<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, 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
                    (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 11, 1999 there were 6,055,945 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 at
           March 31, 1999 and December 31, 1998                            3

           Condensed Consolidated Statements of Operations for the
           Three months ended March 31, 1999 and 1998                      4

           Condensed Consolidated Statements of Cash Flows for the
           Three months ended March 31, 1999 and 1998                      5

           Notes to Condensed Consolidated Financial Statements           6-8

Item 2.    Management's Discussion and Analysis of
           Financial Condition and Results of Operations                  9-19

Item 3.    Quantitative and Qualitative Disclosures About Market Risk      19


                    PART II. OTHER INFORMATION

Item 1.    Legal Proceedings                                               20

Item 2.    Changes in Securities and Use of Proceeds                       20

Item 3.    Defaults Upon Senior Securities                                 20

Item 4.    Submission of Matters to a Vote of Security Holders             20

Item 5.    Other Information                                               20

Item 6.    Exhibits and Reports on Form 8-K                                20

           Signatures                                                      21













Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements

                                       2
<PAGE>
 
                       GENSYM CORPORATION AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                   (Unaudited)


<TABLE>
<CAPTION>
(in thousands)                                 March 31,    December 31,
                                                 1999           1998
                                               --------       --------
<S>                                            <C>            <C>     
ASSETS

Current Assets:
        Cash and cash equivalents              $ 13,047       $ 13,696
        Short-term investments                        0            838
        Accounts receivable, net                  7,449          7,578
        Prepaid expenses                          1,895          1,775
        Deferred income taxes                     1,548          1,548
                                               --------       --------
            Total current assets                 23,939         25,435
                                               --------       --------

Property and Equipment, net                       1,775          1,982

Long-term deferred income taxes                     612            612
Deposits and other assets                           232            239
                                               --------       --------

                                               $ 26,558       $ 28,268
                                               ========       ========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
        Accounts payable                       $    470       $    517
        Accrued expenses                          3,952          3,862
        Deferred revenue                          6,340          6,406
                                               --------       --------
            Total current liabilities            10,762         10,785
                                               --------       --------


Stockholders' Equity:
        Common stock                                 65             65
        Capital in excess of par value           20,427         20,427
        Treasury stock                           (1,869)        (1,279)
        Accumulated deficit                      (2,019)        (1,101)
        Cumulative translation adjustment          (808)          (629)
                                               --------       --------
            Total stockholders' equity           15,796         17,483
                                               --------       --------

                                               $ 26,558       $ 28,268
                                               ========       ========
</TABLE>

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

                                       3
<PAGE>
 
                       GENSYM CORPORATION AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)


<TABLE>
<CAPTION>
(in thousands except per share amounts)
                                                             Three months ended
                                                                  March 31,
                                                              1999          1998
                                                            -------       -------

<S>                                                         <C>           <C>    
REVENUES:
      Product                                               $ 4,060       $ 4,624
      Service                                                 4,296         4,460
                                                            -------       -------
           Total revenues                                     8,356         9,084
                                                            -------       -------

COST OF REVENUES                                              2,145         2,248
                                                            -------       -------

           Gross profit                                       6,211         6,836
                                                            -------       -------

OPERATING EXPENSES:
      Sales and marketing                                     4,478         4,263
      Research and development                                1,557         1,459
      General and administrative                              1,160         1,074
                                                            -------       -------
                                                              7,195         6,796
                                                            -------       -------

           Operating (loss) income                             (984)           40

OTHER INCOME, NET                                               111           162
                                                            -------       -------

           (Loss) income before provision for                  (873)          202
                 income taxes

PROVISION FOR INCOME TAXES                                       45            50
                                                            -------       -------

           Net (loss) income                                $  (918)      $   152
                                                            =======       =======

           Basic and diluted (loss) earnings per share      $ (0.15)      $  0.02
                                                            =======       =======

           Basic weighted average common
                    shares outstanding                        6,150         6,417
                                                            =======       =======

