<PAGE>
 
                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549
                                        
                                   FORM 10-Q
                                        

(Mark one)

 X  Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
 -                                                                             
                                  Act of 1934

                     FOR THREE MONTHS ENDED MARCH 31, 1998

                                      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
                   (Address of principal executive offices)

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


     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 
          ---         ---          

     As of May 1, 1998 there were 6,426,445 shares of the Registrant's Common
Stock outstanding.

                                       1
<PAGE>
 
                              GENSYM CORPORATION
                                Form 10-Q INDEX

                         PART I. FINANCIAL INFORMATION

                                                                     Page No.
                                                                     --------
Item 1.    Condensed Consolidated Financial Statements:
 
           Condensed Consolidated Balance Sheets
           March 31, 1998 and December 31, 1997                           3
 
           Condensed Consolidated Statements of Operations
           Three months ended March 31, 1998 and 1997                     4
 
           Condensed Consolidated Statements of Cash Flows
           Three months ended March 31, 1998 and 1997                     5
 
           Notes to Condensed Consolidated Financial Statements         6-7
 
Item 2.    Management's Discussion and Analysis of
           Financial Condition and Results of Operations               8-16
 
Item 3.    Quantitative and Qualitative Disclosures About Market Risk    16

 
                           PART II. OTHER INFORMATION
 
Item 1.    Legal Proceedings                                             17
 
Item 2.    Changes in Securities and Use of Proceeds                     17
 
Item 3.    Defaults Upon Senior Securities                               17
 
Item 4.    Submission of Matters to a Vote of Security Holders           17
 
Item 5.    Other Information                                             17
 
Item 6.    Exhibits and Reports on Form 8-K                              17
 
           Signatures                                                    18
 

                                       2
<PAGE>
 
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements

                      GENSYM CORPORATION AND SUBIDIARIES
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                  (UNAUDITED)


<TABLE> 
<CAPTION> 
(in thousands)                                 MARCH 31,       DECEMBER 31,
                                                 1998             1997
                                               ---------       ------------
<S>                                          <C>             <C>   
ASSETS

Current Assets:                      
  Cash and cash equivalents                    $ 11,657          $ 10,958
  Short-term investments                          5,546             4,843
  Accounts receivable, net                        7,943             8,311
  Prepaid expenses                                1,698             1,565
  Deferred income taxes                           1,160             1,160
                                               --------          --------   
       Total current assets                      28,004            26,837
                                               --------          --------
Property and Equipment, net                       2,390             2,384

Long-term investments                               700             1,041
Long-term deferred income taxes                   1,000             1,000
Deposits and other assets                           207               255
                                               --------          --------
                                               $ 32,301          $ 31,517
                                               ========          ========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
  Accounts payable                             $  1,385          $    914    
  Accrued expenses                                4,502             4,976
  Deferred revenue                                6,417             5,799
                                               --------          --------
       Total current liabilities                 12,304            11,689
                                               --------          --------
Stockholders' Equity:
  Common stock                                       64                64
  Capital in excess of par value                 20,022            19,941
  Retained earnings                                 539               387
  Cumulative translation adjustment                (628)             (564)
                                               --------          --------
       Total stockholders' equity                19,997            19,828
                                               --------          --------
                                               $ 32,301          $ 31,517
                                               ========          ========    
</TABLE> 
The accompanying notes are an integral part of these condensed consolidated 
financial statements.

                                       3
<PAGE>
 
                      GENSYM CORPORATION AND SUBIDIARIES
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (UNAUDITED)

<TABLE> 
<CAPTION> 
(in thousands except earnings per share)

                                               THREE MONTHS ENDED
                                                    MARCH 31,
                                               1998          1997     
                                               ----          ----
<S>                                          <C>          <C> 
REVENUES:
  Product                                     $ 4,624       $ 5,932
  Service                                       4,460         4,099
                                              -------       -------
     Total revenues                             9,084        10,031
                                              -------       -------
COST OF REVENUES                                2,248         2,331
                                              -------       -------
     Gross profit                               6,836         7,700
                                              -------       -------
OPERATING EXPENSES:
  Sales and marketing                           4,263         4,711
  Research and development                      1,459         1,866
  General and administrative                    1,074         1,001
                                              -------       -------
     Operating income                              40           122

OTHER INCOME (EXPENSE), NET                       162           (16) 
                                              -------       -------
     Income before provision for                  202           106  
      income taxes              

PROVISION FOR INCOME TAXES                         50            40
                                              -------       -------   
     Net income                               $   152       $    66
                                              =======       =======
 
     Basic earnings per share                 $  0.02       $  0.01
                                              =======       =======
     Diluted earnings per share               $  0.02       $  0.01
                                              =======       =======
     Weighted average common shares
      outstanding                               6,417         6,221
                                              =======       =======
     Weighted average common shares
      outstanding assuming dilution             6,513         6,404
                                              =======       =======
</TABLE> 
The accompanying notes are an integral part of these condensed consolidated 
financial statements.
  

