologies into their systems or may outsource responsibility for
such systems to others who do not use the Company's products. There is no
assurance that the Company can successfully persuade development personnel
within these customers' organizations to use G2-based products that can cost
effectively compete with their internally developed products. This would reduce
the need for the Company's products and services and limit future opportunities
for the Company.

      The Company believes that continued investment in research and development
and sales and marketing will be required to maintain its competitive position.
There can be no assurance that competitors will not develop products or provide
services that are superior to the Company's products or services or achieve
greater market acceptance. Competitive pressures faced by the Company could
force the Company to reduce its prices, which could result in reduced
profitability. There can be no assurance that the Company will be able to
compete successfully against current and future sources of competition or that
such competition will not have a material adverse effect on the Company's
business, results of operations, or financial condition.

      Potential for Undetected Errors. Complex software products such as those
offered by the Company may contain unintended errors or failures commonly
referred to as "bugs". There can be no assurance that, despite significant
testing by the Company and by current and potential customers, errors will not
be found in new products after commencement of commercial shipments. Although
the Company has not experienced material adverse effects resulting from any such
errors or defects to date, there can be no assurance that errors or defects will
not be discovered in the future that could cause delays in product introduction
and shipments or require design modifications that could adversely affect the
Company's business, results of operations, or financial condition.

                                       24
<PAGE>

      Dependence Upon Proprietary Technology. The Company's success is heavily
dependent upon its proprietary technology. The Company relies upon a combination
of trade secret, contract, copyright, patent, and trademark law to protect its
proprietary rights in its products and technology. The Company enters into
confidentiality and/or license agreements with its employees, third-party
resellers, and end-users and limits access to and distribution of its software,
documentation, and other proprietary information. In addition, the Company has
placed technical inhibitors in its software that prevent such software from
running on unauthorized computers. However, effective patent, copyright, and
trade secret protection may not be available in every country in which the
Company's products are distributed. There can be no assurance that the steps
taken by the Company to protect its proprietary technology will be adequate to
prevent misappropriation of its technology by third parties, or that third
parties will not be able to develop similar technology independently. In
addition, there can be no assurance that third parties will not assert
infringement claims in the future or that such claims will not be successful.

      Dependence on Key Personnel. The Company's success depends in large part
upon certain key employees, including its executive officers, the loss of any of
whom could have a material adverse effect on the Company. The Company's key
employees are not bound by employment agreements that require them to remain
with the Company. The Company's success will depend in significant part upon its
ability to attract and retain highly-skilled management, technical, and sales
and marketing personnel. Competition for such personnel in the software industry
is intense, and there can be no assurance that the Company will be successful in
attracting and retaining such personnel, or that new key personnel will
integrate successfully into the senior management team. The loss of certain key
employees or the Company's inability to attract and retain other qualified
employees or to adequately replace key personnel who depart the Company could
have a material adverse effect on the Company's business, results of operations,
or financial condition.

      Year 2000 Compliance. Many existing computer systems and software products
do not properly recognize dates after December 31, 1999. As a result, many
companies' software and computer systems may need to be upgraded or replaced to
become Year 2000 compliant. In addition, despite the fact that many computer
systems are currently processing 21st century dates correctly, these companies,
including Gensym, could experience latent Year 2000 problems.

      Changing purchasing patterns of clients impacted by Year 2000 issues or
Year 2000 concerns may result in reduced resources available for purchases of
the Company's products. In addition, there can be no assurance that Year 2000
errors or defects will not be discovered in the Company's products or in its
internal software systems. If such errors or defects are discovered, the cost of
making such systems Year 2000 compliant could be material. Moreover, Year 2000
errors or defects in the internal systems maintained by the Company's vendors
could require it to incur significant unanticipated expenses to remedy any
problems or replace affected vendors.

ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

Investment Portfolio

      The Company does not use derivative financial instruments in its investing
portfolio. The Company places its investments in instruments that meet high
credit quality standards such as money market funds, government securities, and
commercial paper. The Company limits the amount of credit exposure to any one
issuer. The Company does not expect any material loss with respect to its
investment portfolio. The following table provides information about the
Company's investment portfolio, which excludes the Company's funds in demand
deposit and money market accounts. For investment securities, the table presents
principal cash flows and related weighted average interest rates by expected
maturity dates.

             Principal Amounts by Expected Maturity in U. S. Dollars
                      (in Thousands, except interest rates)

                                                              Investments
                                              Fair Value at   Maturing in
                                                12/31/99        FY 2000
                                              -------------   -----------

            Cash Equivalents                       $1,494       $1,494
            Weighted Average Interest Rate           6.13%        6.13%

            Investments                            $5,950       $5,950
            Weighted Average Interest Rate           6.11%        6.11%

            Total Portfolio                        $7,445       $7,445
            Weighted Average Interest Rate           6.11%        6.11%

                                       25
<PAGE>

Impact of Foreign Currency Rate Changes

      During 1999, most currencies in Europe and Asia/Pacific fluctuated, but
ended the year relatively stable against the U.S. dollar. However, the
translation of the parent Company's intercompany receivables and foreign
entities' assets and liabilities did not have a material impact on the
consolidated results of the Company. The Company does not use foreign exchange
forward contracts to hedge its foreign currency denominated receivables. There
can be no assurance that changes in foreign currency rates, relative to the
U.S. dollar, will not materially affect the consolidated results of the
Company in the future.