           Diluted weighted average common
                 shares outstanding                           6,150         6,513
                                                            =======       =======
</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,
                                                                                       1999           1998
                                                                                     --------       --------

<S>                                                                                  <C>            <C>     
CASH FLOWS FROM OPERATING ACTIVITIES:
      Net (loss) income                                                              $   (918)      $    152

      Adjustments to reconcile net (loss) income to net cash (used in) provided
           by operating activities:
           Depreciation                                                                   289            289
           Changes in assets and liabilities:
                Accounts receivable                                                        67            345
                Prepaid expenses                                                         (203)          (235)
                Accounts payable                                                          (35)           485
                Accrued expenses                                                          198           (314)
                Restructuring liability                                                  --              (94)
                Deferred revenue                                                          (64)           626
                                                                                     --------       --------

                       Net cash (used in) provided by operating activities               (666)         1,254
                                                                                     --------       --------

CASH FLOWS FROM INVESTING ACTIVITIES:
      Sales (purchases) of short-term investments                                         838           (702)
      Sales of long-term investments                                                     --              341
      Purchases of property and equipment                                                 (83)          (295)
      Decrease in other assets                                                              1             52
                                                                                     --------       --------

                       Net cash provided by (used in) investing activities                756           (604)
                                                                                     --------       --------

CASH FLOWS FROM FINANCING ACTIVITIES:
      Proceeds from exercise of stock under stock plans                                  --               81
      Purchase of treasury stock                                                         (591)          --
                                                                                     --------       --------

                       Net cash (used in) provided by financing activities               (591)            81
                                                                                     --------       --------

EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                  (148)           (32)
                                                                                     --------       --------

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                                     (649)           699

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                         13,696         10,958
                                                                                     --------       --------

CASH AND CASH EQUIVALENTS, END OF PERIOD                                             $ 13,047       $ 11,657
                                                                                     ========       ========
</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 intelligent operations management in a broad range of
industries, including manufacturing, telecommunications, government, aerospace,
transportation, and financial services.

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 31,1999 and the results of its
operations for the three month period ended March 31,1999 and 1998 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 26, 1999. 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, 1999
and December 31, 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, 1998 consist of commercial paper and
municipal bonds with original maturity dates greater than three months that
mature within one year.


4.  Recently Issued Accounting Pronouncements

     In June 1998, the Financial Accounting Standards Board released Statement
of Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities ("SFAS No. 133"). SFAS No. 133 establishes the accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. SFAS No. 133 is effective
for fiscal quarters beginning after June 15, 1999. The Company does not expect
the adoption of SFAS No. 133 to have a material impact to its financial
position.


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 

                                       6
<PAGE>
 
the equity section of the balance sheet. The components of comprehensive income
for the three months ended March 31, 1999 and 1998 are as follows (in
thousands):

<TABLE>
<CAPTION>
                                                   Three months ended
                                                        March 31,
                                                  1999             1998
                                                -------          -------
<S>                                             <C>              <C>    
Comprehensive (loss) income:
    Net (loss) income                           $  (918)         $   152
    Other comprehensive loss:
        Foreign currency adjustment                (179)             (64)
                                                -------          -------
            Comprehensive (loss) income         $(1,097)         $    88
                                                =======          =======
</TABLE>


6.    Earnings Per Share

         In accordance with SFAS No. 128, Earnings per Share, basic net earnings
or loss per share was computed by dividing net earnings or loss by the weighted
average number of common shares outstanding. Diluted income per share was
computed using the weighted average number of common and potential common shares
outstanding in accordance with the treasury stock method. For the three months
ended March 31, 1998, 96,100 potential shares from stock options were included
in the computation of diluted net earnings per share. For the three months ended
March 31, 1999, 636,074 stock options were not included in diluted weighted
average shares outstanding, as the effect would have been antidilutive.