                                       4
<PAGE>
 
                      GENSYM CORPORATION AND SUBSIDIARIES
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (UNAUDITED)

<TABLE> 
<CAPTION> 
(in thousands)                                                  THREE MONTHS ENDED
                                                                     MARCH 31, 
                                                                1998           1997
                                                                ----           ----
<S>                                                           <C>          <C> 
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income                                                  $   152       $    66         
   Adjustments to reconcile net income to net              
     cash provided by operating activities:
     Depreciation                                                  289           265
     Deferred income taxes                                           -           220
     Changes in assets and liabilities:
        Accounts receivable                                        345           193
        Prepaid expenses                                          (235)         (789)
        Accounts payable                                           485          (540)
        Accrued expenses                                          (314)           (3)
        Restructuring liability                                    (94)            -
        Deferred revenue                                           626           607
                                                               -------       -------
           Net cash provided by operating activities             1,254            19
                                                               -------       -------
CASH FLOWS FROM INVESTING ACTIVITIES:
   (Purchases) sales of short-term investments                    (702)          180 
   (Purchases) sales of long-term investments                      341          (297) 
   Purchases of property and equipment                            (295)         (374)
   (Increase) decrease in other assets                              52           (95)
                                                               -------       -------
           Net cash used in investing activities                  (604)         (586)
                                                               -------       -------
 CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from exercise of stock options under stock plans        81           480
                                                               -------       -------
           Net cash provided by financing activities                81           480
                                                               -------       -------
EFFECT OF EXCHANGE RATE CHANGES ON CASH                            (32)          (87)
                                                               -------       ------- 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS               699          (174)

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                  10,958        11,679
                                                               -------       -------
CASH AND CASH EQUIVALENTS, END OF PERIOD                       $11,657       $11,505
                                                               =======       =======
</TABLE> 
The accompanying notes are an integral part of these condensed consolidated 
financial statements.

                                       5
<PAGE>
 
                      GENSYM CORPORATION AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)
                                        
1.  Operations

Gensym Corporation (the "Company") is a leading supplier of software products
and services for developing and deploying intelligent systems that manage and
improve complex, dynamic operations in a broad range of industries, including
manufacturing, telecommunications, aerospace, transportation, financial
services, and the government sector.

2.  Basis of Presentation

The unaudited condensed consolidated financial statements included herein have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission (the "SEC").  Certain information and
footnote disclosures, normally included in financial statements prepared in
accordance with generally accepted accounting principles, have been condensed or
omitted pursuant to such SEC rules and regulations; nevertheless, the management
of the Company believes that the disclosures herein are adequate to make the
information presented not misleading.  In the opinion of management, the
condensed consolidated financial statements reflect all adjustments (of a normal
and recurring nature) which are necessary to present fairly the consolidated
financial position of the Company as of March 31,1998 and the results of its
operations for the three month periods ended March 31,1998 and 1997 and its cash
flows for the three months then ended.  These condensed consolidated financial
statements and notes thereto should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K filed with the SEC on March 20, 1998.  The results of operations
for the interim period are not necessarily indicative of the results of
operations for the full year.

3.  Cash Equivalents and Investments

The Company applies Statement of Financial Accounting Standards ("SFAS") No.
115, Accounting for Certain Investments in Debt and Equity Securities.
Accordingly, the Company's investments are classified as available-for-sale and
are recorded at fair value, which approximates amortized cost at March 31,1998
and December 31, 1997.  Cash equivalents are short-term, highly liquid
investments with original maturity dates of less than three months.  Short-term
investments held as of March 31,1998  and December 31, 1997 consist of
commercial paper and municipal bonds with original maturity dates greater than
three months that mature within one year.  Long-term investments held as of
March 31,1998 and December 31, 1997 consist of municipal bonds with maturity
dates of greater than one year.