                                       26
<PAGE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                       GENSYM CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                        (In thousands, except share data)

                                                               December 31,
                                                             1999        1998
                                                           --------    --------
                   ASSETS

Current Assets:
   Cash and cash equivalents                                $ 5,710     $13,695
   Short-term investments                                     5,975         839
   Accounts receivable, less reserves of $364
     in 1999 and $423 in 1998                                 9,528       7,578
   Prepaid expenses                                           2,352       1,775
   Deferred income taxes                                      1,261       1,548
                                                           --------    --------
         Total current assets                                24,826      25,435
                                                           --------    --------

Property and Equipment, at cost
   Computer equipment and software                            8,264       8,043
   Furniture and fixtures                                     1,932       1,788
   Leasehold improvements                                       423         490
                                                           --------    --------
                                                             10,619      10,321
   Accumulated depreciation and amortization                 (9,324)     (8,339)
                                                           --------    --------
                                                              1,295       1,982
                                                           --------    --------

Long term deferred income taxes                                 612         612
Deposits and other assets                                       201         239
                                                           --------    --------

                                                            $26,934     $28,268
                                                           ========    ========

   LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
   Accounts payable                                            $387        $517
   Accrued expenses                                           4,694       3,862
   Deferred revenue                                           6,931       6,406
                                                           --------    --------
     Total current liabilities                               12,012      10,785
                                                           --------    --------

Commitments (Note 5)
Stockholders' Equity:
   Preferred Stock, $.01 par value - Authorized
     2,000,000 shares
       Issued and outstanding - none                             --          --
   Common Stock, $.01 par value -
     Authorized - 20,000,000 shares
     Issued - 6,744,565 shares in 1999 and
       6,557,268 shares in 1998                                  67          65
   Capital in excess of par value                            20,923      20,427
   Treasury stock - 501,300 shares in 1999 and 345,200
     shares in 1998, at cost                                 (1,869)     (1,278)
   Accumulated deficit                                       (3,053)     (1,101)
   Cumulative translation adjustment                         (1,146)       (630)
                                                           --------    --------
       Total stockholders' equity                            14,922      17,483
                                                           --------    --------

                                                            $26,934     $28,268
                                                           ========    ========

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

                                       27
<PAGE>

                       GENSYM CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      (In thousands, except per share data)

                                                    Year ended December 31,
                                                 1999        1998        1997
                                               --------    --------    --------

REVENUES:
       Product                                  $19,628     $16,911     $18,433
       Service                                   16,799      18,067      17,076
                                               --------    --------    --------
             Total revenues                      36,427      34,978      35,509

COST OF REVENUES                                  8,574       8,698       9,352
                                               --------    --------    --------

Gross profit                                     27,853      26,280      26,157
                                               --------    --------    --------

OPERATING EXPENSES:
       Sales and marketing                       18,214      18,276      18,802
       Research and development                   6,470       6,023       6,977
       General and administrative                 5,288       4,134       4,528
       Restructuring charge                          --          --       1,558
                                               --------    --------    --------
             Total operating expenses            29,972      28,433      31,865
                                               --------    --------    --------

Operating loss                                   (2,119)     (2,153)     (5,708)

OTHER INCOME:
       Interest income                              505         678         591
       Other income (expense)                        (2)         37         188
                                               --------    --------    --------
             Total other income, net                503         715         779
                                               --------    --------    --------

Loss before provision for income taxes           (1,616)     (1,438)     (4,929)

PROVISION FOR INCOME TAXES                          336          50          40
                                               --------    --------    --------

Net loss                                        $(1,952)    $(1,488)    $(4,969)
                                               ========    ========    ========

Basic and diluted loss per share                 $(0.32)     $(0.23)     $(0.79)
                                               ========    ========    ========

Weighted average common shares outstanding        6,149       6,371       6,310
                                               ========    ========    ========

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

                                       28
<PAGE>

                       GENSYM CORPORATION AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                        (In thousands, except share data)

<TABLE>
<CAPTION>
                                              Common Stock
                                         ---------------------
                                                                              Capital in   Accumulated    Cumulative
                                           Number    $ 0.01 Par   Treasury    Excess of     Earnings     Translation
                                         of Shares      Value       Stock     Par Value     (Deficit)     Adjustment
                                         ---------   ---------    ---------   ---------     ---------     ---------
<S>                                      <C>         <C>          <C>         <C>           <C>           <C>
BALANCE, DECEMBER 31, 1996               6,190,317   $      62    $     --    $  18,727     $   5,356     $     (77)
Exercise of stock options                   91,170           1          --          500            --            --
Issuance of common stock under
  Employee Stock Purchase Plan (ESPP)      127,910           1          --          632            --            --
Translation adjustment                          --          --          --           --            --          (487)
Tax benefit from exercise of
  incentive stock options and shares
  purchased under ESPP                          --          --          --           82            --            --
Net loss                                        --          --          --           --        (4,969)           --

Comprehensive net loss for the year
ended December 31, 1997
                                         ---------   ---------    --------   ----------     ---------     ---------
BALANCE, DECEMBER 31, 1997               6,409,397          64          --       19,941           387          (564)
Exercise of stock options                   18,050          --          --           82            --            --
Issuance of common stock under ESPP        129,821           1          --          404            --            --
Treasury stock--345,200 shares                  --          --      (1,278)          --            --            --
Translation adjustment                          --          --          --           --            --           (66)
Net loss                                        --          --          --           --        (1,488)           --

Comprehensive net loss for the year
ended December 31, 1998
                                         ---------   ---------    --------   ----------     ---------     ---------
BALANCE, DECEMBER 31, 1998               6,557,268          65      (1,278)      20,427        (1,101)         (630)
Exercise of stock options                   24,156          --          --           74            --            --
Issuance of common stock under ESPP        163,141           2          --          422            --            --
Treasury stock--156,100 shares                  --          --        (591)          --            --            --
Translation adjustment                          --          --          --           --            --          (516)
Net loss                                        --          --          --           --        (1,952)           --

Comprehensive net loss for the year
ended December 31, 1999
                                         ---------   ---------    --------   ----------     ---------     ---------
BALANCE, DECEMBER 31, 1999               6,744,565   $      67    $ (1,869)   $  20,923     $  (3,053)    $  (1,146)
                                         =========   =========    ========   ==========     =========     =========

<CAPTION>
                                             Total
                                         Stockholders'  Comprehensive
                                            Equity      Income (Loss)
                                           ---------      ---------
<S>                                        <C>            <C>
BALANCE, DECEMBER 31, 1996                 $  24,068
Exercise of stock options                        501
Issuance of common stock under ESPP              633
Translation adjustment                          (487)          (487)
Tax benefit from exercise of
  incentive stock options and shares
  purchased under ESPP                            82
Net loss                                      (4,969)        (4,969)
                                                          ---------
Comprehensive net loss for the year
ended December 31, 1997                                   $  (5,456)
                                           ---------      ---------
BALANCE, DECEMBER 31, 1997                    19,828
Exercise of stock options                         82
Issuance of common stock under ESPP              405
Treasury stock--345,200 shares                (1,278)
Translation adjustment                           (66)           (66)
Net loss                                      (1,488)        (1,488)
                                                          ---------
Comprehensive net loss for the year
ended  December 31, 1998                                  $  (1,554)
                                           ---------      ---------
BALANCE, DECEMBER 31, 1998                    17,483
Exercise of stock options                         74
Issuance of common stock under ESPP              424
Treasury stock--156,100 shares                  (591)
Translation adjustment                          (516)          (516)
Net loss                                      (1,952)        (1,952)
                                                          ---------
Comprehensive net loss for the year
ended December 31, 1999                                   $  (2,468)
                                           ---------      ---------
BALANCE, DECEMBER 31, 1999                 $  14,922
                                           =========
</TABLE>