7.    Stockholders' Equity

         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. During the three
months ended March 31, 1999, the company repurchased 156,100 shares at a cost of
$591,000. As of March 31, 1999 an aggregate of 501,300 shares had been
repurchased at a cost of $1,869,000.


8.       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.

         The Company is 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.

         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.

                                       7
<PAGE>
 
         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, marketing, and direct research and
development costs. Information as to the operations of the different segments is
set forth below:

<TABLE>
<CAPTION>
(in thousands)

                                                                                 Europe,
                                                                 Advanced       Middle-East &
                             Manufacturing    Communications     Systems         Africa            Total
                             -------------    --------------     -------         ------            -----

<S>                          <C>              <C>                <C>            <C>            <C>    
Three months ended
  March 31, 1999:
     Revenues                    $ 2,340         $ 1,889         $ 1,242         $ 2,885         $ 8,356
                                 =======         =======         =======         =======         =======
     Net contribution            $   445         $   123         $   451         $   923         $ 1,942
                                 =======         =======         =======         =======         =======
     Identifiable assets         $ 8,180         $ 9,203         $ 3,308         $ 5,867         $26,558
                                 =======         =======         =======         =======         =======

Three months ended
  March 31, 1998:
     Revenues                    $ 3,077         $ 2,086         $ 1,321         $ 2,600         $ 9,084
                                 =======         =======         =======         =======         =======
     Net contribution            $   624         $   431         $   384         $   702         $ 2,142
                                 =======         =======         =======         =======         =======
     Identifiable assets         $ 9,375         $ 9,718         $ 3,760         $ 5,415         $28,268
                                 =======         =======         =======         =======         =======
</TABLE>

                                       8
<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
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 resellers and systems integrators, who
provide consulting services and integrated solutions to their customers. The
Company further licenses technology to OEMs, which embed it within their product
offerings.

         In order to better meet the requirements of companies in its primary
target markets, the Company is 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 best serve
their respective markets. The Company believes that this organizational
structure, which has entailed a retraining of the sales force and a major change
in account structure, is the correct strategy for achieving sustained growth and
profitability.

         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".

                                       9
<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,
                                                          1999           1998
                                                         -----           -----
  
<S>                                                     <C>             <C>  
REVENUES:
      Product                                             48.6%           50.9%
      Service                                             51.4%           49.1%
                                                         -----           -----
            Total revenues                               100.0%          100.0%
                                                         -----           -----

COST OF REVENUES                                          25.7%           24.7%
                                                         -----           -----

            Gross profit                                  74.3%           75.3%
                                                         -----           -----

OPERATING EXPENSES:
      Sales and marketing                                 53.6%           46.9%
      Research and development                            18.6%           16.1%
      General and administrative                          13.9%           11.8%
                                                         -----           -----
                                                          86.1%           74.8%
                                                         -----           -----

            Operating income (loss)                      (11.8%)           0.5%
                                                         -----           -----

OTHER INCOME, NET                                          1.3%            1.8%
                                                         -----           -----

            Income (loss) before provision for
                income taxes                             (10.5%)           2.3%

PROVISION FOR INCOME TAXES                                 0.5%            0.6%
                                                         -----           -----

            Net income (loss)                            (11.0%)           1.7%
                                                         =====           =====
</TABLE>


Three Months Ended March 31, 1999 and 1998

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 $8.4 million for the three months ended March 31,
1999 as compared to $9.1 million for the same period in 1998, a decrease of
7.7%. The decrease in total revenues was due to decreased sales of product
licenses and services. International revenues accounted for 50% and 45% of total
revenues in the first three months of 1999 and 1998, respectively.

         Product. Product revenues decreased to $4.1 million in the three months
ended March 31, 1999 from $4.6 million in the three months ended March 31, 1998,
a decrease of 10.9%. The $0.5 

                                       10
<PAGE>
 
million decrease in product revenue was primarily due to lower sales in North
American and Asian markets, partially offset by an increase in product sales in
Europe. Included in the Company's 1998 first quarter revenues was approximately
$1.0 million in domestic license revenues associated with an order, for the
Motorola-Iridium project, that had been concluded in 1996.