4.  Recently Issued Accounting Pronouncements

On January 1, 1998, the Company adopted American Institute of Certified Public
Accountants Statement of Position 97-2 ("SOP 97-2"), Software Revenue
Recognition.  Adoption of this pronouncement did not have a material affect on
the revenue recognition practices of the Company.

The Company adopted Statement of Financial Accounting Standards No. 131,
Disclosures about Segments of an Enterprise and Related Information ("SFAS No.
131") effective January 1,1998.  SFAS No. 131 requires public companies to
report certain information about operating segments in their financial
statements, and establishes related disclosures about products and services,
geographic areas and major customers.  SFAS No. 131 does not need to be applied
to interim financial statements in the initial year of application, however,
comparative information for interim periods in the initial year of application
will be reported in the financial statements for interim periods in fiscal 1999.

                                       6
<PAGE>
 
5.   Comprehensive Income

The Company adopted Statement of Financial Accounting Standards No. 130,
Reporting Comprehensive Income ("SFAS No 130") effective January 1, 1998.  SFAS
No. 130 requires that items defined as other comprehensive income, such as
foreign currency translation adjustments, be separately classified in the
financial statements and that the accumulated balance of other comprehensive
income be reported separately from retained earnings and additional paid-in
capital in the equity section of the balance sheet.  The components of
comprehensive income for the three months ended March 31, 1998 and 1997 are as
follows:

<TABLE> 
<CAPTION> 
(in thousands)                                 THREE MONTHS ENDED
                                                    MARCH 31,
                                               1998          1997
                                               ----          ----
<S>                                          <C>           <C>  
Comprehensive income (loss):          
  Net income                                   $  152       $   66
  Other comprehensive income (loss)                          
    Foreign currency adjustment                   (64)        (110)    
                                               ------       ------
      Comprehensive income (loss)              $   88       $  (44)     
                                               ======       ======
</TABLE> 
 
6.    Earnings Per Share

In accordance with SFAS No. 128, Earnings per Share, basic earnings per share
was computed by dividing net income by the weighted average number of common
shares outstanding during the first three months of 1998 and 1997.  Diluted
income per share was computed using the weighted average number of common and
common equivalent shares outstanding during the first three months of 1998 and
1997 in accordance with the treasury stock method.  For the three months ended
March 31, 1998 and 1997, 96,100 and 182,806 common stock equivalents were
included in the computation of diluted net earnings per share, respectively.

                                       7
<PAGE>
 
  Item 2.          MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS
                                        
OVERVIEW

  The Company was incorporated in 1986 to provide software products for
developing and deploying intelligent systems for decision support and control.
The Company's core product, G2, and G2-based products, are sold to customers for
a broad array of applications in a wide range of industries, including
manufacturing, telecommunications, aerospace, transportation, financial
services, and the government sector. 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 a network of value-added resellers and systems integrators who
provide consulting services and integrated solutions to their customers.  The
Company also licenses its software to OEM customers who use it as a base for
complete product offerings. The Company has established three strategic business
units, Manufacturing, Communications, and Advanced Systems, to manage the
domain-specific expertise, products, and services required to serve mainstream
customers in their respective focus markets.  Gensym intends to continue to
expand the market for intelligent systems by selling and delivering tools and
solutions with and through partners to large organizations with complex
operations and the potential for extensive application proliferation.

  This Quarterly Report on Form 10-Q 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".

                                       8
<PAGE>
 
RESULTS OF OPERATIONS

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

<TABLE> 
<CAPTION> 

                                                THREE MONTHS ENDED 
                                                      MARCH 31, 
                                                1998          1997
                                                ----          ---- 
<S>                                           <C>          <C>  
REVENUES:
   Product                                      50.9%         59.1%
   Service                                      49.1          40.9
                                               -----         -----
       Total revenue                           100.0         100.0
                                               -----         -----

COST OF REVENUES                                24.7          23.3
                                               -----         -----
       Gross Profit                             75.3          76.7
                                               -----         -----
OPERATING EXPENSES:
   Sales and marketing                          46.9          46.9
   Research and development                     16.1          18.6
   General and administrative                   11.8          10.0
                                               -----         ----- 
                                                74.8          75.5
                                               -----         ----- 

       Operating income                          0.5           1.2
                                               -----         -----
OTHER INCOME (EXPENSE), NET                      1.8          (0.1)
                                               -----         -----
       Income before provision for
         income taxes                            2.3           1.1

PROVISION FOR INCOME TAXES                       0.6           0.4
                                               -----         -----
       Net income                                1.7%          0.7%
                                               =====         =====            
</TABLE> 
THREE MONTHS ENDED MARCH 31, 1998 AND 1997

Revenues

  The Company's 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 $9.1 million for the quarter ended March 31, 1998 as
compared to $10.0 million for the same period in 1997, a decrease of 9.4%.  The
decrease in total revenues was attributable to decreased sales of product
licenses, partially offset by an increase in services. International revenues
accounted for 45.0% and 48.5% of total revenues in the first quarter of 1998 and
1997, respectively.