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

                                       29
<PAGE>

                       GENSYM CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)

<TABLE>
<CAPTION>
                                                               Year ended December 31,
                                                            1999        1998        1997
                                                          --------    --------    --------
<S>                                                        <C>         <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss                                                   $(1,952)    $(1,488)    $(4,969)
Adjustments to reconcile net loss to net cash
  used in operating activities:
  Depreciation and amortization                                985       1,245       1,147
  Deferred income taxes                                        287          --        (500)
  Restructuring charge                                          --          --         842
  Changes in assets and liabilities:
    Accounts receivable                                     (2,055)        747       1,375
    Prepaid expenses                                          (720)       (214)         16
    Accounts payable                                          (112)       (400)       (314)
    Accrued expenses                                           982      (1,155)       (490)
    Deferred revenue                                           527         611         (11)
                                                          --------    --------    --------

    Net cash used in operating activities                   (2,058)       (654)     (2,904)
                                                          --------    --------    --------

CASH FLOWS FROM INVESTING ACTIVITIES:
  (Purchases) sales of short-term investments               (5,137)      4,005       3,068
  Sales (purchases) of long-term investments                    --       1,041        (299)
  Purchases of property and equipment                         (298)       (843)     (1,187)
  Decrease (increase) in deposits and other assets              38          32         (80)
                                                          --------    --------    --------

    Net cash (used in) provided by investing activities     (5,397)      4,235       1,502
                                                          --------    --------    --------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Purchases of treasury stock                                 (591)     (1,279)         --
  Proceeds from exercise of stock options                       74          83         501
  Proceeds from issuance of common stock under employee
    stock purchase plan                                        424         405         633
                                                          --------    --------    --------

    Net cash (used in) provided by financing activities        (93)       (791)      1,134

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

EFFECT OF EXCHANGE RATE CHANGES ON CASH                       (437)        (53)       (453)
                                                          --------    --------    --------

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS        (7,985)      2,737        (721)

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD              13,695      10,958      11,679
                                                          --------    --------    --------

CASH AND CASH EQUIVALENTS, END OF PERIOD                   $ 5,710     $13,695     $10,958
                                                          ========    ========    ========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
  Cash paid during the period for -
    Income taxes                                           $   221     $   424     $   445
                                                          ========    ========    ========
</TABLE>

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

                                       30
<PAGE>

                       GENSYM CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

The Company is a leading supplier of software products and services for
developing and deploying intelligent systems that manage and improve complex,
dynamic operations for a broad range of industrial, scientific, commercial, and
government applications.

The accompanying consolidated financial statements reflect the application of
certain significant accounting policies, as described in this note and elsewhere
in the accompanying consolidated financial statements and notes.

(a) Principles of Consolidation

      The accompanying consolidated financial statements include the accounts of
      the Company and its wholly owned subsidiaries. All material intercompany
      transactions and balances have been eliminated in consolidation.

(b) Cash Equivalents and Investments

      The Company accounts for investments under Statement of Financial
      Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in
      Debt and Equity Securities. The Company's investments are classified as
      held-to-maturity and are recorded at amortized cost at December 31, 1999
      and 1998. Cash equivalents are short-term, highly liquid investments with
      original maturity dates of less than three months. Short-term investments
      held as of December 31, 1999 and 1998 consist of U.S. and municipal agency
      bonds and commercial paper with original maturity dates greater than three
      months that mature within one year.

(c) Depreciation and Amortization

      The Company provides for depreciation and amortization using the
      straight-line method by charges to operations in amounts that allocate the
      cost of the assets over their estimated useful lives as follows:

                                            Estimated
              Asset Classification          Useful Lives
              --------------------          ------------
              Computer equipment
                and software.............   3 Years
              Furniture and fixtures.....   5 Years
              Leasehold improvements.....   Shorter of lease term or useful life

(d) Revenue Recognition

      The Company follows the provisions of the American Institute of Certified
      Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software
      Revenue Recognition, as amended by SOP 98-4. Product revenues are
      recognized upon shipment or upon the completion of all significant
      obligations by the Company, whichever is later, provided that the fee is
      fixed or determinable and deemed collectible by management. If conditions
      for acceptance are required subsequent to delivery, revenues are
      recognized upon customer acceptance. Revenues from the sale of multicopy
      licenses are recognized upon the shipment of the product master or the
      first copy of the software product if the product master is not to be
      delivered. Revenues derived from consulting and training are recognized
      upon performance of the services provided that the amounts due from
      customers are fixed or determinable and deemed collectible by management.
      Software maintenance fees are recognized as revenue ratably over the
      period to which they relate. Deferred revenue primarily represents advance
      billings for software services, which include maintenance, consulting,
      training and license prepayment fees.

(e) Research and Development and Software Development Costs

      In accordance with SFAS No. 86, Accounting for the Costs of Computer
      Software to Be Sold, Leased, or Otherwise Marketed, the Company has
      evaluated the establishment of technological feasibility of its various
      products during the development phase. Due to the dynamic changes in the
      market, the Company has concluded that it cannot determine technological
      feasibility until the development phase of the project is nearly complete.
      The time period during which costs could be capitalized from the point of
      reaching technological feasibility until the time of general product
      release is very short and, consequently, the amounts that could be
      capitalized are not material to the Company's financial position or
      results of operations. Therefore, the Company charges all research and
      development expenses to operations in the period incurred.

                                       31
<PAGE>

(f) Foreign Currency Translation

      Assets and liabilities of the foreign subsidiaries are translated in
      accordance with SFAS No. 52, Foreign Currency Translation. In accordance
      with SFAS No. 52, assets and liabilities of the Company's foreign
      operations are translated into U.S. dollars at current exchange rates, and
      income and expense items are translated at average rates of exchange
      prevailing during the year. Gains and losses arising from translation are
      accumulated as a separate component of stockholders' equity. Gains and
      losses arising from transactions denominated in foreign currencies are
      included in other income and were not material for the periods presented.