         Service. Service revenues decreased to $4.3 million in the three months
ended March 31, 1999, from $4.5 million in the same period of 1998, a decrease
of 4.4%. The decrease in service revenues was mainly attributable to decreases
in consulting and training revenue.


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 $2.1 million
in the three months ended March 31, 1999, from $2.2 million in the three months
ended March 31, 1998, a decrease of 4.5%. The decrease was primarily due to
lower consulting labor costs, primarily for subcontractors. Gross margin on
revenues decreased to 73.8% for the first quarter of 1999 from 74.7% for the
first quarter of ended March 31 1998. This decrease in gross margin reflected
primarily a higher percentage of lower margin service revenues as a percentage
of total revenues.


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 increased to
$4.5 million (53.6% of revenues) in the three months ended March 31, 1999, from
$4.3 million (46.9% of revenues) in the three months ended March 31 1998, an
increase of 4.7%. The increase in absolute dollars was primarily due to
increased marketing program costs; the increase in sales and marketing expenses 
as a percent of revenue was primarily due to lower revenue. 

         Research and Development. Research and development expenses consist
primarily of costs of personnel, equipment, and facilities. These expenses
increased to $1.6 million (18.6% of revenues) in the three months ended March
31, 1999 from $1.5 million (16.1% of revenues) in the three months ended March
31 1998, an increase of 6.7%. The increase in the three-month period was
primarily due to an increase in personnel costs specifically attributable
to competitive salary levels for engineering personnel; the increase in research
and development expenses as a percent of revenue was due to higher expenses and 
lower revenue.

         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 $1.2 million (13.9% of revenues) in the three months ended March
31, 1999, from $1.1 million (11.8% of revenues) in the three months ended March
31, 1998, an increase of 9.1%. The increase in absolute dollars was primarily
due to increased personnel and consulting costs associated with turnover of
finance and accounting personnel as well as to additional professional costs
associated with a tax restructuring project in 1999. 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 general
and administrative expenses will decrease in future quarters due to a decrease
in outside consulting requirements.


Other Income

         Other income consists primarily of interest income partially offset by
foreign exchange transaction losses. Other income for the three months ended
March 31, 1999 was $111,000 as compared to $162,000 in the comparable period of
fiscal 1998. The decrease was due primarily to a decrease in interest income due
to a reduction of the Company's combined cash, cash equivalents and short-term
investment balances.

                                       11
<PAGE>
 
Income Taxes

         The Company generated a tax loss carryforward in the United States
during the three months ended March 31, 1999. 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. For the three months ended March 31, 1999 and 1998, the
Company's provision for income taxes pertained to income taxes in foreign
jurisdictions.



Liquidity and Capital Resources

         The Company currently finances its operations (including 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.

         The Company used $666,000 in cash for operations for the first three
months of 1999. Cash used for operations in 1999 was primarily used to fund the
Company's net loss.

         During the three months ended March 31, 1999, the Company used $591,000
of its cash to repurchase shares of its common stock on the open market pursuant
to its stock repurchase program adopted in the third quarter of 1998.

         At March 31, 1999, the Company had cash, cash equivalents, and
short-term investments of $13.0 million. The Company regularly invests excess
funds in highly-rated money market funds, government securities, and commercial
paper.

         At March 31, 1999, the Company had available a bank line of credit
allowing for borrowings up to $1.0 million and providing for interest at the
prime rate. This bank line of credit expired on April 30, 1999. There were no
borrowings under the bank line of credit at March 31, 1999.

         Investing activities provided cash of $756,000 for the three months
ended March 31, 1999, which consisted primarily of $838,000 in proceeds from the
sale of short-term investments off-set by $83,000 for the purchase of equipment.