                                       9
<PAGE>
 
  Product.  Product revenues decreased to $4.6 million in the first quarter of
1998 from $5.9 million in the first quarter of 1997, a decrease of 22.1%. The
decrease in product revenue was primarily due to the continued effects of a
longer sales cycle caused by the reorganization of the Company's sales force in
the first quarter of 1997 and lower sales from certain regions in Europe and
from the Company's distributor in Japan. Included in the Company's 1998 first
quarter revenues is approximately $1.0 million out of an anticipated $1.6
million in license revenues associated with a significant customer order. The
Company anticipates that product revenues will increase on a successive quarter
basis as a result of its planned increase in direct sales personnel and
resources for partner channel development.

  Service.  Service revenues increased to $4.5 million in the first quarter of
1998 from $4.1 million in the first quarter of 1997, an increase of 8.8%. The
increase in service revenues was equally attributable to an increase in
maintenance fees derived from an increased customer base and to an increase in
application consulting services. These were partially offset by a decrease in
training fees.

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.  Cost of revenues decreased to $2.2 million in the first
quarter of 1998 from $2.3 million in the first quarter of 1997, a decrease of
3.6%. The decrease was primarily due to lower consulting labor costs, primarily
in subcontractors.  Gross margin on revenues decreased to 75.3% for the first
quarter of 1998 from 76.7% for the first quarter of 1997. This decrease in gross
margin reflected primarily a higher percentage of lower margin service revenues
as a percentage of total revenues. The Company anticipates that license revenue
will increase faster than service revenue in the future, as its sales force and
partner channels develop, and that overall margins will increase due to the
resultant revenue mix.


Operating Expenses

  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.  These expenses decreased to $4.3 million
(46.9% of revenues) in the first quarter of 1998 from $4.7 million (46.9% of
revenues) in the first quarter of 1997, a decrease of 9.5%. The decrease in
absolute dollars was primarily due to lower facilities and leased equipment
costs due to the field sales office consolidation and other restructuring
actions taken during 1997.  The Company intends to increase direct sales
personnel and marketing programs in the coming quarters and, as a result,
expects that sales and marketing expenses will increase on an absolute dollar
basis.

  Research and Development.  Research and development expenses consist primarily
of costs of personnel, equipment, and facilities.  These expenses decreased to
$1.5 million (16.1% of revenues) in the first quarter of 1998 from $1.9 million
(18.6% of revenues) in the first quarter of 1997, a decrease of 21.8%. The
decrease in absolute dollars in the three month period was primarily due to a
reduction in personnel, the consolidation of headquarter facilities, and other
restructuring actions that occurred primarily in the second quarter of 1997. The
Company plans to add selectively to the research and development staff during
the coming quarters.

  General and Administrative.  General and administrative expenses consist
primarily of personnel costs for finance, administration, operations, and
general management, as well as legal and accounting expenses.  These expenses
increased to $1.1 million (11.8% of revenues) in the first quarter of 1998 from
$1.0 million (10.0% of revenues) in the first quarter of 1997, an increase of
7.3%. The increase in absolute dollars was primarily due to increased personnel
costs and the amortization of the cost of a new financial information system,
which was implemented during the second quarter of

                                       10
<PAGE>
 
1997. The increase as a percentage of total revenues was due to the above
factors as well as to the lower product revenues reported for the period. The
Company expects that over time these expenses will decline as a percentage of
total revenues, assuming revenues increase over time.


Other Income

  Other income (expense), net consists primarily of interest income partially
offset by foreign exchange transaction gains and losses.  Other income
(expense), net increased by $178,000 from net other expense of $16,000 in the
first three months of 1997 to net other income of $162,000 for the same period
in 1998.  The increase was primarily attributable to the Company's 50% share in
the net loss of its joint venture investment, which was recorded in the first
three months of 1997.  No loss was recorded in 1998 as the Company sold its
investment in the joint venture in the third quarter of 1997.  Interest income
was $160,000 in the first three months of 1998 as compared to $167,000 in the
first three months of 1997.