(g) Retirement Plan

      Effective January 1997, the Company amended the Gensym Corporation 401(k)
      Plan (the "Plan") to allow for employer matching contributions. The
      Company has elected to contribute an amount equal to 50% of the first 4%,
      and 25% of the next 4% of an employee's compensation (as defined)
      contributed to the Plan as an elective deferral. The Company's
      contributions to the Plan were $262,000 in 1999 and $316,000 in 1998.

(h) Concentration of Credit Risk

      Generally accepted accounting principles require disclosure of any
      significant off-balance-sheet and credit risk concentrations. Financial
      instruments, which potentially subject the Company to concentrations of
      credit risk, are principally cash, cash equivalents, investments and
      accounts receivable. The Company places its cash, cash equivalents and
      investments in highly rated institutions. One customer accounted for 12%
      of the total revenue in 1999. No single customer accounted for greater
      than 10% of total revenues or represented a significant credit risk to the
      Company in 1998 or 1997. No single customer accounted for greater than 10%
      of accounts receivable at December 31, 1999 or 1998. The Company has no
      significant off-balance-sheet concentration of credit risk such as foreign
      exchange contracts, options contracts, or other foreign hedging
      arrangements.

(i) Income (Loss) per Share

      In accordance with SFAS No. 128, Earnings per Share, basic income (loss)
      per share was computed by dividing net income (loss) by the weighted
      average number of common shares outstanding during the periods. Diluted
      income (loss) per share was computed using the weighted average number of
      common and potential common shares outstanding during the periods in
      accordance with the treasury stock method. For the years ended December
      31, 1999, 1998, and 1997, the computation for diluted loss per share
      excludes the effect of 1,169,294 shares, 729,639 shares, and 819,780
      shares, respectively, issuable from assumed exercise of options, as their
      effect would be antidilutive.

(j) Use of Estimates in the Preparation of Financial Statements

      The preparation of financial statements in conformity with generally
      accepted accounting principles requires management to make estimates and
      assumptions that affect the reported amounts of assets and liabilities and
      disclosure of contingent assets and liabilities at the date of the
      financial statements and the reported amounts of revenues and expenses
      during the reporting period. Actual results could differ from those
      estimates.

(k) New Accounting Pronouncement

      In June 1998, the Financial Accounting Standards Board, or FASB, issued
      Statement of Financial Accounting Standards, or SFAS, No. 133, Accounting
      for Derivative Instruments and Hedging Activities. This statement
      establishes accounting and reporting standards for derivative instruments,
      including derivative instruments embedded in other contracts, and for
      hedging activities. SFAS No. 133, as amended by SFAS No. 137, is effective
      for all fiscal quarters of fiscal years beginning after June 15, 2000.
      SFAS No. 133 is not expected to have a material impact on the Company's
      consolidated financial statements.

      In December 1998, the AICPA issued Statement of Position 98-9,
      Modification of SOP 97-2 Software Revenue Recognition, With Respect to
      Certain Transactions. SOP 98-9 requires use of the residual method of
      recognition of revenues when vendor-specific objective evidence exists for
      undelivered elements but does not exists for delivered elements of a
      software arrangement. The Company will be required to comply with the
      provisions of SOP 98-9 for applicable transactions entered into beginning
      January 1, 2000. The Company does not expect the adoption of SOP 98-9 will
      have a material effect on its financial position or operating results.

(2) LINE OF CREDIT

      The Company had a $1,000,000 working capital line of credit which expired
      April 30, 1999 and which the Company did not renew. The line of credit was
      unsecured, and the interest rate on the borrowings was at the prime rate.

                                       32
<PAGE>

(3) STOCKHOLDERS' EQUITY

(a) Common Stock

      The Company's authorized capitalization consists of 20,000,000 shares of
      Common Stock and 2,000,000 shares of Preferred Stock.

(b) Stock Option Plans

      The following table shows the Company's stock option plans, the number of
      shares reserved for issuance by the Company's Board of Directors, and the
      number of shares available for future issuance as of December 31, 1999:

                                                              Number of Shares
                                                            Available for Future
                                                                  Issuance
                                      Number of Shares       as of December 31,
           Plan Name                Reserved for Issuance           1999
---------------------------------   ---------------------   --------------------

1987 Stock Plan                             600,000                       0
1994 Stock Option Plan                      534,850                 216,378
1995 Director Stock Option Plan             100,000                  78,000
1995 Employee Stock Purchase Plan           500,000                  45,383
1997 Stock Incentive Plan                   500,000                  47,719
                                          ---------               ---------
                                          2,234,850                 387,480
                                          =========               =========

      The 1987 Stock Plan provided for the grant of incentive stock options,
      nonqualified stock options, stock awards, and direct sales of stock. The
      Board of Directors has resolved not to grant any more options under the
      1987 Stock Plan. The 1994 Stock Option Plan provides for the grant of
      incentive stock options and nonqualified stock options. The 1997 Stock
      Incentive Plan provides for the grant of incentive stock options,
      nonqualified stock options, restricted stock and other stock-based awards.
      Under these plans, incentive stock options may be granted at an exercise
      price not less than the fair market value of the Company's Common Stock on
      the date of grant or, in the case of 10% stockholders, not less than 110%
      of the fair market value. Nonqualified options may be granted by the Board
      of Directors at its discretion. The difference, if any, between the
      exercise price and the fair value of the underlying Common Stock at the
      measurement date is charged to operations over the vesting period of such
      options. The terms of exercise of options granted under these plans are
      determined by the Board of Directors. Incentive stock options expire no
      later than 10 years after the date of grant.

      The Board of Directors, on October 22, 1998, authorized the repricing of
      certain incentive stock options. Under the repricing plan, option holders
      were permitted to voluntarily exchange their old options for new options.
      The new options allow the option holders to purchase 80% of the number of
      shares of Common Stock represented by the old options at a price equal to
      the closing price of the Company's Common Stock, or for officers, at a
      price equal to 110% of the closing price, on November 20, 1998. All other
      terms and conditions of the new options remain identical to the old
      options agreement. The closing price of the Common Stock on November 20,
      1998 was $3.88. Under the repricing plan, 670,160 incentive stock options
      were cancelled and 539,948 incentive stock options were reissued.