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

                                       12
<PAGE>
 
Year 2000 Disclosure

         Historically, certain computer programs have been written using two
digits, rather than four digits, to define the applicable year. This could lead,
for example, to a computer's interpreting "00" as the year 1900 rather than the
year 2000. This phenomenon could result in major computer system failures or
miscalculations and is generally referred to as the "Year 2000" problem or
issue.

         The Company has developed a phased Year 2000 readiness plan for the
current versions of its products. The plan includes development of corporate
awareness, assessment, implementation (including remediation, upgrading and
replacement of certain product versions), validation testing, and contingency
planning. The Company continues to respond to customer concerns about prior
versions of its products on a case-by-case basis.

         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 has 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. For example, the Company's core G2
product has two built-in techniques for storing and processing time and date
information. These techniques are time stamps and intervals. Time stamps are
64-bit IEEE floating point numbers. Intervals are stored as integers. Neither of
these representations imposes a practical limit on the size of the date value
stored and do not pose any problems with the passing of the millennium.
Therefore, the Company does not believe that the Company's products, except
those discussed below, will be adversely affected by date changes to the year
2000. 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 third parties in creating the
application or non-compliance of the underlying hardware, operating system, or
third-party software on which the software 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.

         The Company's internal systems include both its information technology
("IT") and non-IT systems. The Company completed a baseline assessment of its
material internal IT systems (including both the Company's own software products
and third-party software and hardware technology) and its non-IT systems. The
Company expects to substantially achieve Year 2000 

                                       13
<PAGE>
 
compliance by the end of September 1999. To the extent the Company is not able
to test the technology provided by third-party vendors, the Company has received
certain written certificates from third-party vendors and is continuing to seek
assurances from other vendors that their systems are Year 2000 compliant.
Although the Company is not currently aware of any material operational issues
or costs associated with preparing its internal IT and non-IT systems for the
Year 2000, the Company may experience material unanticipated problems and costs
caused by undetected errors or defects in the technology used in its internal IT
and non-IT systems. There can be no assurance that the Company will not
experience unanticipated negative consequences or material costs caused by
undetected errors or defects in the technology used in its internal systems.

         The Company does not in general have information concerning the Year
2000 compliance status of its customers. As is the case with other similarly
situated software companies, if the Company's current or future customers fail
to achieve Year 2000 compliance, or if they divert technology expenditures to
address Year 2000 compliance problems, the Company's business, results of
operations, or financial condition could be materially adversely affected.

         The Company has funded its Year 2000 plan from operating cash flows and
has not separately accounted for these costs in the past. The Company may incur
additional costs related to the Year 2000 plan for administrative personnel to
manage the project, outside contractor assistance, technical support for its
products, product engineering and customer satisfaction. The Company may
experience material problems and costs with Year 2000 compliance that could
adversely affect the Company's business, results of operations, and financial
condition.

         The Company has not fully developed a comprehensive contingency plan to
address situations that may result if the Company is unable to achieve Year 2000
readiness of its initial operations. The costs of developing and implementing
such plan may itself be material. The necessity of a contingency plan will be
evaluated based on the outcome of its assessment and testing of the Year 2000
readiness of material third-parties. Preparation of contingency plans will be
completed by May 31, 1999 (and will thereafter be revised from time to time as
deemed appropriate). Finally, the Company is also subject to external forces
that might generally affect industry and commerce, such as utility company Year
2000 compliance failures and related services interruptions. The Company expects
to complete these assessments and testing, as well as the testing of its
internal systems, by the end of September 1999, and does not anticipate that any
of these potential issues will have a material adverse effect on the Company's
business, financial condition and operating results.

              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.

         The foregoing review of the Company's Year 2000 readiness, including
estimates of the time frames and costs for addressing the known Year 2000 issues
confronting the Company, is based on management's current estimates, which were
derived using numerous assumptions. There can be no assurance that these
estimates will be achieved and actual events and results could differ materially
from those anticipated. Specific factors that might cause such material
difference include, but are not limited to, the availability of personnel with
required remediation skills, the ability of the Company to identify and correct
all relevant computer code and the success of third parties with whom the
Company does business in addressing their Year 2000 issues.