Income Taxes

  The Company provides for income taxes based on an anticipated effective tax
rate of approximately 25% for fiscal year 1998 and 0% in 1997.  The effective
tax rate is lower than the statutory rate in 1998 due to the expected partial
utilization of net operating loss carryforwards.  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 its deferred tax asset to the extent
that it cannot conclusively demonstrate that these assets "more likely than not"
will be realized.  In determining the amount of valuation allowance required,
the Company considers numerous factors, including historical profitability,
estimated future taxable income and the volatility of its historical earnings
and of the industry in which it operates.


LIQUIDITY AND CAPITAL RESOURCES

  The Company currently finances its operations (including capital expenditures)
primarily through cash flow from operations and its current cash and short-term
investments balances.  In addition, the Company has $4.0 million of equipment
financed under long-term operating leases.  The Company's operating lease
commitments consist primarily of operating leases for the Company's facilities
and computers.

     The Company generated cash from operating activities of $1.3 million during
the first three months of 1998.  Cash generated in operations in the first three
months of 1998 was primarily due to the net income, increases in deferred
revenue and accounts payable, and a decrease in accounts receivable, partially
offset by a decrease in accrued expenses and an increase in prepaid expenses.
During the first quarter of 1998 the Company's net accounts receivable balance
decreased to $7.9 million from $8.3 million.  Days sales outstanding was 79 days
at both March 31, 1998 and December 31, 1997.

  Investing activities utilized $604,000 and $586,000 during the first quarters
of 1998 and 1997, respectively.  The principle uses in the first quarter of 1998
were to fund the purchase of $702,000 of short-term investments and $295,000 of
property and equipment, partially offset by the sale of $341,000 of long-term
investments.  Principle uses during the first quarter in 1997 were to fund the
purchase of $374,000 of property and equipment and $297,000 of long-term
investments, partially offset by the sale of $180,000 of short-term investments.
The Company expects that its requirements for computers, office facilities, and
office equipment will fluctuate as staffing requirements dictate and that such
equipment and facilities will be available when needed.

                                       11
<PAGE>
 
  At March 31, 1998, the Company had cash, cash equivalents, and short-term
investments of $17.2 million.  The Company regularly invests excess funds in
short-term, highly rated money market funds, government securities, and
commercial paper.  In addition, the Company had long-term investments of
$700,000, primarily consisting of municipal bonds with maturity dates of greater
than one year, which the Company intends to hold to maturity.

  At March 31,1998, the Company had available a bank line of credit to borrow up
to $1.0 million at an interest rate of prime.  This bank line of credit will
expire on May 31, 1998.  The Company expects that the line of credit will be
renewed on substantially similar terms.  The bank line of credit requires the
Company to maintain certain financial covenants.  The Company was in compliance
with all covenants contained in the bank line of credit at March 31,1998.  There
were no borrowings under the bank line of credit for the quarter ended March
31,1998.

  At March 31,1998, the Company expected that cash requirements to settle its
restructuring obligations would be approximately $400,000.  These cash
requirements pertain primarily to lease termination costs.  The Company believes
that the settlement of its restructuring obligations will not materially impact
future liquidity.

  The Company believes that the currently available funds and cash generated
from operations will be sufficient to meet the Company's business requirements
at least through March 31, 1999.


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 Systems.  Substantially all of the Company's
revenues are derived from the licensing and support of software products that
enable organizations to implement intelligent systems for decision support and
control.  Although many organizations have begun to deploy, or have announced
plans to deploy, intelligent 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 systems successfully nor that such systems will gain
widespread acceptance.  In addition, the timing of the implementation of
intelligent systems by organizations may be affected by economic factors,
government regulations, and other factors.  Delays in the introduction of
intelligent 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 complete solutions, rather
than software tools with which to develop such 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 deliver
services to implement these solutions.  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
force 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 organization will be able to compete successfully
against the significantly more extensive and better funded sales and marketing
operations of many of the Company's current and potential competitors.  The
Company's inability to manage its sales and marketing force effectively could
have a material adverse effect on the Company's business, operating results and
financial condition.

                                       12
<PAGE>
 
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.  Such capital
expenditures are also susceptible to industry-specific economic downturns.
Certain industries have experienced weakened demand in the past, which has
adversely affected the Company's revenues, gross margin, and operating results
during such periods.  There can be no assurance that future recessionary
conditions in the markets for the Company's products will not adversely affect
the Company's business, results of operations, or financial condition.