      The 1995 Director Stock Option Plan (the "Director Plan") was approved by
      the stockholders in January 1996 and amended in May 1997. The Director
      Plan provides for the grant of options to purchase Common Stock of the
      Company to non-employee directors of the Company. On June 30 of each year,
      beginning in 1997, each non-employee director is granted an option to
      purchase 3,000 shares of common stock at an exercise price equal to the
      then current fair market value. These options vest in equal portions over
      a five-year period and expire 10 years from the date of grant.

      During 1999, in conjunction with the hiring of the chief executive
      officer, the Company granted options to purchase 361,111 shares at an
      exercise price of $3.25, outside of any existing stock option plans. These
      stock options are included in the schedules below.

                                       33
<PAGE>

The following schedule summarizes the stock option activity for each the three
years in the period ended December 31, 1999:

                                    Number      Option Price    Weighted Average
                                  of Shares      per Share       Exercise Price
                                  ---------    --------------   ---------------
Outstanding at December 31, 1996    584,060    $ 1.60 - 20.00           $  8.73
Granted                             572,620      4.50 - 11.75              6.08
Exercised                           (91,170)      1.60 - 7.50              5.49
Canceled                           (245,730)     4.88 - 20.00             10.71
                                  ---------    --------------   ---------------
Outstanding at December 31, 1997    819,780    $1.60 - $20.00           $  6.65
Granted                             835,698       3.00 - 7.50              4.94
Exercised                           (18,050)      1.60 - 7.50              4.58
Canceled                           (907,789)     3.81 - 20.00              6.90
                                  ---------    --------------   ---------------

Outstanding at December 31, 1998    729,639    $3.00 - $10.00           $  4.44
Granted                             656,320       2.75 - 5.25              3.45
Exercised                           (24,156)      3.00 - 3.88              3.13
Canceled                           (192,509)      3.00 - 7.50              4.35
                                  ---------    --------------   ---------------

Outstanding at December 31, 1999  1,169,294    $2.75 - $10.00           $  3.92
                                  =========    ==============   ===============

Exercisable at December 31, 1999    340,741    $3.00 - $10.00           $  4.53
                                  =========    ==============   ===============

The range of exercise prices for options outstanding and options exercisable at
December 31, 1999 is as follows:

<TABLE>
<CAPTION>
                                       Options Outstanding         Options Exercisable
                                  ----------------------------   ----------------------
                                    Weighted
                                    Average                                    Weighted
                                   Remaining       Weighted                     Average
Range of Exercise     Options     Contractual       Average         Options    Exercise
      Prices        Outstanding      Life       Exercise Price   Exercisable    Price
-----------------   -----------   -----------   --------------   -----------   - ------
<S>                  <C>              <C>          <C>              <C>          <C>
   $ 2.75-4.50       1,035,596        9.09         $3.59            268,121      $3.98
   $ 4.63-6.50          83,010        7.74          5.12             34,130       5.24
   $ 7.50-10.00         50,688        6.96          7.70             38,490       7.71
                     ---------       -----         -----          ---------      -----
                     1,169,294        7.22         $3.92            340,741      $4.53
                     =========       =====         =====          =========      =====
</TABLE>

The Company's 1995 Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Board of Directors in November 1995 and approved by the
stockholders in January 1996. The Purchase Plan authorizes the sale of common
stock to participating employees. In January 1998 the board of directors amended
the Purchase Plan to increase the number of shares of Common Stock reserved for
issuance under the Plan from 200,000 to 500,000.

All employees of the Company meeting certain eligibility requirements are
eligible to participate in the Purchase Plan. An employee may elect to have a
whole number percentage from 1% to 10% of his or her base pay withheld during
the payroll deduction period "Offering Period" for purposes of purchasing shares
under the Purchase Plan. The price at which shares may be purchased during each
offering will be 85% of the fair market value per share of the Common Stock on
either the first day or the last day of the Offering Period, whichever is lower.
The compensation committee of the board of directors may, at its discretion,
choose an Offering Period of 12 months or less for each of the offerings and
choose a different Offering Period for each offering. Under the Purchase Plan,
the Company has sold 455,041 shares as of December 31, 1999.

                                       34
<PAGE>

(c) Stock-Based Compensation

      The Company has computed the pro forma disclosure required under SFAS No.
      123 for all stock compensation plans during the three years ended December
      31, 1999, using the Black-Scholes option pricing model under the fair
      value method prescribed by SFAS No. 123. The assumptions used are as
      follows:

                                      1999           1998           1997
                                  -----------    -----------    -----------
Risk-free interest rate           4.80 - 6.38%   4.65 - 5.71%   5.46 - 6.71%
Expected dividend yield                      0              0              0
Expected lives of option grants      7.0 Years      7.0 Years      6.5 Years
Expected volatility                        90%            70%            63%
Weighted average fair value of
options granted                          $2.85          $3.25          $3.95

For the purposes of pro forma disclosure, the estimated fair value of options is
amortized to expense over the vesting period. Had compensation costs for options
and Purchase Plan shares been determined based on the fair value at the grant
dates as prescribed by SFAS No. 123, the effect would have been as follows:

                                                1999         1998         1997
                                              -------      -------      -------
                                        (In thousands, except per share amounts)

Net loss as reported                          $(1,952)     $(1,488)     $(4,969)
Pro forma net loss as adjusted                 (2,883)      (2,384)      (5,615)
Basic and diluted loss per share as reported   ($0.32)      ($0.23)      ($0.79)
Pro forma basic and diluted loss per share
  as adjusted                                  ($0.53)      ($0.43)      ($0.95)

(d) Stock Repurchase Program

      In the third quarter of 1998, the Company began a program to repurchase up
to 650,000 shares of its Common Stock on the open market. As of December 31,
1999, 501,300 shares had been repurchased at a cost of $1,869,000.