                                       14
<PAGE>
 
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 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.

     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.

                                       15
<PAGE>
 
     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.
Specifically, the Company derives a significant portion of its revenues from the
chemical and petrochemical industries. The Company derived 26.8%, 14.5%, and
12.0%, of its product revenues in the chemical and petrochemical industries in
1997, 1998, and the first quarter of 1999, respectively. Accordingly, the
Company's future success is dependent upon the continued demand for process
control and optimization software from companies in the chemical and
petrochemical industries. The Company believes that economic downturns and
pricing pressures experienced by chemical and petrochemical companies in
connection with cost-containment measures have led to delays and reductions in
certain capital and operating expenditures by many such companies worldwide.
These industries are highly cyclical and have shown weakened demand in the past,
which has adversely affected the Company's revenues, gross margin, and operating
results during such periods. 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 only current 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. 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 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 is developing and has achieved initial commercial

                                       16
<PAGE>
 
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 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 35%, 25%, and 30% of the Company's
product revenues in 1997, 1998, and the first quarter of 1999, respectively.
Sales of the Company's products to and by distributors, primarily the Company's
Japanese distributor, accounted for 8%, 3%, and 1% of the Company's product
revenues in 1997, 1998, and the first quarter of 1999, 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. 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.

     Risks Associated With International Operations. The Company's international
revenues represented 46%, 47%, and 50%, of total revenues in 1997, 1998, and the
first quarter of 1999, 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 new 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,
Systems Management Arts (SMARTS), and Pavilion 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 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 reseller,
such as cement kiln control and refinery scheduling, and they could be
successful in supplying alternatives to products based on the Company's
software.

                                       17
<PAGE>
 
     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.

     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 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 current products and
systems are Year 2000 compliant, the Company utilizes third party equipment and
software that may not be Year 2000 compliant. 

                                       18
<PAGE>
 
Known or unknown errors or defects, with regard to the year 2000 and thereafter,
in the Company's products and systems could result in delay or loss of revenue,
diversion of development resources, damage to the Company's reputation,
increased service and warranty costs, or significant litigation, any of which
could materially adversely affect the Company's business, operating results or
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.  QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

         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 weighted average interest
rates and dates of maturity for the Company's investment portfolio. The fair
value of the marketable securities portfolio is affected by changes in
short-term U.S. dollar interest rates.


<TABLE>
<CAPTION>
       Principal Amounts by Expected Maturity in U.S. Dollars
       (in thousands except interest rates)

                                            Fair value        Investments
                                                    at        maturing in
                                               3/31/99            FY 1999
                                          -------------------------------------
<S>                                       <C>                 <C>   
Cash equivalents                                $9,484             $9,484
Weighted average interest rate                   4.62%              4.62%

Total portfolio                                 $9,484             $9,484
Weighted average interest rate                   4.62%              4.62%
</TABLE>




         The Company conducts business in various foreign currencies, primarily
in Canada, Europe, Middle East, Australia, Japan and other Asian countries. As a
result, the Company is exposed to the effect of foreign currency exchange rate
fluctuations on the U.S. dollar value of foreign currency-denominated revenues
and expenses. The Company does not use foreign exchange forward contracts to
hedge its foreign currency denominated receivables. Looking forward, 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.

                                       19
<PAGE>
 
PART II - OTHER INFORMATION



Item 1.  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. A hearing is scheduled for May 21, 1999. Although
the ultimate outcome of this lawsuit cannot be determined at this time,
management does not believe that the ultimate outcome will have a material
adverse effect on Gensym's financial position or results of operations.


Item 2.  Changes in Securities

         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, 1999.

                                       20
<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 12, 1999         Lowell B. Hawkinson
                                               Chairman of the Board,
                                               Chief Executive Officer,
                                               Director, and Treasurer
                                               (Principal Executive Officer,
                                               Principal Financial Officer, and
                                               Principal Accounting Officer)

                                       21