Product Concentration.  The Company's only current product offerings are G2, an
object-oriented development and deployment environment for building intelligent
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 anticipates releasing new client access and object exchange
products in the second half of 1998.  The Company has from time to time
experienced delays in introducing new products and product enhancements.  There
can

                                       13
<PAGE>
 
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. Also there 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 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 Systems".

Migration to Microsoft Windows and Object Exchange Standards.  The Company
believes that operating systems similar to Microsoft Windows, due to their
interoperability and customization capabilities, are increasingly the preferred
choice of many of its customers.  In order to gain wider customer penetration,
the Company must, in part, address this market choice.  The Company is
developing its next client access product to be fully Microsoft Windows and
MOTIF compliant.  There can be no assurance that the Company will be successful
in developing and marketing this new product.  Any delay or failure to bring
this product to market 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, who are not under
the control of the Company.  Sales of the Company's products by value-added
resellers and systems integrators represented 28%, 35% and 29% of the Company's
product revenues in 1996, 1997 and the first quarter of 1998, respectively.
Sales of the Company's products by distributors, primarily the Company's
Japanese distributor, accounted for 14%, 8% and 3% of the Company's product
revenues in 1996, 1997 and the first quarter of 1998, respectively.  The loss of
one or more major third-party distributors, 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.

A significant business strategy of the Company is to add additional resources
for channel business development and management and to expand its relationship
with its strategic partners.  There can be no assurance that the Company will be
able to negotiate additional strategic partner relationships on acceptable terms
or that any such relationships, if established, will be commercially successful.
There also can be no assurance that existing or potential partners will not
pursue alternative technologies or develop alternative products in addition to
or in lieu of the Company's products either on their own or in collaboration
with others, including the Company's competitors.  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.

Risks Associated With International Operations.  The Company's international
revenues represented 42%, 46% and 45% of total revenues in 1996, 1997, and the
first quarter of 1998, 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, fluctuating import/export
duties and quotas, and unexpected regulatory, economic, or political changes in
international markets.  There can be no assurance that these factors will not
adversely affect the Company's business, results of operations, or financial
condition.

                                       14
<PAGE>
 
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.  Moreover, 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.  In all of the Company's
markets, competition includes "point solutions", real-time and expert system
products and internally developed software.

Certain companies such as Objective Systems Integrators, Inc. and Pavilion sell
"point solutions" that compete with the Company's products with respect to
specific applications or uses. In addition, the Company's software is 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.

Several companies including Comdale Technologies and 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.  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.

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 can be 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.

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

                                       15
<PAGE>
 
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.  In particular, the Company
hired three new executive officers in 1997, resulting in a significant
percentage of key personnel having approximately one year or less of experience
with 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 installed computer systems and software products are
coded to accept only two digit entries in the date code field.  Beginning in the
year 2000, these date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates.  Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail.  Although the Company believes that its products and systems are
Year 2000 compliant, the Company utilizes third party equipment and software
that may not be Year 2000 compliant.  Failure of such third party equipment or
software to operate properly with regard to the Year 2000 and thereafter could
require the Company to incur unanticipated expenses to remedy any problems,
which could have a material adverse affect on the Company's business, operating
results and financial condition.  Furthermore, the purchasing patterns of
customers or potential customers may be affected by Year 2000 issues as
companies expend significant resources to correct their current systems for Year
2000 compliance.  These expenditures may result in reduced funds available to
purchase products and services such as those offered by the Company.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

        Not Applicable

                                       16
<PAGE>
 
PART II - OTHER INFORMATION


ITEM 1.  LEGAL PROCEEDINGS

      None

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

      None

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

      None

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

      None

ITEM 5.  OTHER INFORMATION

      None

ITEM 6.  EXHIBITS AND REPORTS OF FORM 8-K

      (a)   Exhibit Index
            Exhibit 27 - Financial Data Schedule

      (b)   No reports on Form 8-K were filed by Gensym during the quarter ended
            March 31, 1998.
   

                                       17
<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)



                                       /s/ Lowell B. Hawkinson
                                       -----------------------
       Dated:  May 11, 1998            Lowell B. Hawkinson
                                       Chief Executive Officer
                                       (Principal Executive Officer)


                                       /s/ Richard M. Darer
                                       --------------------
       Dated:  May 11, 1998            Richard M. Darer
                                       Senior Vice President of Finance and
                                       Administration, and Chief Financial
                                       Officer (Principal Financial and
                                       Accounting Officer)

                                       18