(4) INCOME TAXES

The components of the provision for income taxes for each of the three years in
the period ended December 31, 1999 are as follows:

                                             1999           1998          1997
                                            -------       -------       -------
                                                       (In thousands)
            Federal
                   Current                  $    --       $   (71)      $   (91)
                   Deferred                  (1,680)         (675)       (2,221)
                                            -------       -------       -------
                                             (1,680)         (746)       (2,312)
                                            -------       -------       -------
            State
                   Current                        6             7             6
                   Deferred                     (36)          (31)          (27)
                                            -------       -------       -------
                                                (30)          (24)          (21)
                                            -------       -------       -------
            Foreign
                   Withholding                  133            48           182
                   Income                       203            66           524
                                            -------       -------       -------
                                                336           114           706
                                            -------       -------       -------

            Change in Valuation Allowance     1,710           706         1,667
                                            -------       -------       -------

                                            $   336       $    50       $    40
                                            =======       =======       =======

Foreign withholding taxes represent amounts withheld by foreign customers and
remitted to the applicable foreign tax authorities in connection with foreign
revenues. Foreign income taxes represent corporate income taxes relating to the
operations of the Company's foreign subsidiaries.

                                       35
<PAGE>

The components of the net deferred tax asset recognized in the accompanying
consolidated balance sheets with the approximate income tax effect of each type
of temporary difference are as follows:

                                                             1999         1998
                                                           -------      -------
                                                              (In thousands)
Net operating loss carryforward                            $ 3,152      $ 2,299
Research and development tax credit carryforward             1,305        1,018
Depreciation                                                   201          122
Deferred revenue                                               345          317
Other temporary differences                                    954          778
                                                           -------      -------
                                                             5,957        4,534
Valuation allowance                                         (4,084)      (2,374)
                                                           -------      -------
Net deferred tax asset                                     $ 1,873      $ 2,160
                                                           =======      =======

The net operating loss carryforwards expire on various dates through 2019 and
are subject to review and possible adjustment by the Internal Revenue Service.

The Internal Revenue Code contains provisions that may limit the net operating
loss and credit carryforwards that the Company may utilize in any one year in
the event of certain cumulative changes in ownership over a three year period.
In the event that the Company has had a change in ownership, as defined,
utilization of the carryforwards may be restricted.

The Company has established a valuation allowance against its deferred tax asset
to the extent that it cannot conclusively demonstrate that these assets "more
likely than not" will be realized.

The provision for income taxes differs from the amount computed by applying the
statutory federal income tax rate as follows:

                                                     1999      1998      1997
                                                     -----     -----     -----
Provision at federal statutory rate                  (34.0)%   (34.0)%   (34.0)%
State income tax, net of federal benefits             (1.2)     (1.1)     (.04)
Foreign income and withholding taxes                 (24.0)     27.9       6.6
Change in valuation allowance                        105.8      49.1      33.8
Utilization of tax credits                           (17.8)    (21.0)     (0.4)
Other, net                                            (8.0)    (17.4)     (4.8)
                                                     -----     -----     -----
                                                      20.8 %     3.5 %     0.8 %
                                                     =====     =====     =====

(5) COMMITMENTS

The Company leases its facilities and certain equipment under operating leases.
The future minimum annual payments under these leases at December 31, 1999 are
as follows:

                         For the Year          Amount
                      Ended December 31,   (In thousands)
                      ------------------   --------------
                             2000                 $ 3,335
                             2001                   1,357
                             2002                     686
                             2003                     291
                             2004                     168
                          Thereafter                  245
                                           --------------
                                                  $ 6,082
                                           ==============

Rent and lease expense under the above leases, net of rental income from
sub-leases, was approximately $3,159,000 in 1999, $2,931,000 in 1998, and
$3,834,000 in 1997.

                                       36
<PAGE>

(6) ACCRUED EXPENSES

Accrued expenses consist of the following:

                                                             1999          1998
                                                            --------------------
                                                               (In thousands)
                                                            ------        ------

Accrued payroll and related expenses                        $1,730        $1,100
Accrued commissions                                            624           460
Accrued bonus                                                  286            65
Other accrued expenses                                       2,054         2,237
                                                            ------        ------
                                                            $4,694        $3,862
                                                            ======        ======

(7) RESTRUCTURING CHARGE

During the second quarter of 1997, the Company recorded a charge of
approximately $2.0 million for restructuring costs associated with the reduction
of its workforce, closing and consolidation of several field sales offices and
consolidation of office space in its corporate headquarters. The charge included
reserves for rent and lease termination costs, severance and other employee
termination costs and the write off of certain assets that would provide no
future benefit to the Company as a result of the restructuring plan. In the
third quarter of 1997, the Company recorded a restructuring credit of $485,000
for the recovery of its investment in a joint venture, a portion of which had
been written off in the previous quarter.

As of December 31, 1999, approximately $18,000 of accrued restructuring charges
remained pertaining to future rent payment obligations, which are expected to be
paid during 2000.

(8) FINANCIAL INFORMATION BY GEOGRAPHIC AREA

Domestic and international sales as a percentage of total revenues are as
follows:

                                             1999           1998           1997
                                             ----           ----           ----
United States                                  54%            53%            54%
Europe                                         31             27             30
Other                                          15             20             16
                                              ---            ---            ---
                                              100%           100%           100%
                                              ===            ===            ===

(9) SEGMENT REPORTING

On December 31, 1998, Gensym adopted SFAS No. 131, Disclosure about Segments of
an Enterprise and Related Information. This pronouncement established standards
for public companies relating to the reporting of financial and descriptive
information about their operating segments in financial statements. Operating
segments are defined as components of an enterprise about which separate
financial information is available that is evaluated regularly by management in
deciding how to allocate resources and in assessing performance of the business.

During 1999, the Company changed the way it evaluates its operations. The
Company views its business as having four operating segments: Manufacturing,
Communications, Advanced Systems, and EMA (Europe/Middle East/Africa).

The Company markets and sells its products through its direct sales force in the
United States, Europe, Africa and Asia, as well as through selected distributors
in other countries, including Japan. The Company also sells its products through
value-added resellers and systems integrators, who provide consulting services
and integrated solutions to their customers. The Company further licenses
technology to OEMs, who embed the technology within their product offerings.

                                       37
<PAGE>

The accounting policies of the segments are the same as those described in Note
1. The Company evaluates performance of its segments based on revenues and
segment profitability. Segment profitability is defined by the Company as net
contribution, which is computed based on gross profit less identifiable
operating costs--principally sales and marketing costs, research and development
costs and identifiable management costs. Identifiable assets consist primarily
of accounts receivable, prepaid expenses, property and equipment, and deposits.
Information as to the operations of the different segments is set forth below:

<TABLE>
<CAPTION>
                                                                       Europe
                                  Manu-       Communi-    Advanced   Middle-East
                                facturing     cations      Systems     & Africa      Total
                                ---------     --------    --------   -----------    -------
Year ended December 31, 1999
<S>                              <C>          <C>          <C>          <C>         <C>
     Revenues                    $ 9,768      $ 9,881      $ 5,328      $11,450     $36,427
                                 =======      =======      =======      =======     =======
     Net contribution            $ 2,863      $ 1,859      $ 1,843      $ 3,405     $ 9,970
                                 =======      =======      =======      =======     =======
     Identifiable assets         $ 3,915      $ 2,501      $ 2,024      $ 4,935     $13,375
                                 =======      =======      =======      =======     =======
     Fixed asset depreciation    $   208      $   175      $    59      $   157     $   599
                                 =======      =======      =======      =======     =======

<CAPTION>
                                                                       Europe
                                  Manu-       Communi-    Advanced   Middle-East
                                facturing     cations      Systems     & Africa      Total
                                ---------     --------    --------   -----------    -------
Year ended December 31, 1998
<S>                              <C>          <C>          <C>          <C>         <C>
     Revenues                    $11,940      $ 7,740      $ 5,135      $10,163     $34,978
                                 =======      =======      =======      =======     =======
     Net contribution            $ 3,329      $ 1,844      $ 1,455      $ 1,818     $ 8,446
                                 =======      =======      =======      =======     =======
     Identifiable assets         $ 4,303      $ 2,450      $ 1,349      $ 3,471     $11,573
                                 =======      =======      =======      =======     =======
     Fixed asset depreciation    $   310      $   160      $    82      $    94     $   646
                                 =======      =======      =======      =======     =======
</TABLE>

Information for the year ended December 31, 1997 has not been provided, as it
would be impracticable to do so.

(10) VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                                    Balance at     Addition                 Balance at
                                   Beginning of   Charged to                  End of
       Description                    Period       Expense     Deductions     Period
--------------------------------   ------------   ----------   ----------   -----------
<S>                                    <C>           <C>          <C>           <C>
Allowance for Doubtful Accounts:

Year ended December 31, 1999           $423          $305         $364          $364
                                       ====          ====         ====          ====

Year ended December 31, 1998           $354          $110         $ 41          $423
                                       ====          ====         ====          ====

Year ended December 31, 1997           $453          $225         $324          $354
                                       ====          ====         ====          ====
</TABLE>

                                       38
<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

      To Gensym Corporation:

      We have audited the accompanying consolidated balance sheets of Gensym
      Corporation (a Delaware corporation) and subsidiaries as of December 31,
      1999 and 1998, and the related consolidated statements of operations,
      stockholders' equity, and cash flows for each of the three years in the
      period ended December 31, 1999. These financial statements are the
      responsibility of the Company's management. Our responsibility is to
      express an opinion on these financial statements based on our audits.

      We conducted our audits in accordance with auditing standards generally
      accepted in the United States. Those standards require that we plan and
      perform the audit to obtain reasonable assurance about whether the
      financial statements are free of material misstatement. An audit includes
      examining, on a test basis, evidence supporting the amounts and
      disclosures in the financial statements. An audit also includes assessing
      the accounting principles used and significant estimates made by
      management, as well as evaluating the overall financial statement
      presentation. We believe that our audits provide a reasonable basis for
      our opinion.

      In our opinion, the financial statements referred to above present fairly,
      in all material respects, the financial position of Gensym Corporation and
      subsidiaries as of December 31, 1999 and 1998, and the results of its
      operations and its cash flows for each of the three years in the period
      ended December 31, 1999, in conformity with accounting principles
      generally accepted in the United States.


                                        /s/ ARTHUR ANDERSEN LLP
                                        ----------------------------------------
                                            ARTHUR ANDERSEN LLP

      Boston, Massachusetts
      January 28, 2000

                                       39
<PAGE>

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURES

      None

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

      The information required by this item is contained in part under
"Executive Officers of the Company" in Part I hereof, and the remainder is
contained under the caption "PROPOSAL 1 - ELECTION OF DIRECTORS" in the
Company's Proxy Statement (the "2000 Proxy Statement"), to be mailed in April
2000, for the Annual Meeting of Stockholders to be held on May 17, 2000 at 10:00
A.M. at the offices of Hale and Dorr LLP, 60 State Street, Boston, MA 02109.
Such information is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

      The information required by this item is contained under the captions
"Director Compensation" and "Compensation to Executive Officers" in the
Company's 2000 Proxy Statement. Such information is incorporated herein by
reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

      The information required by this item is contained under the caption
"Security Ownership of Certain Beneficial Owners and Management" in the
Company's 2000 Proxy Statement. Such information is incorporated herein by
reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

      The information required by this item is contained under the caption
"Certain Transactions" in the Company's 2000 Proxy Statement. Such information
is incorporated herein by reference.

                                       40
<PAGE>

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K

(a) (1) FINANCIAL STATEMENTS

      The following documents are included in Item 8 of this Annual Report on
      Form 10-K:

      Consolidated Balance Sheets as of December 31, 1999 and 1998 Consolidated
      Statements of Operations for the three years ended December 31, 1999
      Consolidated Statements of Stockholders' Equity for the three years ended
      December 31, 1999 Consolidated Statements of Cash Flows for the three
      years ended December 31, 1999 Notes to Consolidated Financial Statements
      Report of Independent Public Accountants

      (2) FINANCIAL STATEMENT SCHEDULES

      All schedules have been omitted since the required information is not
      present or not present in amounts sufficient to require submission of the
      schedule, or because the information required is included in the
      consolidated financial statements or the notes thereto.

      (3) EXHIBITS

      The Exhibits listed in the Exhibit Index immediately preceding such
      Exhibits are filed as part of this Annual Report on Form 10-K, and are
      incorporated herein by reference.

(b) Reports on Form 8-K

      No reports on Form 8-K were filed during the quarter ended December 31,
      1999

                                       41
<PAGE>

                                   SIGNATURES

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

                                            GENSYM CORPORATION
                                            (Registrant)


                                        By: /s/ Patrick Courtin
                                            ------------------------------------
Dated: March 28, 2000                       Patrick Courtin
                                            Chief Executive Officer

Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 22, 2000:


/s/ Patrick Courtin
-------------------------
Patrick Courtin             Chairman of the Board, Chief Executive Officer,
                            and President


/s/ Jeffrey A. Weber
-------------------------
Jeffrey A. Weber            Chief Financial Officer


/s/ Lowell B. Hawkinson
-------------------------
Lowell B. Hawkinson         Director


/s/ John A. Shane
-------------------------
John A. Shane               Director


/s/ Theodore Johnson
-------------------------
Theodore Johnson            Director


/s/ Thomas E. Swithenbank
-------------------------
Thomas E. Swithenbank       Director


/s/ Barry R. Gorsun
-------------------------
Barry R. Gorsun             Director


/s/ Robert A. Degan
-------------------------
Robert A. Degan             Director

                                       42
<PAGE>

EXHIBIT INDEX

Exhibit #   Description
---------   -----------

3.1         Amended and Restated Certificate of Incorporation of the Registrant
            (Incorporated by reference to the Registrant's Annual Report on Form
            10-K filed on March 31, 1997)

3.2         Amended and Restated By-Laws of the Registrant (Incorporated by
            reference to the Registrant's Annual Report on Form 10-K filed on
            March 31, 1997)

4.1         Specimen certificate for shares of the Registrant's Common Stock
            (Incorporated by reference to the Registration Statement on Form S-1
            of the Registrant filed on December 21, 1995)

10.1        1987 Stock Plan, as amended to date (Incorporated by reference to
            the Registration Statement on Form S-1 of the Registrant filed on
            December 21, 1995)

10.2        1994 Stock Option Plan (Incorporated by reference to the
            Registration Statement on Form S-1 of the Registrant filed on
            December 21, 1995)

10.3        1995 Employee Stock Purchase Plan, as amended (Incorporated by
            reference to the Registrant's Proxy Statement filed on April 6,
            1998)

10.4        1995 Director Stock Option Plan, as amended (Incorporated by
            reference to the Registrant's Quarterly Report on Form 10-Q filed on
            August 13, 1997)

10.5        Amended and Restated Registration Rights Agreement dated as of
            August 12, 1991 by and among the Registrant and the parties named
            therein (Incorporated by reference to the Registration Statement on
            Form S-1 of the Registrant filed on December 21, 1995)

10.6        Lease dated as of January 1, 1995 by and between the Registrant and
            CambridgePark One Limited Partnership (Incorporated by reference to
            the Registration Statement on Form S-1 of the Registrant filed on
            December 21, 1995)

10.7        First Amendment to Lease dated as of December 2, 1996 between the
            Registrant and CambridgePark One Limited Partnership (Incorporated
            by reference to the Registrant's Annual Report on Form 10-K filed on
            March 31, 1997)

10.8        Second Amendment to Lease dated as of January 24, 1997 between the
            Registrant and CambridgePark One Limited Partnership (Incorporated
            by reference to the Registrant's Annual Report on Form 10-K filed on
            March 31, 1997)

10.9        Third Amendment to Lease dated as of January 24, 1997 between the
            Registrant and CambridgePark One Limited Partnership (Incorporated
            by reference to the Registrant's Annual Report on Form 10-K filed on
            March 31, 1997)

10.10       Fourth Amendment to Lease dated as of December 4, 1998 between the
            Registrant and CambridgePark One Limited Partnership

10.11       Amendment to the Business Loan Agreement dated June 20, 1991 between
            Gensym Corporation and State Street Bank and Trust Company, as
            amended to date (Incorporated by reference to the Registrant's
            Quarterly Report on Form 10-Q filed on August 13, 1997)

10.12       Distribution Agreement, dated as of January 1, 1995, by and among
            the Registrant, Itochu Corporation and Itochu Techno-Science
            Corporation (Incorporated by reference to the Registration Statement
            on Form S-1 of the Registrant filed on December 21, 1995)

10.13       1997 Stock Incentive Plan (Incorporated by reference to the
            Registrant's Quarterly Report on Form 10-Q filed on August 13, 1997)

10.14       Sublease Agreement dated August 26, 1997 between Gensym Corporation
            and Spaulding & Slye Services Limited Partnership (Incorporated by
            reference to the Registrant's Quarterly Report on Form 10-Q filed on
            November 12, 1997)

10.15       Secured Promissory Note dated October 1, 1997 from Stephen R. Quehl
            to Gensym Corporation (Incorporated by reference to the Registrant's
            Quarterly Report on Form 10-Q filed on November 12, 1997)

10.16       Pledge Agreement dated October 1, 1997 between Gensym Corporation
            and Stephen R. Quehl (Incorporated by reference to the Registrant's
            Quarterly Report on Form 10-Q filed on November 12, 1997)

10.17       Rights Agreement, dated as of April 8, 1997, between Gensym
            Corporation and State Street Bank & Trust Company, as Rights Agent
            (Incorporated by reference to the Registrant's Current Report on
            Form 8-K filed on April 17, 1997)

10.18       Severance arrangement with Lowell Hawkinson dated June 24, 1999.

21          Subsidiaries of the Registrant

23          Consent of Arthur Andersen LLP

27          Financial Data Schedule

Notes

Exhibit 10.12 - Confidential treatment has been granted with respect to certain
portions of this agreement.

Exhibits 10.1, 10.2, 10.3, 10.4, 10.13 and 10.18 - Management contract or
compensatory plan or arrangement required to be filed as an exhibit to this
Annual Report on Form 10-K

                                       43
<PAGE>

                               GENSYM CORPORATION
                   EXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT

Name                                 Jurisdiction of Incorporation
----                                 -----------------------------

Gensym International Corporation     Delaware

Gensym Securities Corporation        Massachusetts

Gensym FSC                           U.S. Virgin Islands

Gensym B.V.                          The Netherlands

Gensym Canada Ltd.                   Canada

Gensym GmbH                          Germany

Gensym S.A.                          France

Gensym Ltd.                          United Kingdom

Gensym Srl.                          Italy

Gensym MENA                          Tunisia

Gensym AB                            Sweden

Gensym Japan Corporation             Japan

Gensym Asia Pacific Pte, Ltd.        Singapore

                                       44